In the debate over tax policy, one argument for not increasing tax rates is that such tax hikes will cause people to work and invest less, thereby causing the economy to grow more slowly. Do all economists agree with this perspective? N.C. State University economist Mike Walden answers.
“Well … we have a political debate about this, but there’s also an economic debate, and it’s a very important economic debate. This is a long-run economic issue that is to what degree do people change the amount of time they work, the amount of money they invest in relationship to the returns they get for that the wage rage or the investment return. And, of course, what taxes do is they reduce those returns. If your tax rate on your labor income goes up, that means you’re earning less per hour. And the question is, Does that mean you’re going to work more or less?
“And there’s a lot of research on this. In general, in general the research does show that people respond to the returns from working. That is, if taxes go down and they get keep more in their paycheck of what they earn, they will want to work a little bit more. It’s a rather modest change, and it does vary across time and it does vary across income groups. And you can make the same argument with investments.
“Now to throw up an added level of complication here, I think it also matters, and the research shows it also matters, for example, if taxes do go up, what does the government do with those taxes? If the government uses that tax money to do things that people need and value, then maybe even with higher taxes, as long as the money is spent in a certain way, people will not change their work behavior. For example, if we need roads to get to work, and the government has to raise taxes to ride those roads, then we’re not going to reduce our work effort because of that.
“So this is a fairly complicated issue. I think it tends to get simplified in some of the public discourse, but it’s a very, very important issue.”