Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 3 Markets and Welfare

Chapter 8 of 36 Application: The Costs of Taxation

Section 7 of 11

…

Study of these three concepts help us determine how big government should be

· supply and demand

· elasticity

· deadweight loss

There is much debate because

· the larger the taxation deadweight loss

· the greater the cost of government

· the larger the deadweight losses

· the stronger the argument for leaner government and reduced taxation

Consider the biggest tax in the U.S. economy: the federal tax on labor income, the three components being

· income tax

· Social Security tax

· Medicare tax

When these three labor taxes are added together the tax on the last, marginal dollar of labor income is about 40 percent.

…

Economists disagree on whether this 40 percent tax on labor income creates a small or large deadweight loss.

This is because economists have two general, opposing views about the elasticity of labor supply.

-1- Economists who believe labor supply is inelastic.

They contend

· a small decrease in net wages will cause only a small decrease in hours people want to work

· the labor supply curve is almost vertical

· labor taxes do not greatly distort market outcomes

· most people want to work full time regardless of the wage level

· a tax on labor results in a small deadweight loss

-2- Economists who believe labor supply is elastic.

They contend

· a small decrease in net wages will cause a great decrease in hours people want to work

· the labor supply curve is almost horizontal

· labor taxes greatly distort market outcomes

· most people will cut back working hours or even not work as the wage level decreases

· a tax on labor results in a large deadweight loss

The -2- economists also contend

· because of lower net wages caused by taxation

· some people consider engaging in the illegal “underground economy”

· including working at jobs and businesses paying with cash or barter

When two political candidates disagree and debate whether the government should or should not increase taxation and provide more or less services part of the disagreement is based on different perceptions and opinions of the elasticity of labor supply and the amount of deadweight loss caused by taxation.

… …

economists have two opposing views

keizai gakusha wa ni-tsu sōhan kenkai

経済学者は二つ相反見解


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