How Distortionary Are Taxes?
The key issue is the elasticity of labor supply. Some economists do believe, as you suggest, that this elasticity is small and, as a result, that taxes aren’t very distortionary. Others believe that the elasticity is larger. Economist Ed Prescott has suggested that the main reason Europeans work less than Americans is the higher tax rates they face.
Think of it this way. Imagine that you are a painter deciding whether to accept another painting job this weekend. I am willing to pay you $500 for the work. It is possible that you would do the job for $500 but not for $300 (the amount you would keep after paying payroll taxes, federal income taxes, and state income taxes)? If you think that all workers make such decisions without regard to remuneration, then the assumption of inelastic labor supply is correct. In this case, taxes are not distortionary. But if some people respond to incentives and would do the job for $500 but not for $300, then that response is what makes taxes distortionary.
How Distortionary Are Taxes? from Greg Mankiw
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