Wednesday, October 29, 2008


Greg Mankiw's Blog: My Personal Work Incentives

Greg Mankiw's Blog: My Personal Work Incentives

Another thought on incentives. Imagine a hypothetical world where everyone's tax rates were 0% except for one unlucky person who gets hit by the 100% rate. Using Mankiw's analysis, this world would be a much more horrible place than it is now or would be under either the Obama or McCain plans.

But it would be just the opposite. 99.9999% of the population would enjoy the massive $28 incentive for earning an extra $1. The one unlucky guy could even be well compensated if just a portion of the population were willing to pitch him a buck for drawing the short stick in the tax lottery.

Which leads us to a flaw in his analysis here. He focuses only on the worse case scenario rather than examining the entire population. For example, for most people the estate tax is 0% because their estates will not be more than the exemption. When confronting the issue of whether to push a bit harder to make that extra $1 they don't care about Warren Buffet's incentives, they care about their own.

To really measure the incentive impact of the different tax plans one has to divide the population into groups and calculate an incentive rate for each one. Computationally challenging but not impossible and it provides a better picture than simply looking at the worse case.

UPDATE: Greg Mankiw has covered this before here. However the calculation does not seem to take population into account. In the above hypothetical the average tax rate is 50% (100% + 0% = 100% /2 = 50%) but that's a very different economy than one where half the population is paying 0% and the other half is paying 100%.
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