Posted Monday, Dec. 17, 2012, at 11:06 AM
The conventional wisdom is that what matters in tax policy for economic growth is marginal tax rates, the rate you would pay on your next dollar of income were you to earn one. Your marginal rate determines whether you want to grab that extra shift, do a super-awesome job to snag that promotion, pitch that extra freelance piece, or whatever else. But Garett Jones argues persuasively that this misses a much more profound set of questions. Most people only rarely get to make labor supply choices on the margin like that. (Economics professors and journalists are important exceptions.) What they make are "lumpy" questions about career choice. That's particularly true for the kind of ambitious people for whom the top marginal tax rate is relevant.
If you're asking yourself, "Should I go into a career where the successful people make really big bucks, or should I pick a career that offers less salary but more nonmonetary compensation?" then the average tax rate—the total amount of money you end up needing to hand over to Uncle Sam—is what counts. As Jones puts it:
[W]hen people are deciding whether to become medical doctors or mere professors, lawyers or struggling novelists, entrepreneurs or Xbox champions, these go/no-go decisions will be shaped by the average tax rate that the rich will have to pay for decades to come.
A subsidiary question that Jones doesn't address, however, is whether we should be concerned about people opting into less-lucrative careers. It seems to me that having smart, ambitious, hardworking people become lawyers is a huge waste. When Apple and Google compete to produce the best smartphone operating system, consumers win as products improve. But while there's presumably some level of lawyerly incompetence that would be socially problematic, at the margin, big firms getting better and better at suing one other doesn't help anyone. By the same token, it's good to have deep and liquid financial markets, but we're clearly past the point where extra expenditure of engineering talent on devising better and faster high-frequency trading algorithms is anything other than a Red Queen's Race. Arguably it'd be better if talented people put less energy into making money and more energy into seeking other kinds of rewards. Everyone admires inventors, but everyone hates patent trolls—to the extent that people in the invention game are more driven by the quest for prestige and admiration and less driven by the quest for money, you might get more inventing and less trolling.
All of which is to say I don't think it's totally obvious how this cuts. Most generally, I don't think that it is or ever has been possible for anyone to really internalize the economic benefits of truly groundbreaking innovations. So to the extent that high-motivation, high-status people are discouraged from seeking more and more cold hard cash as their main career goal, we might see better results. At any rate, as I mentioned last month, the economic implications of the fact that most people want to find a job they like are understudied as a general matter.
Jones' point about the importance of average versus marginal tax rates further emphasizes the point. An obsessive focus on marginal rates seems to implicitly assume a very simplistic set of work/leisure trade-offs in which the only decisions people make are how many hours of toil to put in on the assembly line.