Do The Rich Work Less As Taxes Rise?

By Ryan C. Fuhrmann | April 05, 2012 AAA

Debt levels of the United States government are currently estimated at more than $15 trillion, or roughly equal to its annual gross domestic product (GDP). The situation has arisen from spending more than the government collects in annual tax revenue. Currently, there is much debate on how to stem the tide of the rising deficit, and increasing taxes is seen as part of the solution.
Many individuals would prefer to see the government rein in its spending and see this as the only viable solution to reduce debt levels over the long haul. Others are firmly against raising taxes. Even though it would offer some solution, raising taxes isn't seen as making a worthwhile dent in entitlement programs including Medicare, Medicaid and Social Security payouts. There is also a debate over whether higher taxes actually lower tax revenue because it creates an incentive for people to work less and stay at home, rather than pay their hard-earned income to bureaucrats.

What Studies Show
Recent studies have detailed that higher tax rates result in lower tax payments from the nation's wealthier individuals. At face value, it seems logical that working less and paying less taxes is a primary response to higher tax rates. However, one recent study gave a different and more logical explanation.

"The Wealth Report" in a recent edition of The Wall Street Journal cited an academic study from Jeffrey Thompson at the University of Massachusetts that explained wealthy individuals don't work less, but get more creative in finding ways to reduce their taxable income. Selling financial assets such as stocks was specifically cited. Other potential reasons include selling assets at a loss to offset taxable income, or increasing charitable giving and related ways to lower tax expenses.

Tax Rate Vs. Tax Revenue
Another study from the National Bureau of Economic Research looked into the tradeoff of higher tax rates and tax revenue and concluded that it is best to impose low tax rates on the widest base of taxpayers to boost total tax revenues. It also suggested that wealthier taxpayers will shift to tax avoidance strategies and called into question why governments would pursue progressive tax strategies that charge wealthier individuals more than lower earners. Basically, it concluded there is little benefit to governments for pursuing the wealthy because they are quite adept at finding ways to offset taxable income.

Of course, extremely high tax rates are seen as likely to cause any income level to work less. At the most extreme, a tax rate of 100% would surely kill off any motivation individuals have to work hard and get ahead. The Laffer Curve, created by economist Arthur Laffer, attempts to graphically illustrate the relationship between tax rates and total government revenue. Rather than prescribe specific points at which the tradeoff shifts, it does point out that there is a level at which tax rates grow excessively high and start to lower overall government tax revenues. This could stem from working less and the pursuit of tax avoidance strategies.

The Bottom Line
Overall, there is plenty of evidence to conclude that aggressively pursuing a smaller subset of taxpayers is an inefficient means to shore up the tax base. Even if it does increase tax revenues, it has little effect in making a dent on total tax revenues or reducing the massive level of government indebtedness. The rich may not work less as a result of higher taxes, but the end result is the same because it, as well as higher tax rates in general, result in creative ways for individuals to lower their taxable income.

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