Tuesday, September 11, 2012

Financial Aid and Marginal Taxes

John Cochrane makes an observation that crossed my mind when I was reading the Wall Street Journal yesterday.
So, we're looking at 30, 20, and 50 percent additional marginal tax rates on income or savings -- how much you lose if you make or save an extra dollar. The journal is full of useful tips to game the system. 
Now, to the larger question. What matters for economics is the total, marginal tax rate. If you earn one extra dollar, and then spend it, how much stuff or services do you actually get -- after all taxes are included, including payroll, federal income, estate, excise, state income and excise, local, sales or property (if a good) or a second round of income and social insurance taxes (if a service). Ideally, we'd add in the burden of taxation incorporated in product prices too -- if the government taxes a business and that raises the price of what you pay, that's just like taxing you for buying the good. 
The article Cochrane references isn't literally about taxes (commonly conceived), but it is about how earning more reduces your expected financial aid package from universities.  For the reasons Cochrane gives, effectively, financial aid phaseouts are behaviorally equivalent to taxes.  This subtlety won't be lost to students of economics, but it is often swept under the rug in political discussions of tax rates, which is why you should read Cochrane's post on the topic.

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