The Work Effect

People are often confronted with work-leisure decisions. Should I put in that extra couple of hours of overtime? Should I take on a second job? Should I keep my store open longer hours? If you answer yes to any of these, you'll have to give the government a pretty big slice of that extra income.

At what point do you start working for the government? When it takes 20 cents out of each dollar of extra income (a marginal tax rate of 20 percent)? When it takes 30-cents? Or 40 cents? Each of us makes his or her own decision about the cutoff point. If you are a wage-earner, you will have to pay Social Security tax, federal income tax, and, possibly, some state income tax. Back in 1980, before the passage of the Kemp-Roth tax cut and the tax cuts that came under the Tax Reform Act of 1986, people earning more than $30,000 a year often had marginal tax rates of more than 50 percent. If you paid more than half of your overtime earnings in taxes, would you consider yourself to be working for the government?

Facing high marginal tax rates, many people refuse to work more than a certain number of hours of overtime or take on second jobs and other forms of extra work. Instead, they opt for more leisure time. In sum, high marginal tax rates rob people not only of some potential income but of the incentive to work longer hours. People working shorter hours obviously produce less, so total output is lower than it might have been with lower marginal tax rates. This and the saving-investment argument (considered next) are the two key points made by supply-siders for lower marginal tax rates.