Dan Ariely

Professor, Duke

This conversation is closed.

What are the effects of taxes on motivation and productivity?

One way to fight the budget deficit and income inequality is to change the marginal tax rate. The question is what are the implications of such change.

Some people think that this will cause the wealthy to stop working, others think that this will cause everyone to stop working, yet others think that a long as we care about how we do relative to others an increase of the tax rate will have no effect on effort and productivity.

What do you think will the effects of increased tax rate have on you and on the people you know?

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    Feb 12 2011: I have no empirical data, but in my experience, people who are at the top of their game don't do it for money, and taxes have very little impact on whether or not they're going to invent the next lifesaving drug or record another record album or write another opera.

    On the other hand, I've seen the face of the hardworking hourly employee who is aghast at how much harder he's going to have to work to feed his family. It's hard for me to grapple with tax cuts for the wealthy as a useful policy decision (or a moral one).
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    Feb 16 2011: One old and hoary concept is 'marginal utility'. Simply put (by example), if you tax a man making $10,000 a year at 10 percent, he feels it a lot since he's barely scraping by; if you tax Warren Buffet at 10 percent, he never notices since every added dollar he retains doesn't affect how he eats, where he lives, or whether he can afford medical care. Each added dollar yields a bit less satisfaction than the dollar before..... I doubt that Warren would work harder if you gave him a 10 percent pay raise either (does he even read his income tax form before his accountants give it to him to sign?). If you took the guy making $10,000 a year and gave him a 10 percent increase in income (if he did something specific) I suspect he would jump through hoops to make that extra $1,000 -- a real motivator!
    • Feb 16 2011: I completely agree Thomas. Ambition, competitivness and pride in accomplishments are 'sweeten' by financial rewards, not dependent on them.
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      Feb 17 2011: @ Thomas

      If your goal is to create a moral justification for increasing taxes on the rich, you're wrong to use Warren Buffet as your example of the "rich" guy. An increase in rates can easily affect his investment strategy, but it would have no effect whatsoever on his lifestyle. Instead, lets use the implications of a rise in rates for the normal "run of the millionaire" who makes just over $250,000 per year.

      Raising his rates (in comparison to raising the rates on the guy making $10,000 per year) will indeed have an effect on his lifestyle, especially when you consider that the guy making $10,000 pays no taxes at all, and the guy making $250,000 pays about 50%, when you add together his federal, state, city, sales, real estate, & other taxes.

      The liberal left's assumption that all of the "rich" are billionaires, makes it easy for them to justify the way they treat those who produce more than they consume. The problem with that of course, which also applies to all of the other principals of the left, is that it's a lie, based on erroneous assumptions and revisionist history.

      And while we're at it, just to be honest, let's stop talking about a hypothetical lowering of the taxes on the rich as "giving them a raise". Stealing less from someone isn't the same as giving them something. It's their money, not yours in case you forgot.

      Production of wealth comes before re-distribution of wealth.
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        Feb 17 2011: Seems like our current economic policies (post-Reagan) have been most effective at re-distributing wealth from the middle-class to the upper class. But that I assume you're OK with?
        • Feb 17 2011: Not to nitpick, but redistribution of wealth is different than a shift in what people earn. The fact that the wealthy are earning more (which could be argued as problematical) than the middle class is a significantly different phenomena than redistributing wealth--the direct confiscation of income from one economic strata (or individual) and giving it to another. In the US economy, "redistribution of wealth" only happens in one direction, downward.
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        Feb 17 2011: Response to Bart: Read "The Conservative Nanny State":

        http://www.conservativenannystate.org/

        And then tell me it only happens in one direction.
        • Feb 18 2011: reference point, I am not sure if I would call myself a conservative or not, but I am conservative leaning.
          I have started reading this book, and as a starting point, he isn't using accurate conservative ideals. The so called "conservative" big government is some people taking an ideal and distorting or mis-representing (maybe even abusing the label) an actual conservative ideal.
          As I said, I have only started reading, so I am going to restrict my comments to the introduction.
          As it says, conservatives believe less is better when it comes to a lot of government functions. So I believe there should be less government intervention in, for instance, doctors. Especially in the information age. Just require transparency (Well, considerably less government than now) on the Doctor's part, then people and hospitals can make informed decisions. And also from Chapter 1, immigration is good, but not the illegal immigration of today. The stereotypical Ellis Island immigrant from 50 years ago was a great thing for this country, ready to work, but the largely illegal immigration of today is not the same thing.

          The Fed. Way to much power, and should be reigned in. I know some people that are definitely conservative and their general thought is to entirely eliminate the Fed. I don't know enough to have that strong of an opinion, but limiting is good.

          CEO's - I agree that a lot of CEO's make way to much money. Along with people like athletes and actors. And while it isn't the government's job to help them get higher, it is also not the government's job to decide what they should get at all.

          Patents/copyrights - While education associations doing research is ok, why would a drug company invest in a new drug unless they know they will be able to get that money back. There may be other ways to foster creativeness, but profit is a very good one. So far as Windows goes, there are always "foss software" equivalents, often better.

          I hope I am clear
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        Feb 18 2011: Reply to Charlie. There's a lot worth addressing in your comments, but I'd like to stick to one side issue.

        I've become intrigued by the Conservative vs. Progressive dichotomy, based purely on semantic terms.

        If a progressive is one who wants the world to progress. wouldn't a conservative be one who want's to return to "the good old days"? Is that really what we want? Were the good old days really that good?
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      Feb 18 2011: This view of the world suggests a very high marginal tax at the high rates of income.
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    Feb 16 2011: I think the lack of motivation taxes might cause are related with how you perceive these funds are going to be used. If you could trust completely on your government to spend it in a transparent and reasonable manner, then you wouldn't mind having to pay a little more.

    On the other hand if government did exactly that, they would't need to rise taxes :)
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    Feb 16 2011: I think the tax rate has a greater impact on those who are self employed than on anyone else. Most people who get a paycheck don't feel the amount that leaves for taxes. I think they are reminded of it each week (or two), but they don't feel it because it was never in their bank account. For the self employed they make the money and then have to write out a check, they feel the difference as it leaves their account. I would suggest that if everyone paid in, out of their own bank accounts, they would feel more attached to their tax money and be more involved in what it was spent on. I personally like taxes, they afford us the society we live in, however, I think people should really think about how much they are paying the government each year and which portion goes to what government expenditure. Maybe we should all have to pay in the full amount of taxes but allocate it how we choose. Divisions of the government can make appeals to us about why and how much funding they need and we can let the chips fall where they may.
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      Feb 18 2011: I like the "voting where your taxes go" idea and I think it will increase involvement and competition in a great way.
      • Feb 18 2011: That is what we do here in California. I like the 'idea' also, BUT it doesn't always work out very well and at times special interest spend millions to distort the issues to their advantage.
        Just look at our budget.
        Term limits has also had a bad effect. Again, I like the 'idea' but what happens is the politians refuse to compromise on any issue. They also careen from post to post to post ie from State Represenative to Insurance Commissioner to State Senator -------around and around.
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    Feb 15 2011: Having lived in a so called developing country with a known corrupted system, the problem as I see it, is not the cut or increase in taxes, but how the money collected is used. Administrations in government may get away with their bad administration or misused of funds, but sooner or later people will react to the effects in their pockets or in their hearts. The timing of a society to react would depend on its mindset and maturity.
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    Feb 23 2011: To a large extent it depends on the individual. Simply put, people take action based on what they perceive is possible. If my personal situation is such that more money will change what I see as possible an increase in taxes will have a big consequence. Less money equals at least the perception of fewer possibilities, therefore less action. Personally my career has provided a very good living and at this stage in my life an increase in taxes by a few percent makes little difference to my motivation and actions. Contrast that to my son, a young engineer with four children and a much tighter budget. For he and his family an increase in taxes would be a big deal, create fewer possibilities and thus a lower incentive.
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      Mar 4 2011: You bring up a good point Joe. How many of us would not mind paying more in taxes if it meant reducing the burden on our children?
  • Feb 18 2011: In no way are taxes an inhibitor of motivation and productivity, at least when it comes to startups (which are the number one driver of job growth in the US )

    This is proven out when you take a look at the startup hubs in the US, and throughout the world: they tend to be in higher taxed regions/states. California, New York, Massachussets, none of these are income tax haven states. If income taxes were a major inhibitor of motivation and productivity, one would imagine that New Hampshire and Texas would house the startup hubs. Instead, if you look at startups in the US and around the world, they tend to be where you have high quality public education, better social services, and generally more of a safety net.

    Take a look at this article from INC magazine about startups in Norway:
    http://www.inc.com/magazine/20110201/in-norway-start-ups-say-ja-to-socialism.html

    Tax havens are just that, tax havens where the wealthy go in order to avoid paying taxes, not productivity centers.
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    Feb 15 2011: As a Norwegian, I'm used to income tax of 30-40%, and a VAT of 25% on most goods and services. The income tax is even slightly exponential, so the more you earn, the higher your tax gets. People pay almost 60% tax on all income above $100k. I don't really think of how much money I make on a day to day basis, I just know it's sufficient to provide for my family. And I don't really mind the high tax, because I understand that it provides healthcare, infrastructure and other utilities in a socialiced democracy.
    Many wealthy Norwegians see it as a moral obligation to pay their taxes just like everybody else.
    I think the US could raise taxes, and maybe mostly for the wealthy, but not solely to reduce the debt. You would have to offer some socialiced benefits in return to please the masses.
  • Feb 15 2011: A case study from Croatia: I'm a senior-level professional/consultant with a paycheck that is typical for that job here (which is much less than in the West Europe/US). At this level, the income taxes take away about a half of every extra dollar on my earnings. Also, there's a 23% VAT on everything I buy.

    But as our economic situation worsens, there have been some inovative "taxing" policies that take this further. Daycare centers in Zagreb now have prices that are roughly proportional to the household income per member: the more you earn, the more you pay. This logic taken to the extreme would price all things as percentage of income, so everybody would have the same purchasing power, regardless of what they earn.

    Now, this situation has severely dampened my will to work more and produce more value. A friend of mine went a step further and quit his well-paid job. Turns out he's happier now. Good for him, not so good for our economy.
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      Feb 15 2011: Of course this scenario would work like that, "from everyone according to this ability, to everyone according to his need", it is communism, socialism, collectivism, whatever you want to call it and it has proved a failure.

      It astonishes me how little we learn from history and are inclined to try the same failed things.

      I know if I think that 40%, 50%, or 60% of my income goes to taxes, I am hugely unmotivated.

      A low flat tax is whay would motivate me and would unleash my creativity and productivity.
      • Feb 16 2011: It's actually funny, when you know that Croatia had a socialist economy 20 years ago, and that socialistic politics have been unpopular ever since. As a political marker, that is; not as actual policy.

        Recently, Croatian national TV asked the people on the street: "Should the rich pay more taxes?" The answer was a unanimous "Yes!" But the question is stupid - the rich ALWAYS pay more taxes than the poor. The sad truth is that the average people do not know how the tax burden is distributed. Their think that whatever the rich are paying now, they should always pay even more. Until there are no rich people left. Pure socialism.

        A few years ago there was a big rise of prices on the Zagreb stock exchange, and the issue of introducing the capital gains tax came up in the election campaign. The majority of people were against it, as it was seen back then as an easy way of making money out of the thin air. We still don't have capital gains taxes or a property taxes. Pure capitalism.

        I don't think this is specific to Croatia. People are socialist or capitalist depending on what they think serves their immediate interests at the time. The long-term and the overall health of the economy is not their concern.
      • Feb 18 2011: @Lina - there are positive and negative examples of every facet of human existence. Examine Scandinavia and you will find societies deeply committed to general well-being and unfazed by their high tax scheme. As a USA native, I was shocked to find people holding themselves accountable for paying taxes which no company or government official monitors - such as the media tax. See Martin's comment below, and do a little reading about the successful forms of socialism.
      • Feb 19 2011: @Lina says: 'Of course this scenario would work like that, "from everyone according to this ability, to everyone according to his need", it is communism, socialism, collectivism, whatever you want to call it and it has proved a failure.'

        What about the case of the early Christian Church (see Acts 4:32-25):

        "And the multitude of them that believed were of one heart and of one soul: neither said any of them that ought of the things which he possessed was his own; but they had all things common. 33 And with great power gave the apostles witness of the resurrection of the Lord Jesus: and great grace was on them all. 34 Neither was there any among them that lacked: for as many as were possessors of lands or houses sold them, and brought the prices of the things that were sold, 35 And laid them down at the apostles' feet: and distribution was made to every man according as he had need." (source American King James Version)

        That's as good a description of communal collectivism as you'll find and as far as I know that didn't end in failure.
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    Feb 21 2011: "Tax" seems such an emotional word that I begin to think we are too emotionally invested to think as clearly as we should over this important issue.
    Are there any peer-reviewed studies on the topic that can shed further light? Anecdotal evidence may not be accurate. Certainly, as someone with an above-average income derived entirely from paid employment, I have never changed my daily work life in response to a change in the marginal tax rate, but I don't know for sure if others are different or if it has a more subtle change in the long run; we humans are notoriously bad at understanding our own motivations.
    It probably also depends on what the tax is for. In my countries (Canada, UK) taxes pay for my medical care. In my near neighbour (USA) they would not; I would presumably pay a huge insurance company for the same service. If my payment goes up $100 per year to pay for better care does it make a difference to my motivation or productivity whether it is in the form of a tax or a payment to a corporation? I don't mean here to enter into the US debate on medicare, just to point out again that focus on "tax" as such over-simplifies the question. We are often motivated to work harder so we can buy something better; if Governments were demonstrably providing us with useful and valuable services, why would we be less motivated to buy them through "taxes" than through equivalent payments to large corporations?
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      Feb 21 2011: choice. if government provides chocolate, it will be milk and dark. if market provides chocolate, it is 2 x 10 meters shelf in the supermarket with heaps of products of different taste, size, filling, shape, color, pattern, softness, name, price, attached toy and you name it.

      and it is not theoretical. i lived under socialism, and i've seen the government providing http://en.wikipedia.org/wiki/Szaloncukor to decorate our xmas trees. it came in four tastes: pink, white, dark brown and light brown. noone had any idea what the actual tastes were supposed to be. light brown was a little coffee-ish, pink was probably some fruit. my favorite was light brown. i hated pink. i didn't know how much of a crap this was, until finally capitalism came, and now we have our own supermarkets with lotsa stuff.
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    Feb 21 2011: @Hrvoje Very interesting and insightful comments about the state of "post-socialist" countries, of which you have first hand knowledge.
    Your comments "socialistic politics have been unpopular ever since. As a political marker, that is; not as actual policy."
    and "People are socialist or capitalist depending on what they think serves their immediate interests at the time. The long-term and the overall health of the economy is not their concern."
    illuminate for me why this backwardess in former communist countries... I guess people want the freedom capitalism brings, but not the responsibility for themselves (have cake and eat it too).

    @Julie "Scandinavia" is a very broad concept. If you start examining Scandinavian countries individually, you will see that it is far from a socialist paradise. There are many problems and a move away from socialism, in order to address them, in many of these countries. And it is not because they run out of resources necessarily or are now unhappy to help their fellow-man. They still want to help. Their mentality does not seem to have changed much. Just the idea of what the better tool is for the job, i.e. capitalism rather than socialism.
    And to make it crystal clear: I think capitalism is the tool that helps the most people (rich or poor or in between) in a country, society, the world. Not socialism.

    @Jim I do not believe in or trust records about the particulars of what happened in early Christian days, so your point is moot to me.
    Plus the motivations (e.g. acceptance of original sin and inherent guilt) in such groups distort any useful conclusions about the organization of society on rational terms.
    • Feb 26 2011: You say "this backwardess in former communist countries", but I don't think these attitudes are specific to us. I see the same "backwardness" in the US politics too.

      Also, I would not say that people did "want the freedom capitalism brings". Mostly they wanted to have more - more money, more choices, more flashy stuff - and capitalism provides more. They also associated it with Western democracy, so they bought it as a package.
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      Feb 27 2011: "have cake and eat it too"

      definitely. the best thing about having a government is that you can simply put the burden of thinking on leaders. low taxes, high expenditures without debt: governments can promise this with straight face, and people are ready to (pretend to?) believe.

      it is an interesting game to try to view government actions as a way to relieve people from responsibility of being selfish or short sighted. it fits surprisingly often.
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    Feb 18 2011: I do believe tax on income is a bad idea. tax on consumption would be a better alternative (but this is another discussion altogether.

    So as you are talking about the effects of income tax...
    * I would say increasing tax rate them would make people complain, and make them feel less motivated and less productive (some strikes,...) until they adapt to the change and it gets accepted.
    * It might have an effect on investments: if labor becomes more expensive... and then it gets all macro-economical but i'm not an expert on macro economics... so I don't know

    @ Philip,
    I must disagree with your business school teachings.
    * If you give money first and then take it away, the effect on happiness is more averse than when you give less money in the first place.

    ---
    Would I make less bionicles if the diminishing returns is increased?
    ---
    • Feb 18 2011: Tax on consumption is essentially a regressive tax, whereby those with the least income end up spending a larger portion of their income on taxes. Regressive taxes are problematic for many reasons, but perhaps the reason that might appeal across all income levels is that regressive taxes act as an accelerator on inflation, whereas progressive taxes act to damped inflationary pressures: think about it, as the dollars is worth less, incomes rise, and as incomes rise, larger portions of those incomes (in fact, all progressive taxes) are returned to the government.

      Income taxes on the other hand mean that when you earn more money, you actually earn more money, even if a larger percentage of those earnings got to the government. If you find me someone who would turn down a half a million dollar a year salary because their taxes would increase, I'll eat my shoe. Investments typically have more to do with capital gains taxes and corporate taxes. That said, look at states with some of the highest corporate income taxes: New York and California. They account for almost 20% of the entire US GDP, with a little over 10% of the population.
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      Feb 18 2011: It is interesting that in general, people have less aversion to consumption tax, and I think that it is because consumption tax seems more discretionary and at the control of the individual. But as Bill Cromie points out, there are a few things that people have to get (some heat, food, transpiration, education etc) which makes it much less discretionary and much less appealing.

      One approach is to have consumption tax only on luxury goods, but this seems much less appealing.
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        Feb 18 2011: Thanks for the insights and explanations (as I'm not an economist, I'm moving on thin ice and am aware I might make be totally wrong)

        This said: actually, I would agree with heavier taxes on luxury goods, and very low taxes on necessary goods...

        The advantage of a consumption tax would be that it can include health and pollution cost in a transparent way (at least in principle and if applied on a sufficiently large scale)

        So a big mac might become a 10$ snack, while local rice, bread and veg will cost nearly nothing.
        A HUM-V will cost a factor 10 more, while public transport might be nigh free
        So it is possible to counter the 'regressive' part.

        But tax on consumption would make everything more expensive.
        As taking away given money is worse than giving less money from a psychological point of view... maybe it can be countered by the transparency
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    Feb 18 2011: One one thing that I wonder about is the effect of a step tax rates vs a continuous one. Right now all progressive tax rates get contributions up to a certain amount to be without taxes (for example the first $10,000 are exempt), then there is a low marginal tax on the next amount (between 10,000-20,000), then the tax rate increases.

    Such systems create very clear steps and maybe stopping rules (I don't want to get to the next tax bracket), but what is the tax rate was continuous and slightly increased with every amount earned? Would this make the motivation to work higher or lower?
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      Feb 18 2011: Often thought that myself. Seem to remember a number of people expressing the fear of entering that next bracket.
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    Feb 18 2011: Taxes have no impact on motivation and productivity. They are externalities. Very few people set to work thinking "I'm less motivated to work today because my efforts are being taxed!"
    In business school I was taught that taxes serve two essential purposes
    - to cover the payment of services that improve the common good. What that covers varies with time and societal values (building sewer systems, education, R&D, ...)
    - redistribution of wealth so there isn't a destabilizing difference between the poorest and richest members of society
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      Feb 18 2011: Yes, but would he/she put in an extra hour of OT if they are making 2X dollars vs X dollars?

      I would think there's some influence.
      • Feb 18 2011: Well, would you? Lets do the math:
        Average hourly wage in the US: about $19/hr
        Overtime wage is time and a half, so it's $28.50
        Percentage Taxes on an yearly income of $19/hr: 25% if you are single.
        taxes paid on the hour of OT: $7.13
        taxes paid on hourly for regular time: $4.75
        Income/hr OT: 21.37
        Income/hr regular time: $14.25

        Would you honestly not put in the extra hour of overtime? You are already selling your time for $14.25/hr. Lets imagine it bumps you up to the next tax bracket! the next tax bracket is 28% for income over $82k/year. Now, an important thing to note is that you only pay the extra 3% taxes on income over $82k/year, so, lets imagine that you are one hour over, so your hour of overtime is now worth $7.98 in taxes and $20.52 in added income.

        I don't know about you, but I'd work the extra hour, if I could.
    • Feb 18 2011: Well put. My thoughts exactly, but you put it much more succintly.
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    Feb 17 2011: Really depends on a number of factors.

    Say you're Warren Buffet and you're paying 40% of your income (considering tax loopholes this may be about right) in taxes. If you had to pay 50%, you probably won't work any less. And he (Warren), has in fact endorsed increasing the taxes on the wealthy.

    Now, say your of more moderate means and already paying 50% of your income in taxes. Increasing it to 60% might be quite a disincentive to put in extra hours.

    So the issue really needs to be addressed at different levels.
  • Feb 17 2011: Being a spoiled American I tend to view taxes as the government stealing my hard earned money. What I, the spoiled American, often forget to think about is that taxes do in fact improve my way of life. If my commute to work was safe due to maintained roads and working traffic lights I do not give it a second thought. But do not take my hard earned money. If the employees that work under me got their education in a public school system, using public libraries, using public assistance, I do not give it a second thought that they are the ones making me money and that all of it was possible by taxes. The vast economic landscape and structurally sound country that the spoiled American lives in is possible because of taxes. How the government actually uses those taxes is an entirely different debate but I guess my point is lets make sure that people of all walks of life are given opportunities to excel. If that means raising or even lowering taxes then do it.

    Money has a small motivating factor on those that wish to innovate and excel in a skilled craft. Those that want to be rich will be. Those that wish to be good at their craft will be. Any person making $250,000+ that wishes to complain about taxes and can with a clear conscious thinks that taxes have not enabled them to that salary in the first place doesn't deserve that salary.
  • Feb 16 2011: My personal experience very much suggests that people are driven by the perception of relative reward, not by a rewards actual size (eg take home pay). At least once their basic needs are being met anyway. Once all of someone's needs are met, the issue or relative reward is reduced - people become simply 'happy with their lot in life'.

    Higher tax rates are useful to the point where they allow a greater proportion of a population's basic needs to be met. For both moral and social security reasons I think this is important. I suspect there is also a productivity rationale for helping people reach this first threshold too.

    One of the funny things I notice is when 'successful' people complain about taxes because they feel they 'need/deserve' more than what they are bringing home. Clearly they have some needs which aren't being met; but in 9/10 cases I suspect more money in their pocket wont change this.

    It would be interesting to see whether the tax system would be viewed differently should the following two things happen.. (1) taxes were renamed ''contribution for shared services''; and (2) they made how much each person paid a matter of public record. I'm sure the right minds could come up with an even better name again.
  • Feb 16 2011: I think it depends on the perceived return on investment, in other words if taxes are increased, but the tax payer gets more bang for his buck, i don't think that any demotivation will occur. if the extra money just disappears then de-motivation is sure to set in. In South Africa the rich pay a large amount of income tax >40% but receive nothing in terms of schooling, health care etc so from their point of view more taxes provide no benefit to them. the result is that many
    South Africans invest a large amount of time in avoiding tax and may even consider emigrating
  • Feb 16 2011: Right now, in the UK, I'm essentially paying 50% income tax. Factor in the other taxes it's probably quite a bit harder. Working as an employee of a company, I have very little opportunity to have choice in my tax affairs. I've worked hard and been successful and live a good life. However, taxes play a huge role in reducing any motivation I get from an earnings increase. I work harder, be better, I may get a good bonus or salary raise, but after tax it doesn't make a great deal of difference to my life. So why should I bother? So taxes play a big role in reducing any motivation based on financial renumeration. Personally, I am motivated by other things.
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    Feb 15 2011: i suggest that the question, though being interesting, is misleading. because the most important effect of taxes is not psychological effect on employees, but economic effect on firms. even if we can show that some high payed managers won't work less for less money, we surely can state that (s)he will earn much less, and will have less to spend, accumulate or invest. taxes replace human decision making with government decision making. and luckily, i don't need to show how clumsy and cumbersome governments are.
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      Feb 18 2011: This is a common argument about taxes, but it is not clear to me that governments make worse decisions than individuals. In particular, if you take into account the amazing force of "economies of scale" it suggests that even with a very high level of waste that governments can have a very efficient outcome compared with lots of individuals making decisions.
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        Feb 18 2011: Perhaps we need that "happiness index" to determine when that is so :)
      • Feb 21 2011: i think i'd agree that it's difficult to argue that individuals would make better decisions, simply for the fact that most individuals aren't anywhere near well-informed enough. politicians at least have the benefit of mountains of reports, meetings etc.

        there's also the problem of the word 'worse' - worse for who? sometimes the better choice is the worse one...
        an anology: say you have 2 candidates standing for election, one is pro-environment and is currently in office, the other not. there is a mountain in the district, with lumber, coal and gas resources available. allowing these to be exploited would gain revenue for the area (in the form of jobs) but is a much bigger boon to the area by keeping the air clean, enabling the local water supply to continue (forests provide catchment) as well as recreational space, and as an added effect of keeping the water clean, the neighbouring electoral area's fishing business are benefitted.
        so the clear 'better' choice is to protect the area from development... right? ok so those companies wanting to develop then cease their donations to the pro-environment candidate, and he loses the next election to his opponent who has the funds to get his message out to the people and gather votes. he is elected and the land is developed anyway, as long with a bunch of other lands the pro-environment cnadidate had been protecting. the 'better' choice then is to allow the development, even though it will be bad for the people.
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        Feb 21 2011: Governments don't make decisions any more than corporations do. They also have paid managers who make the decisions who also pay taxes and therefore will have more or less to spend, accumulate or invest, so this argument does not apply specifically to governments and does not show that government decision-making somehow is not human decision-making.
        I agree that governments, if allowed to hide facts and dodge accountability, can be clumsy and cumbersome, but it is far from clear that individuals and corporations are not. Witness our recent economic problems and the utterly stupid decisions made by some financial institutions or large car companies. Not to mention many individuals who took on debt they could not service. Clumsy and cumbersome applies to all us limited humans and our institutions.
        Collectively, we do have techniques and capabilities to improve that, and the very clumsy method of making marginal changes to the gross income (taxes or fees) of those institutions is not likely to do the trick.
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        Feb 21 2011: governments always do what majority wants, since that is what encoded in the rules of the game. hundred years of race selected ideas very well, so today politicians are very sophisticated in saying the exact words that win them the elections.

        so to put it in numbers, if 1% of people wants to do the right thing, in a free society, 1% will do the right thing. and maybe if they are proven right, it can grow. in a democracy, the 1% can easily be ignored.
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      Feb 18 2011: Always wondered if the following might be a solution to the investment issue.

      Allow people to keep tax free all the money that they keep in investments, but tax them at regular rates for any money they take out for personal consumption.

      No need to have a distinctive capital gains tax. Personal income is personal income when cashed in.

      Has there been any discussion on this concept?
      • Feb 20 2011: Tim,
        This is a fairly standard concept when it comes to talking about income and investments. When you start to study Macro Economics, it's how taxes are thought of in a purely theoretical sense: all income is taxed the same: corporate, personal income, capital gains, etc. However, as you dig deeper, the rational behind the distinctions is that the source each type of income has variable multiplier effects on growth. Investment is largely one of the best drivers of growth, and as such, it's enshrined in the tax code as being a more highly desirable form of income, as in general, it creates jobs, growth, etc.
      • Feb 21 2011: that sounds very logical to me, but i wonder how it could be prevented from being abused. for example say you invest in my company and i send you gifts in gratitude, or i send you gifts and expect you to reciprocate by investing. in both cases you would have acquired consumable goods in exchange for untaxed cash, albeit in a roundabout way.
        there is also the additional problem in if i choose to do all my spending in other countries, in which case i would never pay tax in my country of residence.
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        Feb 21 2011: yes, peter schiff regularly calls for abolishment of all income and corporate taxes, and keeping only the VAT. he was ron paul's economic advisor, so he is not some "old man in the pub talking nonsense" figure.
    • Feb 20 2011: RE government inefficiency: It isn't clear to me that government inefficiency is greater than the profit margins of business. Take a look at this article from alternet:
      http://www.alternet.org/story/149725/vision:_how_small,_mostly_conservative_towns_have_found_the_trick_to_defeating_corporations?page=entire

      Essentially, the crux of the argument is that small towns sold their utilities to corporations, expecting greater efficiency, lower prices, better services, etc. They discovered that when you factor in the profit margins the for businesses extract, they were getting a radically worse deal than the state run utilities.

      This is the problem with the whole idea that business is more "efficient" than government.Business is not organized around providing the best service at the lowest cost, businesses extract profits, which, when you consider them in the context of a utility, are waste. Business is only more efficient if the profit margins are less than the "inefficiency" of the government service.
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        Feb 21 2011: the power of the free market lies in competition. working ideas are selected for. they will be kept. failed ideas will be selected against. they will fall short. this is the so called "discovery process" of markets. if state, being one single organization, selects a company, one single entity, it will create no competition, thus, will gain us nothing in efficiency.

        it is very important to understand that players in the capitalism game are not to be idolized. the company is not efficient by its nature. the company is forced to be efficient in a fierce rivalrous environment. or forced to go bankrupt.
  • Feb 24 2011: Can we look at this from a purely economic perspective? Please?
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    Feb 24 2011: I have been teaching economics for 15 years and from what I have studied, increasing taxes does not deter people from working - especially in the US. It is unfortunate that we are a consumer driven nation - especially the 20 to 40 year old group. Individuals will work more to maintain their standard of living.
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    Feb 22 2011: My personal belief is that there is a direct correlation between those who create new taxes and those who think circumcision is a good idea for a religious celebration. In Great Britain if you take a second job it is immediately taxed at 40% where in that is there any motivation to try and get ahead? My mother worked as a Nurse all of her life and upon retiring she took a part time job and was also taxed at 40%, this is the reward for all of her hard work and being part of the WWll generation.
  • Feb 21 2011: Increased tax rate will definitely distorts the incentive to work hard. But if tax income is distributed in such a way that poor will not become richer than rich, than the probability of moral hazard will become less. We can not generalize, its results varies from economy to economy.
    I think its effect is more in developing countries, because in developing countries, growth mainly occurs in industrial sector, so increase in tax rate will discourage the private enterprise to invest in industrial sector,hence debilitates the growth rate in development.
  • Feb 21 2011: There is a number where taxation for the betterment of society becomes confiscation to the detrement of all producers. The trick is to find that number
  • Feb 20 2011: One only needs to look around the world and examine the countries different progressive tax rates to realize that there is far less detriment to productivity with increased taxes then one would intuitively think given that money is the 'primary and ultimate form' of incentivization in our economically driven world.
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    Feb 20 2011: Speaking from the perspective of a young, English man, I have no issue with paying my taxes, although, I think many members of the British Public are somewhat, uneducated, in what their taxes are spent on,
    "What are the effects of taxes on motivation and productivity" is an extremely difficult question to ask, in a Modern World where Globalisation and Social Inclusion is at an all time high, the UK currently spends a huge amount of taxes on a huge variation of outlets, that benefit;
    the poor, other countries in the World, charities, stryggling businesses, young families, socially excluded, the list is endless,

    Everyone will disagree with certain things that taxes are spent on, such as military weapons, whereas others may agree with it.

    Personally I think too many people in the World, myself included, make uneducated, biased statements with regards to Government Spending and taxes, so I find it incredibly difficult to answer this question.
  • Feb 20 2011: I pay my taxes with a sincere appreciation of the responsibility of my politicians to use it for the betterment of my society. When I don't think they are doing a good enough job I get involved in politic because I think democracy works and is the best way for society to make decisions.
    I work because I need to make a living and provide the level of life style I choose for my family . I look at my taxes at the end of the year and am very thankful that I pay about 25% in federal taxes plus the usual in local and sales taxes. I am in the top bracket and don't look for any shelters that everyone can't use . If I want more money each year the best way for me to get it is to work longer harder or smarter. I am not foolish enough to think that my marginal tax rate should change my motivation to work and earn . I work with many highly paid professionals , they ALL grip about their taxes but I have NEVER known one who stayed at home to keep out of the next tax bracket.
  • Feb 19 2011: i've spent considerable time thinking on this and related issues, and i think first it's important to acknowledge that there are basically two kinds of wealthy people. one is the philanthropic, such as bill gates, warren buffet, brad pitt and angelina jolie, who realise that they have all the wealth they could possibly need and continue working not for personal gain but for the benfit of others. the rest never stop trying to accrue personal wealth for whatever reason, i'm not going to judge here.

    perhaps there is a further discussion as to why some people feel that their group consists of all inhabitants of earth (the first group), while for others their circle is smaller, but in any case clearly any changes to taxation are going to affect the 2 groups differently. it seems logical to me that a tax rebalance (increased tax to the rich and decreased tax to the others) would not be opposed to those in the first group since they believe in helping those less well-off anyway which this tax adjustment would do, while it would certainly be opposed by the second group as it would make accruing wealth harder. importantly, those who continue to seek personal gain are also the ones most likely to cut costs such as benefits and employee salaries in line with their drive to benefit themselves, hence would be the least likely to allow tax breaks to trickle down to those 'below', keeping the benefits in their own accounts.

    taxing the poorest also is ultimately self-defeating to the rich, since people with less money have less to spend driving the consumption that rich company owners and investors need. furthermore, a general lowering of taxes mans poorer infrastructure and healthcare, meaning companies are less able to conduct business and more sick people means fewer people earning a spendable salary and paying tax.
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    Feb 18 2011: So is this two questions: what are the effects on motivation? and what are the effects on productivity? or are motivation and productivity so closely correlated that we can ask this as one question?

    I would think we have enough historical data to draw some conclusions on productivity, don't we? I've seen the old chart from the BLS showing productivity vs. real wages where the productivity looks like it is increasing quickly despite flat wages. That would seem to offer evidence that wages don't control productivity and lowering real wages with taxes (within reason) shouldn't have much impact here.

    On reflection, the question is obviously too simple. A lot of other factors will contribute to a person's motivation and productivity. For instance, how the revenue from taxes is spent. If you tax me and then build good roads allowing me to safely reach more customers, I imagine my productivity will increase regardless of how I feel about being taxed.
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    Feb 18 2011: Look at someone who is literally starving to death. Can we tax him an additional 10%?

    Obviously no. It will literally kill him.

    It seems pretty obvious that for the extreme poor increasing taxes is going to be counter productive.
  • Feb 18 2011: We are brainwashed into accepting that 'taxes' mean a taxes on income. Such really are theft and impediments to employment and have become hugely complicated. But Land Tax is much easier to apply - flat rate, no exception - and valid morally. That is, 'If you want a bit of the country for your exclusive use, then you pay the rest of us to keep out'. But don't hold your breath. As ever, it is those with big land holdings that pull the strings or is it, those who pull the strings have big land holdings. Whichever, it means there is an elite influential group for whom increasing land prices are 'just fine'. But increasing land prices are detrimental to the rest of us and a major drag on the economy and society's well-being.
    So let's think more broadly when speaking of 'increasing taxes'.
  • Feb 17 2011: Capitalism is a game that is rigged for the rich. When corporate executives get huge bonuses, that is reflected in higher prices for everyone. It is like a hidden tax on everything we buy. We need to find a way to cut that tax, because it has been going up and up with no end in sight.

    Taxing those gains and giving the money to the government is one approach, but not a very efficient one. For one thing, the government seems to be in the pocket of corporations, so they would just find a way to get it back. It would be better if there were rules to prevent executives from robbing their corporations (and thus their shareholders and customers) in the first place.

    Seeing people getting billions in undeserved gains is more demoralizing to me than any taxes I pay. We need more referees in this game.
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    Feb 17 2011: I would like to slightly dodge the question, and suggest that a holistic approach be taken. Like any good business in hard times, you look at the inflows, the outflows, and whats necessary.

    Simplifying the tax code in some way, and, better utilizing the funds available could go a LONG way.

    Many businesses fail, not for lack of money, but for poor management of such.

    If we could announce that the US would be on sure financial footing with a 5% tax hike, but, we are also able to give these benefits, we are removing these special projects, etc etc etc. I think the public would complain, but would be better off in the long run.
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    Feb 17 2011: It's interesting to note that in the first paragraph, the "professor" asks what the effects of a "CHANGE" in the rates would be, after which he only considers the implications of an INCREASE in rates.

    What might the implications of a LOWERING of rates be?

    If we start off from an unbiased and objective point of view, we'd have a lot more to learn than we do from looking at things through the eyes of the liberal elite.

    fs
    • Feb 19 2011: @Flemi Swemson says, "What might the implications of a LOWERING of rates be?"

      In the US, we have experienced this for a decade now. Don't we know? One of the bigger effects is the greater inequality in the distribution of wealth. The last "lowering of taxes" which occurred in December 2010, resulted in lower income taxes for everyone except someone making about $20k (single) or $40k (joint filer). They see their tax liability increased because the "Making Work Pay" Tax Credit expires as the result of the tax deal.
  • Feb 16 2011: I'm not sure the level of taxes really affects motivation or productivity per se... There are only three options for someone who wants to pay less tax: avoid it, evade it or get on with it.

    Definitely when you are saving every penny and trying to make more each month than goes out in bills, taxes hurt. Or when you are self employed and fight tooth and nail for a contract, only to have to write a cheque to the taxman at the end of it, they really hurt. But however much it hurts, what can you do? You can find legal ways to not pay tax, perhaps by changing nationality, or you can go black-hat and make all your transactions in cash. I can't imagine a situation where people would work *less* as a result of higher taxes.

    Essentially: increasing taxes might lead to less people *paying* taxes altogether, but working less hard? I doubt it.

    (there is also the effect on personal or corporate spending that increased taxes create, as Krisztián Pintér mentions, but that's an entirely different kettle of fish)
  • Feb 16 2011: When Income taxes are high, business owners shelter their profits within their businesses.Sheltered profits must be used to expand operations or hire new workers. When income taxes are low, business owners pay themselves higher salaries and take profits from their businesses., often hoarding them in personal investments.
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      Feb 18 2011: Sadly this is not the reality in the US. The US has one of the lowest effective marginal tax rate in the world (given all the incentives and loopholes) and yet businesses work very hard to hide income. David Cay Johnston (http://en.wikipedia.org/wiki/David_Cay_Johnston) who won many awards for tax reporting describes some of the shenanigans that US businesses engage in -- and I highly recommend his books and blog
  • Feb 16 2011: Taxes are merely currency for politicians to trade for votes from citizens. Sadly, this is not a balanced economic equation and rarely produces the desired behavior on the part of the politician once they receive the citizen's vote. Especially in emerging nations.

    Revenues from taxes are supposed to be used to create a stable political environment that fosters creativity through enterprise, intellectual dialogue, investments in human capital training and development through various levels of education and tax credits to spur the growth of small and medium enterprises. Unfortunately, those tasked with spending the tax revenues, politicians, often lack basic business training, decision-making or insight.

    Not sure if a flat tax, reduction or increase in taxes would affect motivation and productivity. (Here in Texas, a flat tax is very popular to high earning conservatives). I feel the key is to highlight a direct correlation between the deployment of tax revenues and the impact on business or economic growth.

    As Mr. Godin pointed out, the truly talented, creative and innovative will continue to innovate, create and produce, regardless of tax rates. It is the essence of their being, so they are often not motivated by maximizing the financial reward or keeping score at the bank.

    As I told the CEO of a leading US medical service company on a recent visit to India, who was chastising the current administration for "spreading the wealth" and giving his hard-earned money away through entitlement programs; "top earners, if they are truly value-added earners and not just overpaid brokers, have very little to worry about."

    If you are at the top of your game, you will make it to the top of the heap, regardless of the tax rates. It is simply another obstacle to overcome. Having said that, I am sure there is a tipping point and my past experiences in some European nations is testament.
    • Feb 16 2011: The highest standard of living for the most people occurs in countries with the largest proportional middle class.
      Tax codes should be structures to encourage upward mobility and a large healthy middle class; poor aspiring to middle class, middle class aspiring to wealth. If the largest group is middle class there will be a larger pool of tax payers.
      The poor should pay little or no taxes and be a small percentage of the population.
      The middle class should pay a reasonable tax and be over 80% of the population, the wealty a bit more and be the smallest percentage of the population. Basically with variations this is what we have in the US, it's the 'Progressive Tax System . A flat tax is awful. Billionairs paying the same percentage as the impoverished ? Not sensible.
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    Feb 15 2011: It would be better for society in general to better understand that Taxes should be treated as a cost of living, as far as the generality of people receive a good return for the amounts they pay as taxes.
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    Feb 14 2011: I used to live in England. While the 17% VAT tax initially was a bit of a shocker, it quickly became an afterthought. I've always thought it would be interesting to think of how such a thing would impact the United States - one flat rate for all. Rich or poor, everyone pays a flat rate. No loopholes.

    I would imagine that, like in Britain, there may be an initial shock, it would just become an expected part of doing business.

    (Disclaimer: I work for TurboTax.)