Should Tax Rates Decline with Age?

By Hemel, Daniel | The Yale Law Journal, May 2011 | Go to article overview

Should Tax Rates Decline with Age?


Hemel, Daniel, The Yale Law Journal


For nearly a century, economists have recognized that it is "advantageous to ... tax most the source of supply which is least elastic." (1) But although the "inverse elasticity rule" is now a basic tenet of public economics, (2) it rarely yields practicable prescriptions for tax policy. (3) For example, the inverse elasticity rule would suggest that marginal tax rates should decrease as income increases, (4) as taxes are more likely to disincentivize labor for high-income individuals than for low- and moderate-income individuals. (5) However, such a policy may not be politically feasible (6)--or normatively desirable (7)--on account of its regressive implications.

Still, there is one segment of the workforce whose labor supply is highly price-elastic and whose relative tax rates (8) might be lowered without triggering the political concerns and distributive qualms mentioned above: older workers. (9) By one estimate, the price elasticity of labor supply--the percentage increase in hours worked for every one percent increase in after-tax income--is approximately three times as high for sixty-year-olds as it is for forty-year-olds. (10) Other estimates indicate an even more dramatic increase in labor supply elasticity over age. (11) Thus, the deadweight loss per dollar raised from income taxation is much larger for taxes imposed on older Americans than for taxes imposed on prime-age workers. (12) Congress could raise the same amount of revenue while generating less deadweight loss if it increased rates on prime-age workers and lowered rates on older ones. (13)

This Comment evaluates age-adjusted tax rates from the perspectives of economic efficiency, distributive equity, and political feasibility. (14) It presents the first sustained case from a law-and-economics perspective for reducing income tax rates on individuals as they enter old age. It also explains how age-sensitive tax rates can be consistent with distributive equity objectives. Finally, it shows the importance of reconciling optimal taxation theory with political reality and constitutional law. Until now, tax theorists have derived optimal tax rules without reference to political and constitutional constraints. By incorporating political considerations into the optimal tax calculus, economists and tax law scholars can generate policy prescriptions that not only are efficient in theory but also stand a chance at implementation.

I. THE ECONOMIC EFFICIENCY OF AGE-ADJUSTED TAX RATES

Economists of all political persuasions agree that income taxes disincentivize labor to some degree, (15) although they differ dramatically in their estimates of the magnitude of this effect. (16) There are at least three reasons why we might expect labor supply to be relatively insensitive to taxes. First, workers may not respond to changes in their tax burden because they cannot comprehend the intricacies of the Tax Code. Second, nonpecuniary factors such as social pressure may lead individuals to remain in the workforce even when marginal tax rates are extraordinarily high. (17) Third, wage earners do not necessarily have full control over their labor supply. It may be difficult for them to slide along the "intensive margin" (that is, to adjust the number of hours that they work per day or the number of weeks that they work per year) because employers often demand a minimum number of hours from their employees. By contrast, workers generally have much more freedom to make choices at the "extensive margin," such as to exit the labor force entirely. (18)

If individual workers cannot make marginal adjustments to their hours, then we would expect the price elasticity of labor supply to be greater for individuals who are considering exit from the workforce than for individuals who might desire an incremental reduction in hours. (19) In other words, we would expect the disincentive effects of taxation to be greater around the retirement decision than at midcareer. …

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