Economists talk about the “tax wedge.” This term refers to the difference between pre-tax and after-tax costs.
The term can be used to refer to any difference caused by our tax structure. For example, a merchant sells something for $1.00, but the purchaser pays $1.07 if there is a sales tax of 7%.
Frequently the term is applied to labor costs where the “wedge” can be quite large. An example might be an individual capable of earning $30.00 per hour in his occupation, willing to do home improvement work that he could have someone else do for $20.00 per hour. From a purely economic standpoint, such behavior is a misallocation of resources (naturally we assume that the person is able to get as much work at $30 as he desires) according to society’s supply-demand preferences as reflected in prices/wages.
So why does this behavior occur? Taxes. For simplicity, assume a person pays 40% in taxes. After taxes, he makes $18.00 per hour. If he does his own repair, he “earns” $20.00 per hour. In effect, he works for himself “off-the-books” where his “earnings” are not subject to tax. Wise for the individual but not necessarily a proper basis for a societys to achieve an efficient allocation of resources.
A friend sent the following via email (origin unknown). It illustrates in rather dramatic detail the effects of “off-the-books” versus “on-the-books” income. The former refers to unreported income for the recipient. It is cast in terms of immigrants, for obvious political purposes.
Rather than blame the immigrant, it seems more reasonable to blame our incredibly overbearing and convoluted tax structure and the incentives to exploit the welfare state.
The behavior attributed to illegal immigrants is rational for both illegals and citizens. “Off-the-books” income occurs regularly in what is sometimes referred to as the “shadow” economy. The incentives to “game” the system are overwhelming for lower income Americans. Joe and all the rest of us “on-the-books” are the ones being exploited by our own government. As the tax burden rises, so will the number of people who attempt to generate unreported income.
A GOOD SIMPLE SUMMARY WHICH MOST PEOPLE CAN UNDERSTANDSubject: “Joe Legal” and “Jose Illegal”
You have two families: “Joe Legal” and “Jose Illegal”.
Both families have two parents, two children, and live in California .Joe Legal works in construction, has a Social Security Number and makes
$25.00 per hour with taxes deducted.Jose Illegal also works in construction, has NO Social Security Number, and
gets paid $15.00 cash “under the table”.Ready? Now pay attention…
Joe Legal: $25.00 per hour x 40 hours = $1000.00 per week, or $52,000.00
per year. Now take 30% away for state and federal tax; Joe Legal now has
$31,231.00.Jose Illegal: $15.00 per hour x 40 hours = $600.00 per week, or
$31,200.00 per year. Jose Illegal pays no taxes. Jose Illegal now has
$31,200.00.Joe Legal pays medical and dental insurance with limited coverage for his
family at $600.00 per month, or $7,200.00 per year. Joe Legal now has
$24,031.00.Jose Illegal has full medical and dental coverage through the state and
local clinics at a cost of $0.00 per year. Jose Illegal still has
$31,200.00.Joe Legal makes too much money and is not eligible for food stamps or
welfare.Joe Legal pays $500.00 per month for food, or $6,000.00 per year. Joe Legal
now has $18,031.00.Jose Illegal has no documented income and is eligible for food stamps and
welfare. Jose Illegal still has $31,200.00.Joe Legal pays rent of $1,200.00 per month, or $14,400.00 per year. Joe
Legal now has $9,631.00.Jose Illegal receives a $500.00 per month federal rent subsidy. Jose
Illegal pays out that $500.00 per month, or $6,000.00 per year. Jose Illegal
still has $31,200.00.Joe Legal pays $200.00 per month, or $2,400.00 for insurance. Joe Legal now
has $7,231.00.Jose Illegal says, “We don’t need no stinkin’ insurance!” and still has
$31,200.00.Joe Legal has to make his $7,231.00 stretch to pay utilities, gasoline, etc.
Jose Illegal has to make his $31,200.00 stretch to pay utilities,
gasoline, and what he sends out of the country every month.Joe Legal now works overtime on Saturdays or gets a part time job after
work.Jose Illegal has nights and weekends off to enjoy with his family.
Joe Legal’s and Jose Illegal’s children both attend the same school. Joe
Legal pays for his children’s lunches while Jose Illegal’s children get a
government sponsored lunch. Jose Illegal’s children have an after school ESL
program. Joe Legal’s children go home.Joe Legal and Jose Illegal both enjoy the same police and fire services, but
Joe paid for them and Jose did not pay.Do you get it, now?
Monty:
If the government eliminated welfare and gave each person a dollar per dollar deduction in their income tax every time they hired a person to work in their home, we could get a lot closer to full employment. Instead, the legitimate renovator or house keeper has to pay tax too, so the money I make to pay the guy who works in my home is taxed twice. The only way a home owner can avoid double taxation is to pay the person under the table, but he still would win if he did the work himself. If given a tax break for hiring people, on top of all the renovators and other repair people we hire, we could (and would) also hire a full-time cook and house keeper, and probably another assistant or two. As it is, the government takes our money in the form of taxes and, after removing huge administrative costs, gives it away to people who do nothing.
High taxes and high welfare benefits destroy the efficient allocation of resources.