Yet tax cuts do not affect everyone the same. For instance, suppose that the government were to cut the tax rates that apply to the first $50,000 of earnings. Taxpayers with incomes below $50,000 would have a greater incentive to try to make more money because each dollar of earnings would be taxed at a lower rate. But that is not true for someone earning above $50,000. This person would view the tax cut as infra-marginal--the reward for additional work would not improve.
How much incentives are improved by such a tax cut, therefore, depends on the ratio of low-income to high-income taxpayers. That ratio, in turn, varies by age. Few 20-year-olds make more than $50,000 a year, so this tax cut would encourage almost everyone in that age group to work harder. Yet because many more 40-year-olds are in the high-income group, the tax cut would boost incentives for far fewer of them.
Not only is it easier to improve incentives for young workers, but they are also more likely to respond. Middle-aged workers are often locked into jobs that give them little choice about how much they work. Young workers are still choosing career paths and have more flexibility. As a result, their labor supply elasticities are larger. Kremer estimates that young workers are about four times more responsive to work incentives than the middle aged.
Monday, April 17, 2006
Should Taxes Depend on Age?
Very interesting idea coming out of Harvard. Should Taxes Depend on Age.