Arnold Kling  

Over-worked or Over-taxed?

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Americans work more than Europeans. Do we work too much, or does Europe tax work too much? Edward Prescott argues the latter.


Americans on a per person aged 15-64 basis work in the market sector 50 percent more than do the French. This was not always the case. In the early 1970s, Americans allocated less time to the market than did the French. In comparisons between Americans and Germans, the story is the same. Why are there such large differences in labor supply across these countries? Why did the relative labor supplies change so much over time? In this lecture, I determine the importance of tax rates in accounting for these differences in labor supply for the major advanced industrial countries and find that tax rates alone account
for most of these differences in labor supply.

For Discussion. Prescott estimates that for every 100 euros a worker produces in the high-tax countries, 60 euros goes to taxes and only 40 euros goes to that worker's consumption. Is that a sufficiently high tax rate to have a large effect on labor supply?


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CATEGORIES: Supply-side Economics



COMMENTS (18 to date)
Lawrance George Lux writes:

I could only source seven pages of Prescott article, but I was at a loss at his refusal to define the difference of Capital cost between Leisure consumption and Government consumption. Government expenditures include high capital cost items, not obtainable by average Households. Higher Government taxes express the lessened ability of European Households to finance Big-Ticket items.

The high tax rate on European Households would not seemingly indicate the Prescott initiative; simply a case of finding numbers to buttress a position. It is highly indicative that Prescott discounted the untaxed Underground labor market, a potent force in Europe; where serious segments of Productivity is left untaxed. lgl

Ray Gardner writes:

Lawrance mentions the well known and ubiquitous Underground European economy. As a general rule, black markets do not occur except where restrictions make them necessary.

In the presence of such an underground market and in light of falling productivity, the ramifications of such a confiscatory tax rate seem obvious.

People have to work harder for the same quality of life that they would otherwise have in a freer market. This is proven by the very presence of such a large black market. To think otherwise is to propose that people are engaging in extralegal economic activity solely for grins and giggles. Of course they are not, so the semi-rhetorical question remains; why are so many engaging in under the table business? To bolster their personal economies, why else.

Ray Gardner writes:

More to the point of the Prescott initiative; that such high tax rates reduce the measurable, taxable productivity of the population, I’ll restate the point of the size of the underground economy.

People are not engaging in extralegal activity for any reason but to improve their lot in life; whether that be a second car or an air conditioner for their Paris apartment. The very fact that so many people have to go outside the normal means of business to acquire what they deem as necessary to their personal economy is proof enough that the tax rates are retarding productivity and thus the quality of life.

For more quantitative information along these lines, the web site freetheworld.com publishes a global economic freedom index.

I wonder about this kind of thing sometimes. (And I'm saying this as a real econ naif, so go easy on me.) I mean, isn't there an underlying assumption here that if only it weren't for government meddling/excessive taxation/corruption/whatever nearly everyone would be out spending lots of time and energy maximizing income via legit channels?

Well, says who? Seems unlikely to me. So: what evidence does anyone have that this is a legitimate assumption? And if it isn't, why make it?

I'm often struck that it never seems to occur to people that perhaps the reason a European indulges in some black-market tomfoolery might not be that excessive tax rates give him no other option (although it might be that too). Perhaps he simply prefers to conduct that kind of life life in that way. Perhaps his people (so to speak) have always done things this way; perhaps he gets a secret thrill out of doing things this way; perhaps he's comfortable with what we consider corruption (perhaps he finds it sexy -- there are a lot of novels based on this idea); perhaps this is his preferred way to make a separate kind of peace with the market.

In other words, perhaps he's already expressing a preference, just not a monetary preference. Perhaps not, of course. But why is the possibility that this might be the way he prefers to conduct a life so seldom considered?

It seems to me that deviations from a free-market ideal don't really need to be explained in this way. Why should anyone be expected to want a free-market ideal? Perhaps that's appealing to some people, but perhaps it's the last kind of life a French person would opt for.

And besides, people have positive reasons for going about things the way they do, not just negative ones. And perhaps also, once a population's income gets to a certain point, people might simply become less concerned with maximizing income. Perhaps, income-wise, at a certain point they're happy enough. What then do their druthers become?

Bob Dobalina writes:

>

I think most of us would argue that plenty of people value leisure more than wealth, so, no, I don't think anyone makes that assumption.

The assumption we make is that the state sometimes makes crime a better vocation than it otherwise would be, absent all of governments prohibitions. No one would be pushing coke if it could be legally purchased in a drugstore; the cigarrette smuggling racket would be markedly less attractive if the margins were slimmer (if taxes were lower.

I don't think any of the regulars (of which I am not one) here are utopian, but for the most part, we believe that people are better off when they are more free. While there's plenty of empirical evidence to support this claim, some of us subscribe to this philosophy because we feel it is the only just way to be governed.

Ray Gardner writes:

Actually, the assumption that people prefer freedom over oppression is not being questioned, at least not seriously. The question is, if and where a definitive line can be drawn as to what is restrictive and what is, relatively speaking, not restrictive. So it’s axiomatic that people prefer freedom; we’re just talking about degrees of freedom and how individual freedom is affected by external influences i.e. taxes.

No one can determine that “certain point” where another person is happy enough. Who are you or who am I to attempt such an egregious act of hubris? Thus the well documented failure of centrally planned economies.

So the base line for those who champion individual rights is that the government’s role in our lives is to protect the citizens from force and fraud, essentially. Once the government gets involved in making choices for individuals who are not harming anyone else through force or fraud, personal freedom is diminished. Spending someone else’s money on a noble cause thus strips the cause of its nobility.

So the free market in essence then is the natural, default condition of human economy where people are free to engage in voluntary actions with one another. The less free that market, the less free the person who belongs to that market or community. Thus “deviations from free market ideals” are deviations from human freedom.

To otherwise assert that the average person prefers oppression is simply ridiculous, the entirety of human history refutes such an idea.

Ray Gardner writes:

Looking at this in a more quantitative manner, the very mechanics of how a black market operates refutes the idea that the average person would prefer the extralegal to the legal.

Products cost more in a black market, this is a quantitative fact thus the argument against the drug war (would the name Al Capone still be a household name if it were not for Prohibition?). Outside of the pretentiously fashion conscious who feel they need to spend more on certain items, no one purposefully spends more on a product than they have to. Nor will they go out of their way to buy the same product that could be purchased across the street, ceteris paribus.

So outside of the habitually criminally minded (for whom the infamous Dr. Goddard coined the term ‘moron’) the average person will not engage in a black market if there are legitimate alternatives.

Blowhard also referred to some kind of ancestral black market heritage. This is bogus of course, there is no such thing but I believe what Mike is trying to say is that perhaps the French are attempting to emulate the simple artisan lives of their ancestors. If this is indeed the case, then he is actually making the point that people do prefer freedom over oppression in that they are longing for a time when they could go about their business out of the sight of so many regulatory eyes. This is of course a very simple but accurate definition of a free market.

Ray Gardner writes:

One last thing that is interesting to note is that part of Mike’s example assumption was that if the government would just get out of the way, “everyone would be out spending lots of time and energy maximizing income.”

This is more than just semantics so bear me out but everyone already maximizes their income, free market or not. This is part of the point; when the government takes more than 50% of a person’s income, they tend to set lower levels of “maximization.”

To say that “everyone would be out spending lots of time and energy” is not true however. As has already been stated, everyone has differing levels of comfort and ambition so people always maximize their energy vs. earning an income. This comes full circle as to how to increase overall productivity and thus the quality of life for that society by allowing people to find their own maximization and not imposing a centrally planned idea on what that level should be.

Eric Krieg writes:

>>This comes full circle as to how to increase overall productivity and thus the quality of life for that society by allowing people to find their own maximization and not imposing a centrally planned idea on what that level should be.

Awesome point, Ray. People have to remember that human behavior is set at the margins. How hard you need to work for the next dollar of AFTER TAX INCOME determines if you are going to bother to work or not.

With a progressive income tax system, essentialy you are paid less the harder you work. It seems to me that this goes against human nature.

Many thanks for the explanations. But I still wonder ...

An example: Your assumption seems to be that a person is free to the extent that his government lets him be free. ("Once the government gets involved in making choices for individuals who are not harming anyone else through force or fraud, personal freedom is diminished.") Sympathetic though I am personally to the argument, my experience (admittedly 30 years ago) with the French suggests to me that, as far as most Frenchpeople are concerned, they wouldn't agree. As far as they're concerned, they already are free. There's a government out there, but there will always be a government, and what's the use of getting upset about that, one might as well get upset about the state of the weather; one takes it into account as best one sees fit and gets on with life. One is always one's own free man. Perhaps, if you feel that the government is getting greedy, you spend a little time dodging it via blackmarket channels -- why not? In what way does that mean one isn't free? One has freely chosen to dodge the government, which after all is a mere fact of life one deals with, like one deals with disease and hunger. One attends to it, wearily and wisely, and it certainly doesn't enslave one's person, except perhaps at the gulag extremes.

Another example: "For the most part, we believe that people are better off when they are more free." But many French people wouldn't feel free without their whole nanny-state apparatus, the health care, etc. It's what sets them free, in their eyes. They feel oppressed by our focus on competitiveness and on matters of economic efficiency. I know this contradicts my point above -- but the French wouldn't care; they aren't bothered by these kinds of contradictions, and find people who care about such things to be naive.

Another example: "Everyone has differing levels of comfort and ambition so people always maximize their energy vs. earning an income. This comes full circle as to how to increase overall productivity and thus the quality of life for that society by allowing people to find their own maximization and not imposing a centrally planned idea on what that level should be."

Two points:
* OK, if the French, say, are already maximizing their energy vs. earning an income, as you say, well, perhaps the way they are doing so (high tax levels, long vacations, high-ish level of unemployment, some stagnation, substantial black market) suits them. Perhaps it's their preference. What proof do we have that this doesn't suit them?
* You seem to be convinced that in all cases a "centrally-planned idea" is a bad and oppressive thing. I'm hardly advocating socialism. But what if the French don't see "central government" as the same kind of semi-optional, antagonistic thing we tend to see it as? What if they see it as inevitable, semi-desirable, inevitably corrupt and greedy, but also admirable -- something whose taxes they'll certainly spend a little time dodging (why not?), but also something they'd never imagine doing without. What if, in a general way, centrally-planned things are OK by the French? Centrally-planned things, after all, can be mighty convenient. Stylish too. Perhaps the French like the combo of convenient (restricted choice) and stylish. What proof do we have that they don't? Plus they have a long history of doing the centrally-planned thing; it seems much more like their "default position" than anything you and I would think of as a free-market does.

Arnold writes in his posting intro: "Americans work more than Europeans. Do we work too much, or does Europe tax work too much?" I guess my final musing comes down to: Arnold presents a fact, and the poses a question. Good for him! My response: How and why does that question follow that fact? Perhaps no one's doing the right thing and no one's doing the wrong thing. Perhaps Europeans and Americans just have different ways of going about life.

Bob Dobalina writes:

Well, first--

"Perhaps, if you feel that the government is getting greedy, you spend a little time dodging it via blackmarket channels -- why not? In what way does that mean one isn't free?"
Are you serious? If one operates in the black market the government can confiscate his property or imprison him. Doesn't sound "free" to me.

Aside from those objectionable questions-- Is it your assertion that since their democratic government voted to give up these "freedoms", they are not truly worse off? I suppose I might grant you that point. If 100 of my closest friends decided to start a commune, voluntarily suspending their freedoms, I wouldn't claim that they were irrational. But I'd fight them to the death if they tried to conscript me.

It's my position that if the French wish to live in the arrangement that they do, it should certainly be their choice-- I have no right to tell them how to live. What I take issue with is the enslavement of those working people in France who do not want to be a part of the bureaucratic machine. A system where those who toil and create must forfeit the fruits of their labors so that postmen and clerks can take long holidays and retire on fat pensions is nothing short of slavery, in my book.

Sure I'm serious. And I'm sorry that you find the observation and question "objectionable" -- apologies, though I'm not sure for what.

Look, the French have different attitudes towards a number of things than Anglo-ish countries do. One's the question of corruption; another's the relationship of the individual to the state. Anglo-ish countries tend to be moral and reform-driven where corruption's concerned; we get outraged by it, we think it's automatically evil, we think it gets in the way of where we want to go. The French don't see corruption that way. In their eyes, it's an inevitable part of life. Arguing with it is childish; corruption can even be something to be savored. (No coincidence that the French love cheese that smells like corpses.) We're all gonna die, governments and businesses (and individuals) will all be corrupt to a point, a lot of secrecy is to be expected ... And to fight all that is just to get your knickers in an uptight twist. Let us not be infantile. Let us drink some coffee and eat some cheese instead -- that's what life is really about.

So, sure I'm suggesting that a certain amount of black-market activity isn't just tolerated by the French but expected. How much, I have no idea. When do they start thinking it's too much, and that something needs to change? And how can one tell? Good questions for economists to look into. But like I say, they not only don't mind a certain amount of corruption, they rather enjoy it -- it adds flavor, and a life without flavor isn't a life worth living. But they certainly don't think it can or should be willed away. And to those who point out that corruption drags down economic efficiency -- well, the French nose would go right up. Why should they bow down before such impersonal gods? That would be degrading.

I'm not defending this -- I'd rather live in the States than in France. But I did live there for a year and I do have French friends. And I'm pretty sure it's fair to say that they would never, ever automatically let a question of economic efficiency make a decision for them. That just wouldn't be French -- and "being French" is something they're devoted to. It's why they get up in the morning. They may well (and often do) take economic efficiency into account, and past a certain point they may well think it's imperative that something drastic be done about economic efficiency. (And maybe now's such a moment, what do I know?) But, good lord, to let such considerations automatically prevail? Why, the thought of it! In their minds, it's always *up to them* to make these decisions. The idea of letting a spreadsheet or an equation make a major decision for them? Absurd. Degrading. Oppressive.

Another attitude the French have that's very different than what we're used to is their attitude towards government. We seem to see government as semi-optional, as existing at our behest, as always on trial, and in great need of policing. (Personally, I don't mind this view at all.) And to many of us, our sense of personal freedom depends on our ability to beat back the government -- to be un-interfered with by it. Freedom to us is often freedom *from* government. The Frenchperson's relationship with his/her government isn't like that at all. On the one hand, it's more like having a neighbor, or a tree in the front yard, or the weather. It's inevitable, it's there, it ain't going away; you live with it and you deal with it. And your sense of your personal freedom certainly doesn't depend on it, at least until it really starts to misbehave.

On the other hand, done properly, government isn't the antithesis of freedom, it's an enabler of freedom. They're quite happy looking to government to make a lot of decisions for them. (Once these decisions are made, they're then free to go back to the real business of a Frenchperson, which is "being French.") They think that's one of the reasons government is there; they're paying it, to some extent, to do this job.

Freedom to them isn't a matter of carving out a little space where you'll be undisturbed by the bureaucrats. Freedom is first something you have in yourself, and is second something the government helps provide by taking care of certain arrangements for you. It frees you from some of these burdens -- which they'd otherwise feel oppressed by. You freely choose, on your own, to interact with this system as you see fit. It would never occur to them to try to "be free" of government -- that would strike them as absurd.

I should add, by the way, that I've known a couple of rich French people, a couple of poor ones, and a couple of working-class ones. And they've all been equally French -- "quality of life" (cheese, wine, vacation, etc) considerations generally prevail over economic math, at least until they feel something really must be done. And they're proud of this; it's in this that, to some extent, their Frenchness resides. It's important to all of the French people I know that *they* do the choosing, not the economic equation, even if it's the equation they finally choose. And in their eyes, there's no question: we're the oppressed ones. They see us as enviably prosperous and energetic, perhaps, but also as slaves to questions of economic efficiency, fools and rubes who let maximizing value in money terms make all the decisions for us. Forever chasing after dollars and "fun" and clueless about how to savor what it is to be alive. In their eyes, we just don't know how to live.

Please don't mistake me as an advocate for any of this. I much prefer the American thing to the French thing, although I do think the French are on to a few things. (Some excellent cheeses!) But boy is it ever obvious to me when I'm with the French that they prefer the French thing to the American. Immense self-satisfaction and a feeling that any sane person deep inside really aspires to be French are characteristics of the French, no? So until we have good proof that the French are unhappy with the way they're going about their beloved mission of "being French" -- and they do get a lot out of "being French," it's a source of great satisfaction to them -- I'm going to assume they're doing a pretty good job of it.

But perhaps there are good indications that the French these days are fed up with their way of arranging matters and want to change it. Are there?

Lawrance George Lux writes:

A number of assumptions were made about the European Underground Market, which assumes it is identical to the American Black market. It includes such arenas as 'Tipping' for personal service. No Waiter in France would accurately report his Tips, if they are even taxed; the French have a habit of starting Revolutions.

Your assumptions that the European Black market is always more expensive is also wrong. European business has had a long history of producing for Wholesale for the Black market (without reporting that Production to the Government), because they know many Consumers cannot afford consumption with the tax; they maximize Production receiving the same Wholesale cost, knowing Black Market operators sell the Product for less.

Previous statements were quite right, it has much to do with the Social context. Europeans would be outraged if the Government withheld Social services, but they want to pay for those Services in a context where their taxes are limited.

Prescott chose to ignore the European Underground Market in his analysis, showing he did not adequately understand the European economies. lgl

Jim Glass writes:

"Americans work more than Europeans. Do we work too much, or does Europe tax work too much? "
~~

Strikes in Italy yesterday over the government's attempt to raise the retirement age (now 57 for many) a little as a small step towards averting future insolvency.

Europeans can work as little as they want, that's up to them, but they can't both work little and less *and* provide retirement benefits for themselves that become greater and more as time goes on, through their transfer tax retirement systems, no matter what they do with tax rates.

They are trying to legislate a free lunch for themselves. If one wants to see Bastiat's "government is the fiction by which everybody strives to live at the expense of everybody else" in action, look no further.

Eric Krieg writes:

>>They are trying to legislate a free lunch for themselves.

And some would say that that is their business.

I'm not one of those people.

When the Europeans create these welfare states, the suppress their own internal demand for imports (not to mention a whole lot of other things). Thus, US export oriented countries are denied yet another functional market.

Lackluster demand in Europe because of their welfare state combines with lackluster demand in Japan because of their disfunctional banking system to make it REALLY difficult to be an export oriented firm in the US, or even China. Countries like China then have to focus even more strongly on the US market, the only functional one on the face of the earth.

dsquared writes:

Of every 100 produced by a worker in high-tax countries, 40 goes to the government and 60 is available for the worker's consumption? Is Prescott really suggesting that the rate of profit in high-tax countries is zero?

Eric Krieg writes:

>>Of every 100 produced by a worker in high-tax countries, 40 goes to the government and 60 is available for the worker's consumption?

The top marginal tax rate in France, Germany, and Italy far exceeds 40%.

Ronan Martorell writes:

>> But perhaps there are good indications that the French these days are fed up with their way of arranging matters and want to change it. Are there?

Of course, there are. Mismanagement with state monopolies (e g Telecoms, Mail, Energy) are more and more scrutinized by their control authorities in charge of their auditing. High-civil servants now publicly express their views towards market-driven reforms in the state utilities, once a tabu in France. A major reform with public finance is also being put into force in the same way. In brief,the Parliaments will now check state expenses according to program-oriented budgeting instead of voting for credit authorizations.


>> Is that a sufficiently high tax rate [60%] to have a large effect on labor supply?

Yes, but in France one also have to take into account the peculiar structure of the labour market. One out of five workers is still active in the public sector where the wage progression is so-to-say 'automatic'. Indeed french civil servants are rewarded upon an experience-based scheme, which is strictly incremental since a public servant cannot be fired excepted in a few extreme situations (criminal convictions). Some extra premiums based on individual performance are now suggested but the trade unions remain strongly opposed to such (minor) reforms.

Speaking about french peculiarities, we must also remind that personal income tax is still not a pay-as-you-earn tax but is annually declared and paid upon receipt afterwards.

However, I think that the French-American divide about individual preferences for work and leisure cannot be generalized without falling into mere prejudices. For instance, I used to work 50-55h a week for a (french) telecom operator in Paris some years ago. A british colleague of mine then told me about his disappointment when he came from his previous job working 41h a week (strictly observed) for a british operator. In Germany, working overtime is still mainly regarded as unefficient and not professional even outside the public sector.

Lord Maynard, a british economist, is developing some interesting theories about optimal taxation. Even if one does not fully agree with some of his assumptions, this approach competes elegantly with public-choice or market-oriented theories in my humble opinion.
See his papers about the economics of happiness for further information. ("Happiness : Has Social Science a Clue ?" available at http://cep.lse.ac.uk/layard/ )

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