Discussions about the incentive effects of taxes can be misleading.

The focus is usually on the tax rates imposed. But one’s incentives are not best measured by tax rates, but by how much value created for others (reflected in consumers’ willingness to pay) is retained by the creator, which I refer to as take-home income.

These two variables — tax rates and take-home income — are reciprocal in the sense that the higher the marginal tax rate, the smaller the take-home income relative to the value created. But the latter is a more precise tool, because it reveals how much incentives change as a result of a tax change.

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