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Does It Pay to Work?

Author

Listed:
  • Jagadeesh Gokhale
  • Laurence J. Kotlikoff
  • Alexi Sluchynsky

Abstract

Does it pay to work? Given the number and complexity of federal and state tax and transfer systems, this is a tough question to answer. The problem is greatly compounded by the fact that what one earns in one year alters not just current taxes and transfer payments in that year, but in future years as well. Thus, understanding the net effective tax on work and the changes in this taxation associated with policy reforms requires an intertemporal model capable of carefully determining tax and transfer payments at each stage of the life cycle. This study uses ESPlanner, a financial planning software program, to study the net work tax levied on workers with different earnings capacities. ESPlanner smooths households' living standards subject to their capacities to borrow. In so doing, it makes highly detiled, year-by-year federal and state income tax and Social Security benefit calculations. To produce a comprehensive net work tax measure, we added to ESPlanner all other major transfer programs. We focus on lifetime average and marginal net work-tax rates, which are measured by comparing the present values of lifetime spending from working through retirement both in the presence and in the absence of all tax-transfer programs. We form these tax rates for young stylized married workers. We report seven findings. First, our fiscal system is highly progressive. Households earning the minimum wage receive 18 cents in benefits net of taxes for every dollar they earn. In contrast, households with million dollar salaries pay 54 cents in taxes net of benefits pe r dollar earned. Second, progressively is primarily restriced to the bottom end of the income distribution. Average net work tax rates of middle class households are relatively high compared with those of the rich. Third, while the poor face negative average taxes, they face significant positive marginal net taxes on working. Indeed, a minimum wage household that chooses to work is forced to surrender 34 cents of every dollar earned in net taxes. Those with earnings that exceed 1.5 times the minimum wage face marginal net taxes on full-time work above 50 percent. Fourth, low-wage workers face confiscatory tax rates on switching from part-time to full-time work. Fifth, the same is true of secondary earnings spouses in low- wage households with low incomes. Six, the marginal net tax on working is particularly high for young households with low incomes. Seventh, average and marginal net work tax rates are relatively insensitive to the assumed rate of real wage growth and the discount rate. And eighth, major tax reforms, such as switching from income to consumption taxation, can have an significant affect on the fiscal system's overall progressivity.

Suggested Citation

  • Jagadeesh Gokhale & Laurence J. Kotlikoff & Alexi Sluchynsky, 2002. "Does It Pay to Work?," NBER Working Papers 9096, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:9096
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    References listed on IDEAS

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    1. David Altig, 2001. "Simulating Fundamental Tax Reform in the United States," American Economic Review, American Economic Association, vol. 91(3), pages 574-595, June.
    2. Hubbard, R Glenn & Skinner, Jonathan & Zeldes, Stephen P, 1995. "Precautionary Saving and Social Insurance," Journal of Political Economy, University of Chicago Press, vol. 103(2), pages 360-399, April.
    3. Jagadeesh Gokhale & Laurence J. Kotlikoff, 2002. "Social Security's Treatment of Postwar Americans. How Bad Can It Get?," NBER Chapters,in: The Distributional Aspects of Social Security and Social Security Reform, pages 207-262 National Bureau of Economic Research, Inc.
    4. Don Fullerton & Diane Lim Rogers, 1994. "Distributional Effects on a Lifetime Basis," NBER Working Papers 4862, National Bureau of Economic Research, Inc.
    5. Steven Caldwell & Melissa Favreault & Alla Gantman & Jagadeesh Gokhale & Thomas Johnson & Laurence J. Kotlikoff, 1999. "Social Security's Treatment of Postwar Americans," NBER Chapters,in: Tax Policy and the Economy, Volume 13, pages 109-148 National Bureau of Economic Research, Inc.
    6. Boskin, Michael J. & Kotlikoff, Lawrence J. & Puffert, Douglas J. & Shoven, John B., 1986. "Social Security: A Financial Appraisal Across and Within Generations," CEPR Publications 244432, Stanford University, Center for Economic Policy Research.
    7. Michael D. Hurd & John B. Shoven, 1985. "The Distributional Impact of Social Security," NBER Chapters,in: Pensions, Labor, and Individual Choice, pages 193-222 National Bureau of Economic Research, Inc.
    8. David Bradford, 1995. "The Distributional Analysis of Tax Policy," Books, American Enterprise Institute, number 52866.
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    Cited by:

    1. Miao, Jianjun & Wang, Neng, 2011. "Risk, uncertainty, and option exercise," Journal of Economic Dynamics and Control, Elsevier, vol. 35(4), pages 442-461, April.
    2. Laurence J. Kotlikoff & David Rapson, 2007. "Does It Pay, at the Margin, to Work and Save? Measuring Effective Marginal Taxes on Americans' Labor Supply and Saving," NBER Chapters,in: Tax Policy and the Economy, Volume 21, pages 83-144 National Bureau of Economic Research, Inc.
    3. Laurence J. Kotlikoff, 2007. "Is the U.S. Bankrupt?," Boston University - Department of Economics - Working Papers Series WP2007-015, Boston University - Department of Economics.
    4. Palacios, Robert & Sluchynsky, Oleksiy, 2006. "Social pensions Part I : their role in the overall pension system," Social Protection and Labor Policy and Technical Notes 36237, The World Bank.
    5. Matthew S. Rutledge & John E. Lindner, 2016. "Do Late-Career Wages Boost Social Security More For Women Than Men?," Working Papers, Center for Retirement Research at Boston College wp2016-13, Center for Retirement Research.
    6. Barbara A Butrica & Karen Elizabeth Smith & C. Eugene Steuerle, 2006. "Working for a Good Retirement," Working Papers, Center for Retirement Research at Boston College wp2006-8, Center for Retirement Research, revised May 2006.
    7. Simon Gilchrist & Fabio M. Natalucci & Egon Zakrajsek, 2007. "Investment and the Cost of Capital: New Evidence from the Corporate Bond Market," Boston University - Department of Economics - Working Papers Series WP2007-027, Boston University - Department of Economics.
    8. Laurence J. Kotlikoff, 2006. "Is the United States bankrupt?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 235-250.
    9. Alan J. Auerbach & Laurence J. Kotlikoff & Darryl Koehler & Manni Yu, 2017. "Is Uncle Sam Inducing the Elderly to Retire?," Tax Policy and the Economy, University of Chicago Press, vol. 31(1), pages 1-42.
    10. Louis Kaplow, 2007. "Optimal income transfers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 14(3), pages 295-325, June.
    11. Harry ter Rele, 2005. "Measuring lifetime redistribution in Dutch collective arrangements," CPB Document 79, CPB Netherlands Bureau for Economic Policy Analysis.
    12. Laurence J. Kotlikoff & David Rapson, 2005. "Comparing Average and Marginal Tax Rates Under the FairTax and the Current System of Federal Taxation," NBER Working Papers 11831, National Bureau of Economic Research, Inc.

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    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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