The income tax deadline is approaching fast, and for many of us, preparations for an income tax reckoning at the state and federal level are well underway. Unlike at Christmas, this isn’t a warm and fuzzy giving season. In fact, tax season is a fiscal adjustment period for a lot of people, because the biggest tax bite has already been taken via payroll withholding. Those who didn’t quite ante up enough usually feel put upon when they must write a check for additional tax payments. Few of us even look at the sum, or would relish the prospect of writing out one very large check at the end of each year.
Oddly, I think, some folks who overpaid their taxes view the return of their money, at zero interest, as a kind of government-granted bonus. While I’m not thrilled if I owe additional tax at year’s end, I also know that I would not voluntarily place my money in a savings account at zero return—the equivalent of overpaying my tax (and therefore qualifying for a refund). But taxes take a bite out of more than our finances—they take a bite out of our actions, and influence our choices. This is especially true in our decision to pursue work (be productive) vs. leisure. The more heavily we tax work and productivity, especially at the margin, the more we induce people to choose less work.
“At the margin” means that people are not making all-or-nothing decisions about work and work effort. The marginal approach applies for most economic decision-making. In the labor market, productivity choices are influenced by the marginal tax rate—the percentage of each additional dollar income earners get to keep, rather than turn over in tax payments to government.
The higher the marginal tax rate, the greater the disincentive effect on work. When the government collects $.70 out of every additional dollar I earn, for example, I behave differently than when it collects $.10. My willingness to take on extra hours, show up on time, be diligent, etc., is affected by the difference. Depending on deductions, filing status, and other factors, a person’s effective and average tax rate will usually differ from their marginal tax rates
The cumulative effect of high marginal income tax rates can be chilling for the economy, and even reduce income tax revenues overall. According to the Tax Foundation, for the first four months of 2004, Americans worked entirely to pay their taxes. Organizations that calculate the date on which Tax Freedom Day occurs, on the national and state levels, give an idea of just how many days of the year Americans work to pay taxes at various levels.
North Carolina has discouraged economic growth and activity with relatively high marginal tax rates. A reversal of this policy would not only stimulate employment, it would reduce the temptation to engage in the risky strategy of state industrial policy—handpicking firms and industries to receive tax breaks and other taxpayer-financed “incentives.” If the goal is to get more North Carolinians working, low marginal tax rates are the market alternative of choice.