Raising Taxes Stifles Initiative Invisibly
AUGUST 01, 1993 by RICHARD W. STEVENS
Mr. Stevens is an attorney in Alexandria, Virginia.
A business talk show host recently stated that even with higher taxes on everybody, the American spirit of initiative and hard work would survive. Nobody, he said, would stop working hard just because his taxes went up. A true story shows how that host was wrong.
Thirteen-year-old William Johnson was having trouble in his algebra class. William would fail algebra if he did not quickly improve his quiz grades. Mr. and Mrs. Johnson had exhausted themselves trying to help William with his studies. The Johnson family decided to get some outside help from a tutor. They answered a local newspaper advertisement offering tutors.
Across town, Sarah Thomas was a young mother with a mathematics degree and two small children. Her husband was making a good living, and Sarah was able to stay home with the kids. Still, Sarah wanted to keep her academic skills sharp and make a few extra dollars. Sarah answered a local newspaper advertisement seeking math tutors.
The source of these newspaper advertisements was a small local business, run by another homemaker with ambition. The business connects tutors with those needing them, and charges a small fee. When Sarah learned that she could make $15 per hour helping someone, and doing something she loved, she was enthusiastic. Soon Sarah was tutoring William in algebra.
After a few weeks, Sarah started wondering flit was worth it. Her husband’s income put the Thomases in the 31 percent marginal federal tax bracket. State taxes took 4 percent, too. So for every $15 Sarah made, she could keep $9.75. This wasn’t bad, but then she learned she had to pay self-employment tax (Social Security) of about 15 percent. Now she was left with $7.50.
Of course, when she worked Sarah had to pay a babysitter to watch the kids. If Sarah were to tutor one hour, she would have to pay the babysitter for two hours, since round trip travel time to William’s house was about 30 minutes. Sarah paid the babysitter $3 per hour, for a total of $6. The 10 travel miles, at approximately 20 cents per mile, cost Sarah another $2. Her out-of-pocket expenses now amounted to $8 for a one-hour session.
Now Sarah incurs $8 in expenses against $7.50 in after-tax income. Sarah is eligible, however, for the 20 percent child care tax credit of $1.20. Her net after-tax income for the tutoring session: 70 cents.
When Congress raised taxes on the “rich,” the Thomas family was hit with a 36 percent marginal tax rate. The new taxes cost Sarah another 75 cents. She was now losing $.05 per hour of teaching time, and making nothing for the 30-minute commute time and preparation time.
Sarah Thomas could not afford to lose money tutoring, and sadly had to quit. The small business that connected tutors to pupils lost a tutor. William lost the services of smart, patient Sarah. And the government lost $7.50 in tax revenue.
In the market economy, free exchanges of goods and services for money result in mutual benefits for those concerned. The parties to such exchanges become wealthier because they trade what they value less for what they value more. Each gets more of what they consider valuable. Efficiency in production and distribution of goods and services in a system of free exchange leads to increased wealth for all the participants.
When Sarah tutored William, Sarah gained $15 (less expenses) and some psychic reward, and William gained knowledge and better grades. It was a fair bargain.
Individually, the tax rates by themselves had not looked too fearsome: 31 percent federal, 4 percent state, and 15 percent Social Security. And a 5 percent increase in marginal rates seemed modest enough.
But even before the $8 in expenses, Sarah’s income per session dropped from $7.50 to $6.75 with the tax increase. She would be making only 75 cents more in the transaction than her babysitter.
Sarah could not simply pass the taxes through to William’s parents by increasing her fees. The Johnsons were really stretching their budget to afford a tutor at all, and could not pay more to cover Sarah’s taxes. By imposing the increased tax, the government ended the transactions which had enriched William, Sarah, the tutoring agency, and the babysitter.
After stifling the Sarah-William transaction, the government provided nothing to compensate for the loss. Nobody was better off. The government didn’t even get the expected tax revenue. Since nobody counts what cannot be seen, nobody can accurately tally how many times people stop doing things to create wealth because of taxation.
True, the Johnsons will spend or invest the $15 on other things in the economy, and will gain some benefits. But the Johnsons will have lost the benefit they wanted most for that $15. Instead of tutoring services, perhaps they will get pizza or shares in a mutual fund. It will be like sitting down to a prime rib dinner, only to have government require you to accept several cheese sand wiches substituted for the same price. In real human terms, the Johnsons lost the full benefit of the $15 by being forced to take their second choice.
High taxes abort economic productivity. Raising marginal income taxes, even if only on the “wealthy,” must result in lost wealth with no compensating gain. And yes, big government tax policies can and will invisibly snuff out the American spirit of individual initiative and hard work.