Tax Rates Cut and Effect on Real Humans

February 8, 2009

There is a long interview in the new business section of Atlantic Monthly with the respected economist Robert Barro holding forth his views on multiplier effects of Government Spending.
I last studied macro-economics more than a decade ago and remember little of the Keynesian models. What was really interesting is this reply

Q: I would need to go back and check. But one question, and I think Greg Mankiw raises this question as well, is, Why does this set of evidence depart from what seems like the standard Keynesian theory that a dollar of spending would have a larger multiplier than a dollar of tax cutting?

A: I don’t think it is really confusing at all, because when you cut taxes there are two different effects. One is that you cut tax rates, and therefore give people incentives to do things like work and produce more and pay more…….

Now I have no idea where this particular evidence comes from but it does seem a little weird to me that Tax Rate Cuts would encourage people to work more. I have personally moved and had my income shift from one tax jurisdiction to another and I have known hundreds of people moving from high tax jurisdictions to low (India to Malaysia, Malaysia to Singapore, Europe to Middle-East), a lot of these have actually worked for me in both locations and I can unequivocally say that they did not change their working patterns. They did not start working harder or start being more productive. Probably the most relevant eg. would be people moving from Malaysia to Middle East (UAE, Saudi, Qatar etc) where the currencies are roughly pegged at the same level to US Dollar, costs of living are relatively similar (housing costs more but cars are cheaper), and the effective tax rate declines from 22-23% in MY to 0% in ME. I have seen no change in productively levels as a business would measure in terms of lines of code churned out, Service requests handled, proposals made, sales-calls made etc.

Marginal Tax Cuts on Individuals have absolutely no effect on their desire, willingness or incentive to work. Income effects, Social Norms and larger Macro-environment dominates.