Could higher taxes on higher incomes push people into professions that make the world a better place?
Higher tax rates provide less incentive for employees to earn top dollar. After all, they will not be able to keep as much of whatever they make. And according to new research by the Kellogg School’s Charlie Nathanson, an assistant professor of finance, tax rates have a measurable impact on the professions that individuals decide to enter, with higher rates making lower-paying professions more attractive.
Given that professions that provide the clearest benefits to society—like engineer, schoolteacher, or medical researcher—often tend to be lower-paid than jobs like investment banker or fund manager, the study provides evidence that higher tax rates also offer a modest but direct social benefit.
However, the research finds that in terms of the impact of federal fiscal policy, government subsidies of society-benefiting professions play a larger role in maximizing collective well-being.
Taxes and Career Choices
In any given time and place, some professions are more popular than others. In aggregate, these individual career choices can have a broad social impact.
“We speculated that in some countries where taxes are higher people might be more likely to go into fields with clearer societal benefits like engineering and academia.” - Nathanson
This impact has long been on Nathanson’s radar. He attended Harvard University, where, he notes, “I saw so many peers going into just two sectors—finance and consulting,” he says. “That made me wonder about the effect on the economy of such a large percentage of people going into such a small number of professions.”
More recently, he and his colleagues—Benjamin Lockwood of the University of Pennsylvania and E. Glen Weyl of Microsoft Research and Yale University—decided to explore whether taxes play a role in making some jobs more attractive than others.
“We speculated that in some countries where taxes are higher”—and therefore factors other than salary may play a greater role in career decisions—“people might be more likely to go into fields with clearer societal benefits like engineering and academia,” he says.
A Model to Maximize Social Benefits
The specific goal of the research was to understand what type of income tax structure would maximize collective social well-being. The researchers considered alternatives that included progressive taxes (in which tax rates rise with income level), flat taxes, and even taxes specific to certain professions.
They developed a model that allowed people to make choices about a range of occupations, with the assumption that people would want to maximize their well-being. In the model, well-being was based on three things: what people earned, how much people liked what they do, and how hard people worked. “Working hard takes time and effort that could be devoted to something else,” says Nathanson.
The researchers then varied tax structure and rate to see how people chose occupations and how hard they worked. Importantly, manipulating the tax structure also varied the take-home pay associated with certain income levels—often quite dramatically. “By shifting marginal tax rates you can make someone earning $2 million gross and someone earning $200,000 gross have the same take-home income,” Nathanson says. It is easy to see how such a wide range of rewards for the same job could lead people toward or away from higher-paying professions.
They also relied on the distribution of incomes for each profession, rather than average incomes, which allowed for better apples-to-apples comparisons of people at similar levels within different careers. “That way we could put into the model that if you were going to be a doctor earning in the 90th percentile but switched to engineering, you’d be an engineer earning in the 90th percentile,” Nathanson says. This reflects the logic that people who are likely to excel, or underperform, over time in one discipline could likely expect the same outcome in a different discipline.
Finally, the researchers took into account the benefits to society of a given occupation, or its “positive externality.” “We included estimates for what kind of positive spillover each profession has,” Nathanson says.
Some professions are thought to offer more “spillover” than others. For example, a teacher may be helping students in her classroom gain important skills, meaning the collective impact of her work goes well beyond the $60,000 a year she earns for herself. Of course, if a profession detracts from society, it would exert a negative externality.
One challenge is that it is difficult to gauge exactly how much benefit or detriment a specific occupation provides. “In many cases you could argue for both positive and negative effects,” Nathanson notes. Still, for research purposes, what matters is the relative value of different professions. “It’s not that you need higher-paying jobs to be negative for society to answer our research question,” he says, “but more that lower-paying jobs [like research and teaching] need to have some positive benefit.”
Not Taxes, Subsidies
So which income tax structures leave everyone collectively better off?
The findings suggest that progressively higher taxes for higher income levels, with a top rate of about 36%, are associated with collective well-being. This is similar to the US’s current tax structure. Still, the effect is modest. “Having progressive income taxes only improves well-being by about 1% over a flat tax,” Nathanson says.
Part of the challenge is that income tax is a fairly “blunt tool” for trying to influence occupational choice—just one factor of many. “Even if people’s choices are influenced by taxes they won’t necessarily chose a job with more positive effects on society,” he says. “They might have six different choices and may not chose to work on curing cancer.”
Interestingly, the research shows that subsidizing specific professions has much larger influence on people’s job choices and, in turn, social implications. For example, the government dedicates large amounts of funding to scientific research, a lower-paying profession that Nathanson’s research highlights as having large positive societal effects.
Lockwood, Benjamin B., Charles G. Nathanson, and E. Glen Weyl. (Forthcoming.) “Taxation and the Allocation of Talent.” Journal of Political Economy.