The Effect Of Income Tax On Work Effort

As always there are two certainties in life as they say, death and taxes. The latter will be the main focus of the essay in particular, as ever the topic of taxation is an intriguing one with more than a few viewpoints. In this essay we’ll look at the topic of taxation in relation to both income and indirect taxes, asking the question, “Does it discourage work effort?”.

Income tax can be defined as tax levied on the earnings of companies and individuals. Earnings subject to income taxes can come from diverse sources, including wages, salaries, dividends, interest, royalties, rents etc. In the United States, income tax is one of the biggest sources of revenue for the federal government. The U. S. government's total revenue is estimated to be $3. 643 trillion for Fiscal Year 2020, Income taxes contribute $1. 822 trillion to that number. Whilst in the UK in 2018/19 income tax receipts in the amounted to £191 billion. On the other hand, an indirect tax is collected by one entity in the supply chain (usually a producer or retailer) and paid to the government, but it is passed on to the consumer as part of the purchase price of a good or service. The consumer is ultimately paying the tax by paying more for the product. Import duties, fuel, liquor, VAT and cigarette taxes are all considered examples of indirect taxes. Taxation can be viewed as discouraging work effort for a number of reasons,

Firstly, when workers’ earnings rise but their after-tax income rises less because of increases in their income tax, their incentive to work typically declines. The percentage of an additional dollar of a person’s earnings that is unavailable for such reasons is called the marginal tax rate. In the UK for the year 2019/2020 the tax band is as follows: What’s the incentive of working harder in order to gain a high paying job, to gain less money? The last thing the economy needs is to discourage those things that add productive value to the economy. On the one hand, the effect of an income tax could potentially encourage people to work more. This is due to the “income effect. ” (Assuming that working harder/ longer hours generates a higher level of pay)

The effect of an income tax makes people feel poorer. And as a result, they feel compelled to work harder in order to maintain something close to their ideal pre-tax standard of living. Another way to put it is that leisure is a normal good meaning that people prefer to consume less of it when they are poorer and since the tax makes you feel poorer, you consume less leisure. This can also be used for the other side of the argument; however, we can use the substitution effect instead, as the tax makes non-work, or leisure, less expensive. And as a result, people feel compelled to take more time off since it will cost them less in forgone income. It parts it does depend on the preference of the individual, how much they love their job and how much they value their leisure time. If the person enjoys the role that they’re working in they will be likely to work more and harder leading to more promotions and ultimately a higher rate of pay, so in that sense taxation will not discourage the persons work effort at all. Whilst on the other hand if the individual doesn’t really like the job they do or if they value their leisure time better than working, that will discourage the persons work effort.

The obvious solution to the problem would be to just lower the rates of taxes, that way everyone in the economy makes gains more money and as a result there will be a higher incentive to work harder. However, there are several negatives effects of a lower tax rate, firstly as mentioned previously income taxes is a big contributor to government revenue and a reduction will lead to a fall in the revenue received by the government and ultimately lower government spending on the economy. However, the reverse argument for that case would be that lower income taxes leads to higher incomes for households and could lead to an increase in household spending, higher consumption and investment. In relation to the indirect tax, the effect could be seen as more unfair than income taxes. For example, inelastic goods especially (Inelastic demand in economics is when people buy about the same amount whether the price drops or rises. That happens with things people must have, e. g. petrol for drivers) the price of the tax can be directly passed unto consumers and with no other substitutes, the customer has no other choice but to keep buying such products. When demand is inelastic the tax burden is mainly on the consumer. Whilst on the other hand for elastic products the burden can be shared more equally between the consumer and the producer. When demand is elastic, the tax burden is mainly on the producer. One of the major concerns of this is that Indirect taxes make the distribution of income more unequal because of their regressive effects. The people on lower oncome will get taxed a higher proportion of their income than the rich, making it a regressive tax. Furthermore, for goods which are necessary, the people on lower income will struggle to have any money left over after buying such essential goods and services. As a result, indirect tax could discourage work effort in that people will have to spend higher levels of money on consumption for goods and services, thus, leaving them with less disposable income. Workers will begin the question why they work so hard if it leaves them with less disposable income every month. Future productivity levels in the economy may fall as result, as workers reduce their output. However, the government could help the situation by intervening. This could be by reducing the levels of indirect tax or by creating laws in which producers are forced to pay the tax burden, that way consumers won’t have to pay higher prices for goods and services. The benefit system in the UK may also furthermore discourage people for working at all. Some people who are on the low-income threshold may opt to not working at all instead of working harder. That way the problem if tax is solved for the individual.

In conclusion, as said previously the answer to the question really depends on the individual’s preference. There will always be a debate on what the right amount of income tax is and if it is fair on the population. In relation to indirect taxes, the relation to work effort can be seen as a lot less influential, depending on the products elasticity the tax burden paid by the consumer can vary depending on the elasticity.