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The best idea I heard today
...in a wonderful but still unpublished paper titled "Should Taxes Be Independent of Age?" my Harvard colleague Michael Kremer suggests that younger workers should face lower income tax rates than older workers.
Quite simply the elasticities of the young are larger; Greg Mankiw has more. Get this:
Kremer estimates that young workers are about four times more responsive to work incentives than the middle aged.
Posted by Tyler Cowen on April 14, 2006 at 11:44 AM in Economics | Permalink
Comments
Though this would increase the efficiency of taxation, wouldn't it also increase the incentive for teens to drop out of high school and/or college. Maybe the tax cuts could be directed at people 23 and older and then start moving back up.
Posted by: JoelW at Apr 14, 2006 12:55:10 PM
Or how about, very similarly, exempting the first $X thousand someone earns in their lifetime from taxes? It'd be a sort of standard 'deduction reserve' account that only gets used up once you've got a few years experience behind you.
This would give both young and late marginal entrants to the workforce an extra incentive to be productive and learn on-the-job skills, with little burden on employers.
Another idea: the 'deduction reserve' could be replenished when policymakers want to provide employment assistance without either cash transfers or make-work: displaced workers, returning veterans, disaster relief, etc.
Posted by: Gordon Mohr at Apr 14, 2006 1:10:56 PM
Why anyone thinks this is a good idea is a bit puzzling, given that the tax code is already (somewhat) progressive, ie., higher marginal tax rates as income rises. (Admittedly, lots of the exemptions and exclusions mute the progessive effect somewhat.) IMHO, it's actually a rather bad proposal since it essentially utilizes age as a proxy for income, whereas the current tax code utilizes income directly.
Posted by: Bill at Apr 14, 2006 1:32:43 PM
Since income generally is very much a function of age and experience
the tax system already does this to a great extent.
Posted by: spencer at Apr 14, 2006 1:44:34 PM
Relatively higher tax-rates on the elderly will encourage them to leave the workforce even earlier than they already do. This will further stress already insolvent social welfare programs.
Posted by: Elroy at Apr 14, 2006 1:58:13 PM
Bill is missing the point here.
Tax economists argue that government should tax something which citizens will not alter. This prevents agents from modifying their behavior to avoid the tax.
For example, government would like to tax nascent ability instead of income. This is in fact impossible since we don't have a good measure of ability that agents can't alter, but it would be prefereable since taxing income acts as a disincentive to work.
Age here acts as a proxy both for productive ability and more importantly for labor-leisure preferences, NOT a proxy for income. In simple terms, it is imposing the income tax on those that are least likely to change their labor decisions.
An interesting idea.
Posted by: DB at Apr 14, 2006 1:59:31 PM
Contrary to the above comments about income and age, the current tax code has several features which disadvantage the young: they are less likely to file jointly, more likely to pay rent than mortgage interest, and more likely to live in higher-tax urban areas. And, for those < 18, there is no income progressivity, since they get taxed at their parents' rates.
OTH, maybe age is just a proxy for having a mortgage and kids to feed. If you believe we should tax older workers more, should you also believe that we should raise taxes on people who marry young or buy houses young more than their single, renting peers?
Posted by: DK at Apr 14, 2006 2:55:21 PM
DB, I didn't miss the point. The fact is that age IS highly correlated with income (at least until retirement), and income is taxed progressively. And in turn, it may well be the case that income is a better proxy for labor-leisure preferences than age -- that's an empirical question. Since I haven't read the paper (I can't find it on Kremer's website), I don't know whether he accounted for income before concluding that younger people are more tax-inelastic than older people.
Posted by: Bill at Apr 14, 2006 3:31:46 PM
I don't pretend to understand the reasoning or repercussions, but this statement alone bothers me:
"To understand Kremer's argument, start with a simple premise: An income tax discourages people from working and thus prevents the economy from reaching its full potential. Tax cuts reduce this disincentive, encourage people to work harder, and expand the economic pie."
While I've heard people say something to this effect, I don't believe that all people are dumb enough not to comprehend that even while they pay more taxes when they make more money, they're still making more money...
Posted by: susan at Apr 14, 2006 3:37:17 PM
But Susan, if you are being taxed at a very high rate, lets say over 50% from all taxes, you most certainly will think twice before going after a new job or business venture, knowing that there is risk, and loss of leisure time involved. Everything is a tradeoff.
Posted by: kyle n at Apr 14, 2006 4:28:46 PM
Susan, if your choice is to work an extra 10 hours a week and get either an extra $12k or $20k in take-home pay, wouldn't the larger sum make you more likely to take the job? The magnitude of the effect of lowering marginal income tax rates is, of course, an empirical question.
Age is correlated with income of course, but (1) the correlation's well short of 1 (hi there, young investment bankers and traders and biglaw associates) and (2) the argument is that should be lower tax rates for the young vs. old at the same level of income.
Posted by: gundryggia at Apr 14, 2006 4:34:22 PM
Age might be correlated with income, but as one ages, the periods between jobs last longer and longer. Age discrimination is rampant in the US. As a software developer, I am starting to see salaries return to the 1999/2000 range, while as a over 40 year old developer, I find I am offered a fraction of those salaries.
Somehow, this sort of proposal seems to be a wedge method to attempt to introduce a flat tax. If folks are really so concerned about flat taxes, they should really be interested in elminating deductions, since the key to a flat tax working is the elimination of deductions. Since flat taxers aren't interested in getting rid of deductions, one can only presume that the other proferred rationale for flat taxes is likewise deceitful.
Posted by: Peter at Apr 14, 2006 8:48:56 PM
For those of you unable to navigate Kremer's website:
http://post.economics.harvard.edu/faculty/kremer/webpapers/Should_Taxes.wpd
Posted by: L at Apr 14, 2006 9:11:47 PM
Tax economists argue that government should tax something which citizens will not alter.
When tax economists start suggesting an LVT, I'll believe that.
as an aside, I wonder why the MR crowd, with its libertarian streak and aversion to taxing capital-- you know, capital as it was to Marx and Ricardo, back in the good old days of three factors of production-- hasn't gotten behind the nascent LVT movement.
Posted by: Bob Dobalina at Apr 14, 2006 9:21:42 PM
I just goes to show that those who would tax us are theives and extortionists, trying to bleed us as much as possible.
They should have a large T branded on their forheads, so we could know who they are, and treat them accordingly.
Posted by: Hinheckle Jones at Apr 15, 2006 12:31:12 AM
Susan -- I use to hear this argument about taxes causing people to not work from the young Wall Street types that regularly worked 60 to 80 hours a week to make the big wall street money. They never seemed to understand that their very own actions belied the argument they were making.
Posted by: spencer at Apr 15, 2006 9:34:44 AM
Thanks all, and I do understand that motivating factors are different to everyone (to those who guard personal lives with diligence I say "Hallelujah!"). I just don't feel that most working people would be stopped by "well, I'll have to pay more in taxes." Motivating factors are usually materialism--and often just mere survival, or future stockpiling. At my age (58) I just want to pay off the mortgage (and yes, more and more people in this age group still have mortgages because of upgrading lifestyle) and be able to feel comfortable enough in retirement (after age 67-70) to not become dependent upon government assistance.
Posted by: susan at Apr 15, 2006 10:22:37 AM
In fact, I should have added: Do you want me to pay more in taxes and then ask for it all back in assistance in ten years or would it be better if I saved that money and planned to take care of myself?
Posted by: susan at Apr 15, 2006 10:25:53 AM
Younger workers should face lower income tax rates than older workers? Where were these clever people when the Boomers were younger workers earning $1.10 / hour?
As always, follow the money, or more correctly, the Boomers and their money.
Posted by: Lee at Apr 15, 2006 12:22:31 PM
Susan, you said:
"I don't believe that all people are dumb enough not to comprehend that even while they pay more taxes when they make more money, they're still making more money..."
The issue here Susan, is the trade off between work and leisure. I've already turned down work doing technical editing for a book because the post-tax income in my tax bracket wasn't worth my time. I'd have done it for the amount offered, but after taxes were removed, the leisure time was more important to me.
My employer offers the option to drop back to part time (20-30 hours per week) at pro-rated salary. I've actually given it some thought. If my marginal tax rate get's to high, then the marginal cost of working fewer hours goes down. In other words, it get's much cheaper for me to buy vacation time.
Posted by: quadrupole at Apr 15, 2006 6:38:46 PM
Yes, quadrupole, I do see your point in making the case for this, and do agree that there comes a point when one must weigh one against the other as to the value. Whether it is a question of overtime, as for the young, or high salaries for more mature workers who have reached exempt status, I still think that to be a personal choice. What I worry about is the older workers who don't make all that much money and still have the same high cost of living plus mortgages and families to support, and less time in number of earning years left to be able to survive after forced retirement. More people would retire early if they could afford to do so. They simply cannot; and this would make it even harder.
Posted by: susan at Apr 15, 2006 8:26:08 PM
Do these guys have anything to do with their time?
Posted by: Robert Schwartz at Apr 16, 2006 12:54:39 PM
Susan, you said:
"What I worry about is the older workers who don't make all that much money and still have the same high cost of living plus mortgages and families to support, and less time in number of earning years left to be able to survive after forced retirement."
This I think, is exactly the point. Older workers have less of a choice about cutting back on work, they need the money more. A relatively young worker is much less likely to *need* the money because they are much less likely to have all those expenses you listed. If a highly paid younger worker is able to live on a third of what they make, then they are much more likely to consider cutting back in order to extend their leisure if their marginal return on work becomes to low than an older worker who *needs* every dollar they can get.
If I need a third of what I earn, and I'm taking home 50% on the dollar for the last 10 hours each week I work, then dropping back to 30 hours a week means I reduce my takehome by 12.5% of my salary, but if I move to a 10 hour work day, I gain a 4 day weekend. That's a pretty attractive trade. I'm now living on 44% of my earnings, but I have 4 day weekend! Every week! Woot!
If I am an older worker who needs every dollar he takes home to pay the mortgage, support the family, save for retirement etc, I can't even consider cutting my work time, even if my marginal tax rate on the last 10 hours each week is 50%, 60%, etc. In fact, if you raise my marginal tax rate, I may have to work *harder* to try to make up the takehome, because I *need* the money.
Please note, I am NOT saying that the above is fair. Not in the least. There is an aspect of our sensibilities that says that the older worker should pay a lower tax rate because he *needs* the money more. But purely in terms of the effect of marginal tax rates on output, it's likely that applying a lower tax rate to the young is less likely to lower marginal output than applying it to an oldr worker.
Posted by: quadrupole at Apr 16, 2006 3:19:22 PM
A little off point, but I think it is outrageous that a 14 year old working at the Dairy Queen pays SS and Medicare taxes.
Can we wait until age 18 at least? This would also cut the employers match expense, perhaps an incentive to hire the next worker?
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