Taxation: A Very Short Introduction by Stephen Smith

Author:Stephen Smith
Language: eng
Format: epub, pdf
ISBN: 9780199683697
Publisher: OUP Oxford
Published: 2015-02-09T05:00:00+00:00

Although we often refer to the ‘disincentive’ effects of income taxes, it will be seen that the effect of income tax is not always in the direction of reducing the amount that an individual chooses to work. A tax on labour income has, in fact, two different effects, which economists refer to as the ‘substitution’ and ‘income’ effects, respectively, and these do not necessarily pull in the same direction.

The substitution effect arises because—for a given standard of living—a tax on labour income affects the attractiveness of work at the margin. In other words, it reduces the gain from an additional hour’s work, compared with the alternative—more time for leisure, perhaps. The substitution effect of an income tax certainly works in the direction of reducing labour supply. If an increase in income tax could be implemented in such a way that it did not affect someone’s overall standard of living and only impacted on their decision whether to work an extra hour or not, it is clear that additional tax acts as a disincentive. Fewer people would choose to work the extra hour.

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