How People Respond to Tax Rate Increases and What it Means for the Cost of Health-Care Reform

Health-care reform is going to cost of lot of money. As it stands right now, we are talking about $1.3 trillion over ten years. But it’s not just spending, of course. It’s taxes, too. According to Harvard University economist Greg Mankiw, the implicit tax rate from health-care reform is 23 percent on average, but for lower income levels, the implicit marginal tax rate is even higher. It’s roughly 34 percent. That’s a lot of taxes on Americans whom president Obama claimed wouldn’t see their tax burden go up.

At a time when Ayn Rand’s novel, Atlas Shrugged, makes a strong comeback, it is important to ask: How much does the Atlas really shrug? Do people really work less when marginal tax rates go up? Would an increase in marginal tax rates reduce GDP, and by how much?

On his blog, Mankiw points to the latest paper on the impact of tax rate on people’s behavior from another Harvard economist (here). Based on this paper, Mankiw calculates how much income an average taxpayer will lose due to the health-care reform driven increase in tax rates: “His taxable income will fall by 17 percent. Thus, the economic impacts from these implicit tax hikes are sizable.”

That is important because when CBO scores the cost of health-care reform, it assumes that GDP will remain constant. But if Atlas does shrug, the GDP will be reduced and the cost of health-care will be way higher than projected so far. So brace yourself for gigantic and sustained deficits in the future.