Question

Income taxes lower the effective wage rate. Explain why taxes might have only a modest effect on hours worked. If this is true, explain how total labor supply can still be reduced substantially by an increase in income tax rates even if individual workers do not decrease hours worked. In the context of these labor supply effects, explain why a progressive income tax might be efficient.

Answer 1

According to the federal government, tax was levied according to the income earned by the individuals accordingly, Though income taxes levied in the US nation are usually progressive in nature, but in some way the effects of such taxes on labor income and essential consumption expenditure leads to the reduction of the incentives and the hike for the working employees section in all the levels. Let us discuss the strong effect of income taxes effecting the decrease in the wage rate as well as the decrease in the supply of labor rate in the considerable rate.

The employers of the firms will always the perspective of earning more gains with less spending on the cost of production. The function of providing wages to the employees are considered as the important cost for the firms in the production function. The more wages they are providing the more tax has to paid from the pockets of both employees and the employers. After so much deductible tax in the form of Corporate Tax and the Income Tax, employers and the employees has the responsibility of saving their critical situation by the following ways.

Employers has to reduce the quantity of the employees by adopting the situation of lay-off methods in which considerable number of employees are given compulsory voluntary retirement who are in service for many years without any proper reason and secondly on the other side, the employees need to shift their occupation from the legalized company to the company which earns through shadow economy, Shadow economy in the sense is the illegal formalized company in which they cheat the federal government without paying any tax nor binding any statuary requirements to be followed by the firms. Obviously those employees who in the situation of earn money in order to run their own family they find jobs in such firms who fetches gains through shadow economy.

When the US country levies huge taxes on labor income and expenditure, the employees working in the organized sector need to sacrifice the facilities like Huge coverage health insurance, Sick leave assistance, Educational and Housing loan facilities and other social security benefits, etc. Secondly the situation of Tax Wedge also effects the supply of labor in the short-run as well as in the long-run labor market. Tax Wedge refers to the explaining the situation of market-inefficiency prevailing in the labor market in which the employees can check their payment for their contribution of work towards the production of goods and services before tax deduction and the after the tax deduction accordingly with the final net salary received by them. It also compared with the earnings with the more hours they compensated to work, But beyond the work if the salary are less they starts to seek the job in the unorganized sectors which holds the shadow economy. So if the less tax are levied on income of the consumer expenditure, supply the labor will increase without any shift of change from organized firm to the informal firm also without change in the production pattern of the firms.