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Dan Ariely

Professor, Duke

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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 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.

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