Fortune issue: March 16, 1998
Ax Taxes for Xers!
By N. Gregory Mankiw
With my 40th birthday just days behind me, it's a little painful to admit this, but if Congress passes a tax cut this year, as many Republicans advocate, I think it should target younger workers--and exclude those of us with graying hair and expanding waistlines. Call it the Generation X Tax Cut: Only taxpayers under the age of 30 need apply.
Current law already uses many factors beyond income to set a person's tax liability--marital status, number of children, mortgage size, charitable giving, and so on. Age is one variable conspicuously omitted. Yet in a recent and still unpublished paper titled "Should Taxes Be Independent of Age?" MIT economist Michael Kremer cogently argues that younger workers should face lower income tax rates than older workers.
To see why, start with a simple premise: An income tax discourages people from working and thus prevents the economy from reaching its full potential. Tax cuts reduce this disincentive, encourage people to work harder, and expand the economic pie.
Yet tax cuts do not affect everyone the same. For instance, suppose that the government were to cut the tax rates that apply to the first $30,000 of earnings. Taxpayers with incomes below $30,000 would have a greater incentive to try to make more money because each dollar of earnings would be taxed at a lower rate. But that is not true for someone earning above $30,000. In economics-speak, this person would view the tax cut as infra-marginal--the reward for additional work would not improve.
How much incentives increase from such a tax cut, therefore, depends on the ratio of low-income to high-income taxpayers. That ratio, in turn, varies by age. Few 20-year-olds make more than $30,000 a year, so this tax cut would encourage almost everyone in that age group to work harder. Yet because many 40-year-olds are in the high-income group, the tax cut would boost incentives for far fewer of them.
Not only is it easier to improve incentives for young workers, but they are also more likely to respond. Middle-aged workers are often locked into jobs that give them little choice about how much they work. Young workers are still choosing career paths and have more flexibility. Kremer estimates that young workers are about four times more responsive to work incentives than the middle aged. The bottom line: If the government wants to get the most economic gain for each dollar of lost tax revenue, it should offer a tax cut to younger workers. Such a tax cut would also give cash to people at precisely the time in their lives when they most need it. Many young workers are college students working part-time to pay tuition, recent graduates saddled with large student loans, or young couples trying to save for a down payment on their first home.
An ancillary benefit from a youth-targeted tax cut would be reduced crime. According to arrest rates, the young are about 20 times more likely than the middle aged to commit property crimes, such as burglary, robbery, and auto theft. They are also more likely to engage in illegal drug trade. Like all career moves, the tendency toward criminal behavior depends on the alternatives. A tax cut would help discourage the young from entering the underground economy by enhancing the reward for legal work.
Could a youth tax sell politically? Politicians are fond of saying that they want to help the young get a good start in life, which usually means new forms of government spending, such as Clinton's pet AmeriCorps program. But the best way to help is much simpler: Just let the young keep more of what they earn.
N. GREGORY MANKIW is a Harvard economics professor and author of Principles of Economics.