France's new leader is not a fan of the 35-hour work week, and is said to be considering a proposal to help end it--tax-free overtime. See, e.g., Jamey Keaten, Sarkozy Win Comes From Unlikely Corners, Yahoo.com (May 7, 2007). The TaxProf listserve has discussed this issue, so I asked occasional guest blogger Wayne State Law School Professor Mike McIntyre if he would provide his views in a form for the readers of this blog. He graciously provided the following statement.
In the recent presidential election in France, Nicolas Sarkozy won election on a promise to change the famously relaxed French way of life in return for faster economic growth. One of his proposals was to make overtime pay tax free. The idea is to induce French workers, who traditionally have enjoyed a 35 hour work week, to spend more time in paid employment.
There is substantial evidence that full-time workers generally do not work longer hours when offered higher pay (or its equivalent — tax-free pay). Economists speculate that this inelasticity of hours worked is due chiefly to the inability of most full-time workers to control their work week. That is, workers generally must decide whether or not to work, and, if they work, their jobs typically require them to work the standard amount, no more or less. Some economists suggest, nevertheless, that if workers were offered a practical option of working overtime, they might do it if they were given a sufficient economic incentive.
I have some doubt that the Sarkozy plan would do much to change the work habits of the French. The French seem to understand better than most that life is short and ought to be enjoyed. Everything in life involves some tradeoffs, however, so perhaps some French workers would give up some leisure if they could get paid at a high enough rate.
I’ll not try to assess the economic prospects of the Sarkozy plan. I am interested, however, in discussing its fairness — actually, its serious unfairness. The unfairness may not be obvious to some people. We have been accustomed by public rhetoric to think that work is good and more work is better. Well, I don’t want to argue about the merits of work for work’s sake. The point I want to discuss is whether an exemption for overtime work, even if it is intended to promote work, also compromises the fairness of the income tax.
The classical argument for giving a preference for income derived from wages over other forms of income is that workers must sacrifice their leisure in order to obtain their income, whereas coupon clippers need not get up from their chairs to collect their dividends and royalties. It is an argument with some intellectual appeal to the French. For many years, the French had a differential rate for earned income. That is, they taxed earned income at a lower rate than investment income, more or less on the theory that the worker was giving up something and the investor was not. I never liked the theory (I'd give it a 3 on a 1 to 100 scale) because the investor also gives up something --- as does anyone engaged in a market exchange.
Tax analysts should be able to agree that the issue of giving a deduction (in effect) for lost leisure is one to be decided at a high level, with the technical result turning on how that high-level analysis comes out. In effect, that debate is over the merits of a tax on income. I strongly favor an income tax, but I'll not try here to make the case for that tax over the various alternatives.
The technical tax issue is whether the tax system should give basis for the previously untaxed stuff that taxpayers give up to earn income. I like the current answer --- no basis for untaxed stuff. I really don't care much if the untaxed stuff is leisure, time preferences, or a great sadness at having to pay taxes.
We see a reverse of this "giving something up" argument today for those who want ONLY to tax wage income (the flat-tax group, for example --- well, if they understand the flat tax and still favor it, they actually want to tax only the portion of wage income that is earned and spent in the same jurisdiction). To make the argument for the flat tax, they somehow conclude that giving up leisure doesn't count, but giving up alternative uses of investment assets does count. If I had to pick one view or the other, I'd decide that giving up leisure counts and giving up investment opportunities does not. But my clear preference is to ignore both. That is, I want a real tax on income.
Whatever the merits of that "giving up" argument (for leisure or investment opportunities), it is not a good argument for not taxing workers named Joe, or, in Mr. Sarkozy’s case, for not taxing income generated by overtime work. The obvious example of inequity is the guy making $500 per hour who works overtime and the guy making $5 per hour working overtime. They both give up the same leisure, but the tax benefit to one is huge and to the other is trivial.
An alternative way of looking at the equity problem is to speculate on who would take up the offer of a tax subsidy for overtime pay. Again, I'll give two extremes. A has three children and four dogs, and her household falls apart if she works more than 35 hours a week. (It may even be in serious trouble with her working more than 20 hours a week, but she needs the money.) B has so much time on his hands that he spends 60 hours a week engaging in discussion of the Iraq war on the Internet. A will not respond to the subsidy offer, whereas B would grab it in his teeth and never let go. A is already giving up far more, in terms of the value of her leisure, than B. Why, exactly, should B (rather than A) get the tax benefit, if the value of leisure forgone is the new test of taxable capacity?
Of course, if we are prepared to assume that everyone makes the same amount aside from overtime and everyone has the same preference for leisure, then we can see the beginnings of the equity argument for giving a deduction for the assumed value of leisure. I'm not real good at tax policy in alternative universes (I've written some nasty stuff about the endowment tax, for example), so I don't have much to say about the fairness of Mr. Sarkozy’s suggested treatment of overtime in a world of almost complete equality. In the world we actually live in, the primary tax problem arises from the huge disparities in income between the rich and middle classes. It is not helpful in addressing that problem to simply assume that those disparities do not exist.
I don't want to sound radical, but my solution to the alleged problem of workers not wanting to work overtime is to pay them time and a half for overtime, double time on holidays. Of course, I'd also tax those people earning the overtime income at the normal (graduated) rate. I recognize that some people end up earning more than others for the same hour of work. But that is life in a market economy and is not a special problem of tax fairness (the general problem is addressed with graduated rates).
Much of tax policy is deciding what differences DON'T matter in assessing tax liabilities. In my view, different preferences for leisure should not matter. YMMV.