The Causes of Leisure Inequality

My problem with Lansburg's latest piece in Slate is that it leaves the impression that lower income workers have lower incomes because they work fewer hours. I don't think Lansburg means to give this impression but in my opinion he doesn't work hard enough to avoid it.

The cause for the inequality in leisure is, by my guess, a result of both rising wage inequality and the progressiveness of the tax structure. Allow me to explain.

As most economic students know rising wages have two effects on the amount people choose to work. On the one hand people want to work more because they are getting paid more for each extra hour. On the other hand people want to work less because they've already earned so much from their previous hours work and so they don't need the extra money as much. In the end we are not sure which way it will go.

However, progressive taxation adds a wrinkle. Lots of money is taken from those at the high end and redistributed roughly evenly in the form of government services. This means that rising wages ensure that everyone has more whether they work more hours or not.

The effect is biggest for the poor because government services are a larger part of their consumption. As the rich get richer the poor receive larger and larger transfers and this induces less work. One of the most obvious examples is the child tax credit.

When the Bush administration lowered taxes it cuts rates for the wealthy but it also greatly increased the direct transfer to the poor and middle class through the child credit. This has in economic terms a wealth effect but no substitution effect. The result is that the poor and middle class are incentivized to work less.



Hat tip to Mankiw