Tax Incentives and Economic Growth

By Barry P. Bosworth | Go to book overview
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Labor Supply

THE DETERMINANTS of labor supply are frequently overlooked in discussions of the supply side of the economy. Yet the quantity and quality of work effort are critical to any program to expand aggregate supply, and the behavior of workers can be expected to be sensitive to their evaluation of the economic incentives for choosing between work and leisure. Because labor represents about 75 percent of the value of the inputs into production, even relatively small marginal responses can have substantial aggregate implications.

It is sometimes alleged that the tax and transfer systems have contributed in a major way to the slowing of economic growth in the United States. High marginal tax rates are seen as a major disincentive to work effort, and the availability of unemployment insurance and welfare programs leads some economists to conclude that the unemployed are unwilling to work. In many respects the supply response is fundamental to current disputes over the nature of today's unemployment problem. Some agree with Keynes's view of unemployment as a reflection of inadequate total demand for labor; others see a supply-side problem created by legislation that holds wages too high and transfer programs that create disincentives to work. The first group views unemployment as involuntary and supports an expansion of aggregate demand to increase job opportunities. The other interprets unemployment as a voluntary decision and urges structural reforms to reduce transfer programs and intensify competition for existing job openings.

The responsiveness of labor supply to price incentives is also important to the debate on capital formation because many of the proposals to reduce the taxation of capital income are implicitly proposals to increase the tax on wages.1 The supply-side gains in higher rates of capital

This is true of proposals to shift the income tax structure toward a consumption- based tax. But some supply-side advocates would object to the need for an increase in labor taxes of an equal offsetting magnitude because they foresee such a large increase in aggregate income that the rate of taxation is permanently reduced.


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Tax Incentives and Economic Growth


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