They work more and harder and take more of their compensation in taxable form and less in fringe benefits. At the National Bureau of Economic Research we have used a large publicly available sample of anonymous tax returns to estimate how the actual revenue loss would compare to the official estimates that ignore this behavioral response. Our analysis shows that when the proposed Bush tax cuts are fully phased in the net revenue loss would be only about 65 percent of the officially estimated costs. If high marginal rates induce someone to work less or to work less productively, both he and the nation lose. If high marginal rates also induce someone to take his or her compensation in the form of fringe benefits or more expensive perks rather than in taxable cash, they lose even more.
Economists call such waste the deadweight loss of a tax.
The proposed reduction in marginal tax rates will not just allow individuals to keep more of their income. It will also produce an enormous net gain in national well-being. The gain from reducing distortions is a permanent gain that will continue in the future if marginal tax rates are kept down. This gain is separate from and additional to any increase in the rate of economic growth that results from the improved incentives to save and invest and take risks with that capital. Fourth, the distribution of President Bush's tax cut is essentially proportional to existing taxes.