Soundbite: Rich Response
It was a bedrock belief of the supply-side economic policy revolution of the 1980s that people work more when taxed less. Such thinking hardly passed from the scene when Ronald Reagan rode off into the sunset, or even when George H. Bush reneged on his "no new taxes" pledge. Indeed, the current Bush in the White House is pushing his proposed $1.6 trillion tax plan partly on supply-side grounds.
Does Atlas Shrug?, a collection just published by Harvard University Press, explores how the rich—defined variously as the top 1 percent, .5 percent, and .1 percent of earners—actually respond to taxes. (The book's title alludes to Ayn Rand's bestselling 1957 novel, Atlas Shrugged, in which the world's most productive "men of the mind" go on strike to protest what they see as unfair conditions.) National Correspondent Michael W. Lynch caught up with the book's editor, University of Michigan economist Joel B. Slemrod, in mid-April.
Q: Why focus on the rich?
A: The richest 1 percent of Americans earn a disproportionate amount of income and pay an even more disproportionate amount of taxes. They have a high fraction of savings and wealth. So there's no question that in terms of dollars and economic impact, they are more important than just your average one out of 100 people. How much of any tax break goes to the top 1 percent is also a very hot political issue.
Q: Do the rich respond to tax incentives? You write that the '90s, an economic golden age, were a time when marginal tax rates were extremely high.
A: The rich certainly respond to the incentives caused by taxation. But there's a hierarchy of response. The most responsive type of behavior is the sort where, if you change the timing of some activity, you can lower your taxes; capital gains realizations are a prime example. A second type of behavior includes accounting and financial responses. Firms are fairly willing to adjust their financing, their dividend payouts, and the like in response to taxation. The bottom rung of this hierarchy is what I call real behavior—labor supply and savings decisions. On the whole, those are not that responsive to taxation.
Q: So how much people work is not that responsive to the marginal tax rate?
A: Right. Quantitatively, there's not that large of a response. The one exception is the labor-market participation rate of married women. This conclusion is based on studies that look at variations in tax rates in points of time and variations in tax rates over time.
Q: What are the economic implications of the proposed Bush tax cuts?
A: There are positive incentives from lower taxes, but they are not so large that we could expect this to be a panacea, a sure-fire way to ensure prosperity over the next generation. So it matters, but it's not the only thing that matters.