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The Bush Tax Cuts: How did they affect incentives to work?

The Bush tax cuts actually had a surprisingly small effect on the marginal tax rates faced by most Americans. Many households in the bottom half of the income distribution owed little or no federal income tax even before the tax cuts. Others higher up in the income distribution are subject to the alternative minimum tax, which was reduced by the Bush tax cut legislation, but only temporarily. These factors and others meant that the tax cuts did not reduce marginal tax rates for about three-fourths of households, indicating that the tax cuts did not change incentives to work for the majority of workers.

  • A study using the tax model at the U.S. Department of the Treasury showed that the 2001 tax cut, when fully phased in, would provide no reduction in marginal tax rates for 76 percent of households. Even among those with positive tax liability, 64 percent would experience no reduction in marginal rates, according to the study.
  • Similarly, calculations using the TPC microsimulation model indicate that if both the 2001 and 2003 tax cuts were made permanent, 60 percent of filers, who collectively represent more than 40 percent of taxpayers and report 30 percent of all taxable income, would not see a reduction in marginal tax rates relative to pre-2001 tax law.
  • Many provisions of the tax cuts reduced taxes owed but did not increase the incentive to work. For example, the creation of the new 10 percent tax bracket meant lower taxes for those further up the income ladder, but many of those taxpayers continued to face the same marginal tax rates of 15 percent or more. The expansion of the child tax credit reduced taxes for income taxpayers with children but did not alter the marginal tax rate for many of them. Calculations using the TPC microsimulation model indicate that if the tax cuts were made permanent, 44 percent of all filers with an income tax cut, representing 34 percent of taxable income, would receive a net tax cut in the sense of facing a lower total tax bill, but would not experience a reduction in marginal tax rates on wages. (Indeed, this model shows that because of complex interactions in the tax code, the tax "cuts" actually caused 7.7 million filers to face increases in marginal rates!) Thus the tax cuts did reduce taxes for many households, raising their after-tax income in a way similar to receiving a bonus check, but did not reduce their marginal tax rate, which is what matters when deciding whether to earn additional income.
  • The standard presumption in economic theory-and the evidence from research-is that when people get more income, but their incentives to earn additional income do not increase, at least some will choose to work less. In effect, they will take some of their tax cut in the form of more hours of leisure.
 
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   Entry 3 of 9