This is called the substitution effect.īut another effect-the income effect-works in the opposite direction. In other words, he might substitute a certain amount of leisure for work because the opportunity cost of an hour of his leisure has declined: In this case, George's supply of labor falls in response to an increase in his tax rate.

Because George now works the same amount of hours for less income, he may instead choose to work less. To see this, consider an increase in George's payroll tax rate, which lowers his after-tax income. Marginal tax rates, most economists believe, are important from an economic standpoint because they influence decisions to work, save and invest. For example, up to a certain income level, taxpayers pay 15 percent in taxes for every additional (or marginal) dollar they make the highest income taxpayers, by contrast, pay up to a federal marginal tax rate of 39.6 percent. In this case, the tax affects economic activity by altering people's incentives to work or not to work (leisure).Īt its core, the current federal income tax structure is a system built on progressive tax rates, which means that the more money you make, the higher your tax rate.

A tax wedge also results from a tax on income.

A sales tax, for instance, creates a 'wedge' between the price a consumer pays for a good and the price the seller receives. From an economic point of view, however, most taxes introduce distortions in an economy.

Some form of tax collection apparatus is necessary to fund the myriad governmental entities and the responsibilities they are charged with. Most of the proposals put forth are not only a significant departure from the current framework, but, in many cases, also differ markedly from each other. It also appears that a large number of Americans and their political representatives concur with this assessment given the large number of tax reform proposals advanced recently. There seems to be a general consensus among economists that the existing federal income tax structure in the United States: 1) is complex 2) hobbles economic growth by creating disincentives to save and invest and 3) creates a substantial compliance cost burden for individuals and businesses. The income tax has made more liars out of the American people than golf has.

What should flat negative income tax