Does It Pay to Work?

Does it pay to work? This is a tough question to answer because of the complexity of the tax code and a plethora of dynamic linkages involved. First, earning more today typically alters current saving and, therefore, future capital income taxes. Second, earning more today generally alters future consumption and, therefore, future consumption taxes. Third, changing future levels of income and assets changes the eligibility for and levels received of income- and asset-tested transfer benefits. Fourth, the most important transfer program, Social Security, explicitly links future transfer payments to current earnings. Fifth, income taxes in retirement depend on past earnings because Social Security benefits depend on past earnings and these benefits are subject to federal income taxation. This paper attempts to capture the net effective tax on work by using an intertemporal model capable of carefully determining tax and transfer payments at each stage of the life cycle.