People are already advised to reduce their income

One of the myths about explicit and implicit taxes is that Americans have no clue what's going on, and cannot react to tax rates of which they are purportedly ignorant. That's wrong on many levels, one of which that less than two weeks after the Obamacare launch, personal finance columnists began advising readers to watch their income and consider cutting it in order to enhance their subsidy.

You might attempt to reconcile these two by assuming that nobody reads such columnists, except that the one column I linked has been shared thousands of times on facebook and I assume read by tens of thousands.

HT Tom Daula

Two posts on the sales tax and work incentives

If you want to measure the incentive for working, the sales tax needs special consideration.

(A)  Arithmetic.  Think of it this way:

(Disposable income) = (Total income) - (income taxes) - (sales taxes)

Sales taxes are levied as a percentage s of one's disposable income: namely, when you buy a dollar's worth of items at the store you get an extra sales tax charge of s dollars. Income taxes are, for simplicity, a fraction t of income. We have:

(Disposable income) = (Total income) - t*(Total income) - s*(Disposable income)

Equivalently:

(Disposable income) = [(1-t)/(1+s)]*(Total income)

(B) Labor supply behavior.  In order to understand how labor supply behavior changes in response to tax rate changes, to a first approximation all we need to know is the percentage change in [(1-t)/(1+s)]. Over the past 10 years, U.S. sales taxes (levied at the state and local levels) have hardly changed, which means that the time series for t, which is what I showed in my WSJ article, is all we need to calculate the percentage change in [(1-t)/(1+s)].

John Cochrane explains this further on his blog. Today I gave an example, from the U.K., where sales tax rates were NOT constant.

The U.K. example also reminds us how the sales tax is included in the CPI so that, if you do have a marginal tax rate measure inclusive of the sales tax, you should NOT multiply it by a real wage deflated by the CPI because that would double-count the sales taxes. The MTR series that I showed in my WSJ article (and available here in excel format) does not include sales taxes, and therefore can be multiplied by wages deflated by the CPI.

Indeed, economists researching wages should make this multiplication more often than they do (which is hardly ever), because taxes are part of the functioning of prices in the labor market.

(C) Welfare analysis.  If you want to calculate the new deadweight losses from new income taxes, you have to consider the sales tax and any other other wedge between total income and disposable income, even if the sales tax were constant over time, because the behavioral changes avoiding the new income taxes have the side effect of reducing sales tax revenues.  That's what I do in the small section of my book (Appendix 4.3) that quantifies labor market deadweight losses.

Public Policy and Wages in the US and UK

Copyright, The New York Times Company

Between 2009 and 2011, the value-added tax in Britain increased to 20 percent from 15 percent. (The value-added tax is essentially a national sales tax.) Because the tax is part of the overall price of essentially anything bought in the country, it was no surprise that the rate of inflation of prices on consumer goods was elevated during those years as businesses passed on the cost of the taxes they paid to their customers.

In many circumstances, wages roughly keep up with consumer price inflation as the sellers of consumer goods use their extra revenue to compete for workers. But wage inflation is not guaranteed when consumer price inflation comes from sales tax increases, because the extra revenue goes to the public treasury in the form of sales tax receipts rather than going to the sellers of consumer goods.

In this way, increasing the sales tax rate to 20 percent from 15 percent should reduce real wages by 4 or 5 percent. (By real wages, I mean the resources that a person has as a consequence of working after taxes, subsidies and inflation. Because of taxes and subsidies, those resources are less than the aggregate economic value created by working and less than the cost to employers of having employees on the payroll.)

A recent study of wages in Britain confirmed this: inflation-adjusted wages fell 4 or 5 percent in Britain between 2009 and 2011.

While British workers saw their purchasing power eroded by the sales tax increase, the unemployed did not, because unemployment benefits in Britain are automatically indexed to inflation. Additional inflation of 5 percent meant a 5 percent rise in unemployment benefits. By giving a raise to the unemployed without giving a raise to workers, the added sales tax in Britain reduced the reward of working.

The United States does not have a national sales tax. A few states did increase their state sales tax rates between 2011 and this year (others decreased it), but the national average increase since 2007 has been only a couple of tenths of a percentage point.

Nevertheless, adjusted for taxes, subsidies and inflation, wages are lower in the United States, too. As I showed in a post last year (see especially the second chart), public policies in the United States reduced real wages by increasing the incomes of unemployed people through new unemployment benefits, food stamp expansions and other increases in benefits of the social safety net.

As long as the United States and Britain retain their wage-depressing public policies, neither country should expect its labor markets to return to what they used to be.

Ungated version of my marginal tax rate paper

http://caseybmulligan.com/MulliganMTRACA.pdf

excel spreadsheets with the marginal tax rate series are here (use the version with "update" in the file name).

Best Kept Secret in Labor and Public Economics

I continue to be impressed how many experts in labor and public economics are not aware of what happened to marginal labor income tax rates over the past several years. Not that they have their own estimate of marginal tax rates, or find my estimates to be biased, they just don't know:

My marginal labor income tax rate series are available in electronic format.

Video: The Second Wave of Redistribution

How ObamaCare Wrecks the Work Ethic

Copyright, Dow Jones & Company

A new wave of redistribution will arrive in America on Jan. 1, primarily thanks to the Affordable Care Act. The president's health-insurance plan forces those who hire, work and produce to pay full price for health care, while creating generous discounts for practically everyone else.

This second redistributionist wave of the Obama era will follow a first wave of tax hikes, additional unemployment benefits, food-stamp expansions, waived work requirements for welfare benefits, etc. These measures were supposed to be temporary, intended to help people cope with the recession. The recession officially ended in mid-2009, but many of the administration's measures continue.

Regardless of whether redistribution is achieved by collecting more taxes from families with high incomes, levying employment taxes on businesses, providing more subsidies to families with low incomes, or all of the above, an essential consequence is the same: a reduction in the reward for working. In a National Bureau of Economic Research paper issued in August, I quantify the combined effect of the two redistribution waves and higher payroll taxes on the financial reward for working.

The chart nearby shows an index of marginal tax rates for non-elderly household heads and spouses with median earnings potential. The index, a population-weighted average over various ages, occupations, employment decisions (full-time, part-time, multiple jobs, etc.) and family sizes, reflects the extra taxes paid and government benefits forgone as a consequence of working.

The 2009-10 peak for marginal tax rates comes from various provisions of the "stimulus" programs in the American Recovery and Reinvestment Act of 2009 and the extension of unemployment benefits to 99 weeks in some states. At the end of 2012, the marginal tax rate index reached its lowest value since 2008: 43.9%. A little over a year later (January 2014), the index will be close to 50%, driven up by the expiration of the payroll tax cut and multiple provisions of the Affordable Care Act. The ACA employer penalty, delayed until 2015, adds more than a percentage point in that year alone, while other ACA provisions strengthen their disincentives for the various reasons cited above.

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The Affordable Care Act signup page on the HealthCare.gov website
Reuters

By 2016, the index exceeds 50%, which is at least 10 percentage points greater than it was in early 2007.

The 50% rate is even higher than the rates that prevailed when the so-called Recovery and Reinvestment Act's redistribution was at its peak. Without new federal legislation and a departure from the strategy of forcing workers and employers to finance everyone else's health care, the new 50%+ rate will not be a peak, but rather a new normal for tax rates.

To appreciate the added burden that the two redistribution waves put on the labor market, look at what people keep, on average, when they decide to retain or accept a job, or to take on a longer work schedule. Before the recession, a decision to work would benefit public treasuries by an amount equal to 40% of the compensation from the job. The worker and his family got the other 60%.

In the years 2015 and beyond, full-time workers with median incomes will keep only half of the compensation created by their decisions, with the other half going to the government in the form of additional taxes and savings on subsidy payments. By keeping 50% rather than 60%, workers will find that the reward for holding a job will have fallen a damaging 17%.

Advocates of redistribution try to perpetuate the income-maximization fallacy that business continues as usual as long as tax rates are less than 100%, because receiving even 1% of your compensation is supposedly better than getting no compensation at all. But even if full confiscation were the only way that taxes would depress the labor market, recall that the nearby chart is just an average: The average rate rising to 50% and above involves millions of people with rates far higher.

America absolutely must have taxes and safety-net programs, even though they reduce the reward for working. But advocates for the recent program expansions have failed to acknowledge that redistribution necessarily increases marginal tax rates and contracts the labor market.

Don't be surprised if the second redistribution wave coincides with a recessionary double-dip.

Mr. Mulligan is a professor of economics at the University of Chicago and the author of "The Redistribution Recession" (Oxford, 2012).

Here Comes the Second Redistributionist Wave

Copyright, Dow Jones & Company, Inc.

A new wave of redistribution will arrive in America on Jan. 1, primarily thanks to the Affordable Care Act. The president's health-insurance plan forces those who hire, work and produce to pay full price for health care, while creating generous discounts for practically everyone else.

Read more

Low-Wage Work Incentives Take a Big Hit

Copyright, The New York Times Company

Beginning this week, families can use the Affordable Care Act’s marketplaces to enroll for health insurance coverage that begins Jan. 1, and in many cases receive federal assistance with their premiums and other health costs on the basis of their expected income for calendar year 2014.

Because people who work part time or are unemployed for part of the year have less annual income than people who work full time and all year, working less means qualifying for more generous subsidies. By working part time or not at all, participants in the marketplaces will also create fewer penalties for employers who don’t make affordable coverage available once those penalties go into effect in 2015. (Employers are penalized only for full-time employees and only during the months that they are on the payroll.)

These new rules will make it less rewarding to be a full-time worker and a little less burdensome to be unemployed or underemployed. In my testimony in June before the Subcommittee on Human Resources of the House Ways and Means Committee, I quantified these new disincentives in terms of marginal tax rates — the percentage of compensation lost from paying taxes and replacing benefits associated with not working. The group I looked at was non-elderly household heads and spouses whose earnings abilities – that is, the amount that they earn when they are working full time – are in the middle of the distribution, earning roughly $800 per week when the work is full time.

Such workers (hereafter “midwage workers”) will see their marginal tax rates increase by an average of five percentage points between now and 2016, taking into account that many people will not take part in programs for which they are eligible for help. Before the Affordable Care Act, the compensation for each additional hour of work by a midwage worker was, on average, split 55 percent for the employee and 45 percent for the government (the government got its part by receiving more taxes from the employee, and paying fewer benefits, such as unemployment insurance payouts and food stamps, to the employee). Under the act, the split will be 50-50.



The unemployment rate, the employment rate and the propensity to work full time are usually measured nationwide, with every adult counting in the average regardless of whether he or she is a low-wage worker, a high-wage worker or somewhere in between. It’s worth giving attention to midwage workers because, by definition, much of the population is fairly close to the middle.

But is also informative to look at low-wage workers, because they are more likely to fall into poverty and their employment patterns may be more sensitive to incentives.

It turns out that low-wage workers will also see a reduction in their reward to work over the next couple of years, and to a greater degree than workers in the middle will. The chart below compares the five-percentage-point result for midwage workers and its components, with the tax-rate changes for low-wage workers (by which I mean workers who earn roughly $550 per week when they work full time, which is roughly twice minimum wage).

Work incentives for low-wage workers are eroded more than 10 percent of their compensation over the next couple of years, compared with 5 percent for midwage workers. Before the Affordable Care Act, the compensation for each additional hour of work by a low-wage worker was split 50 percent, on average, for employee and 50 percent for the government. Under the law, it will be 39-61.

One reason that low-wage workers will have a greater shift in their incentives is that, because they earn less, a given dollar amount is a greater percentage of their compensation than it would be for a midwage worker.

More important, low-wage workers will qualify for larger dollar subsidies in the marketplaces than midwage workers will. Working full time or spending fewer weeks unemployed will mean less, or even zero, assistance with health expenses.

In other words, some good news from the new marketplaces is that low-wage workers will be given a lot of assistance with their health expenses. But that assistance has the unfortunate consequence of higher income taxes on low-wage people: working more rather than less will not pay as well under the Affordable Care Act than it does now.

The Biggest Bargaining Chip Ever?

Obamacare is not too popular, and the Obama administration (like most administrations) is comprised of politicians who normally pay attention to such things. Obamacare is a logistical nightmare, and even proponents cannot rule out the possibility that it will shrink the economy. For sure, if the law goes ahead, some of the promises from Obama administration will prove to be false and embarrassing.

Yet the convention wisdom is that the Obama administration really wants Obamacare to go ahead. How can that conventional wisdom be reconciled with the facts above? One interpretation -- the conventional interpretation I guess -- is to assume that the Obama administration is simultaneously (a) obsessed with the "legacy" of starting "universal" health care, and (b) sufficiently over-confident or risk loving that they assign little probability to the nightmare scenarios that would make the Obamacare legacy not worth owning.

A second interpretation is that the Obama administration only wants to appear this way, so that it can sell delays or repeals of Obamacare to the Republicans and charge them an exorbitant political price. E.g., agree to delay or repeal Obamacare in exchange for (a) 2-5 percentage point increase in taxes on the "rich" or on big businesses and (b) planning to work on a "bipartisan" health care "solution" that would reduce the number of Americans without health insurance below a threshold (say 30 or 40 million).

Under this scenario, the Obama administration does not have to worry much about Obamacare logistics, or (ignoring those employers who have already changed their way of doing business in expectation of Obamacare -- they can always go back to business as usual) the possibility of significant economic damage, because it does not really plan to carry this thing out.  This scenario has few, if any, broken promises.

This scenario also has a good cop/bad cop version with President Obama sticking to his support for Obamacare but Mrs. Clinton and a few others agreeing, for a price (see above), to talk him out of it.

What do you think? If the second interpretation is correct, what should the Republicans be doing?  Should Democrats "sell" Republicans control of Obamacare (repeal), or just rent it ("delays")?