MISCONCEPTIONS ABOUT INCOME TAX AND INCENTIVES1
| DOI | http://doi.org/10.1111/j.1467-9485.1969.tb00028.x |
| Author | C. V. Brown |
| Date | 01 June 1969 |
| Published date | 01 June 1969 |
SCOTTISH
JOURNAL
OF
POLITICAL
ECONOMY
FEBRUARY
I968
MISCONCEPTIONS
ABOUT
INCOME
TAX
AND
INCENTIVES
C. V.
BROWN
IT
is
difiicult to decide either conceptually
or
empirically whether,
and to what extent, income taxes are an incentive or disincentive
to
work effort. However, it is clear that
if
there is a relationship between
taxation and work effort, that relationship
will
be found between
work effort and the rates of tax people
think
they pay.
If
people
think
they pay different rates of tax from those they actually pay,
then any incentive
or
disincentive effects
of
taxation will be related
to their misconceptions about the tax system rather than to the actual
tax
system. The present enquiry was started
in
order to test the
hypothesis that a substantial proportion of people
in
Britain over-
estimate their marginal rates
of
tax
on
earned income, due to mis-
conceptions about the effects of earned-income relief. The paper
is
divided into four
sections:
a brief review of the theory; a review
of
some earlier empirical work
on
taxation and work effort
in
Britain;
a
presentation
of
the results of the present enquiry, which reveal
widespread misconceptions
among
those interviewed; and
a
final
section
pointing
to
the
need for further research, for better explanation
of
the
tax
system, and for a change in the system
of
differentiating
between earned and unearned income.
1
I
am grateful
to
the Carnegie
Trust
Fund for the Universities of
Scot-
land for a grant to cover part
of
the
cost
of this research; to the firms which
provided information;
to
Dr.
J.
A.
Brand for assistance
with
the design and
administration
of
the survey; and
to
Professors
T.
Wilson and D.
J.
Robert-
son, Dr.
L.
C.
Hunter, Messrs.
A.
s.
Skinner and
R.
W.
Smith and Miss
D.
Dawson for helpful comments.
A
summary of somy
of
the points made
in
this
paper entitled
'
Do
tax
myths
cripple incentwe? appeared
in
the
Finan-
cial
Times
for May
24,1967.
1
1
2
C.
V.
BROWN
I
When someone asks the question ‘Do income taxes reduce the
incentive to work?’ what they probably ought to have in mind is
the question ‘Under a ceteris paribus assumption would the supply
of work effort be increased (decreased) if the
tax
rate were decreased
(increased)?’ Economic theory suggests that the answer to
this
question
can conceptually be divided into two effects: a substitution effect
which would cause an individual faced with
a
higher
tax
rate to
work less, and an income effect which would probably cause the
individual to work more.
It is very difficult to give
any
quantitative meaning to terms such
as
‘
work more
’,
‘
work less
’.
In
some cases there would be a very
close correlation between
‘
working more
’
and
‘
working more hours
’
-e.g. when
a
worker was attending
a
machine set to
run
at
a
constant
speed. However, it is equally possible to
think
to conceive of a
situation in which working
‘
more
’
would involve
an
actual reduction
in hours. For example, it is conceivable that a man might produce
100
units in an eight-hour day when paid an hourly wage, but produce
120
units in seven hours when paid by piece rates. When
on
piece
rates this man has in
a
meaningful
sense worked
‘
more
’
despite a
shorter number of hours.
The term ‘work effort’ has been used
to
combine the idea
of
labour input as both a function of the length of time
on
the job and
the intensity
of
effort per unit of time.z
Due
to the difficulty of measur-
ing intensity it is commonly assumed in both theoretical and empir-
ical studies that labour input can
be
equated with hours worked?
The assumption that work effort can be equated with hours
worked is followed in
this
paper, including Diagram
1
where the
distinction between the income effect and the substitution effect
is
illustrated in
familiar
text-book fashion.
In
Diagram
1
income is measured
on
the horizontal
axis
and
leisure
on
the vertical axis-the distance
OA
representing the total
number of hours available. The indifference curves reflect an indi-
vidual’s preferences between leisure and income. The individual is
assumed to
try
to
reach the highest possible inmerence curve given
the gross rate
of
earnings he
thinks
he receives, less the rate at which
See
Hilde Behrend ‘The
Effort
Bargain
’
Industrial and Labour Rela-
tions,
Vol.
10, Number
4,
July, 1957, pp.
503-515.
See
for
example
R.
A.
Musgrave The Theory
of
Public
Finance.
and
the
Royal Commission
on
the Taxation
of
Profits
and
Incomes, Second
Report,
1954, Cmnd. 9105.
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