Question

Why might one person work more, earn more, and pay more income tax when his or her tax rate is cut, while another person will work less, earn less, and pay less income tax under the same circumstance?

Short answer

Under the same circumstance, a person would work more and pay more income tax if the opportunity cost of leisure is high. However, another person would work less and earn less if the opportunity cost of leisure is low.

Step-by-step solution

The tax rate and incentive to work 

The differences in tax rates alter people’s incentives to work.The Laffer curve is inverted U-shaped. It implies that two tax rates (lower and higher) yield the same revenue to the government.For lower tax rates, a person might be induced to work more and pay more income tax. The reason is that for lower tax rates, the opportunity cost of leisure is higher, so a person would substitute labor for leisure. Hence, he would earn more and pay more income tax.

However, for higher tax rates, a person might be induced to work less and pay less income tax. The reason is that for higher tax rates, the opportunity cost of leisure is lower, so a person would substitute leisure for labor. Hence, he would earn less and pay less income tax.