As the Bush-era tax cuts are set to expire in 2010, ambitious health
care legislation is moving through Congress, and entitlement programs
are growing at unsustainable rates, U.S. policymakers face important
questions about the optimal size and scope of federal spending. The
federal government finances its spending through labor taxes, including
taxes on income, payroll, and consumption-taxes that generate
significant disincentives for employment. In Taxes, Transfers, and Labor
Supply: An International Perspective, Richard Rogerson contends that the
unintended consequences of increased labor taxes would be too large for
policymakers to ignore. Rogerson compares fifty years of time series
data from the United States and fourteen other OECD countries. He finds
that a 10 percentage point increase in the tax rate on labor leads to a
10 to 15 percent decrease in hours of work. Even a 5 percent decrease in
hours worked would mean a decline in labor market productivity equating
to a serious recession. But, whereas recessions are temporary, changes
in government spending patterns have permanent repercussions. Although
government spending provides citizens with many important benefits,
these benefits must be weighed against the disincentivizing effects of
increased labor taxes. Policymakers who fail to account for this
decrease in labor productivity risk expanding government programs beyond
the economy's ability to support them.
