The initial tax rate will affect the impact of a tax cut of a
given size. For example, if the initial tax rate—on wages,
say—is 90 percent, a 10 percentage point reduction in
taxes doubles the after-tax wage from 10 percent to
20 percent of the pre-tax wage. If the initial tax rate
is 20 percent, however, the same 10 percentage point
reduction in taxes only raises the after-tax wage by one
eighth, from 80 percent to 90 percent of the pre-tax
wage. Although income effects would be the same in
the two cases, the substitution effect on labor supply
and saving would be larger when tax rates are higher,
so that the net gain in labor supply from a tax cut would
be larger (or the net loss would be smaller in absolute
value) when tax rates are high. In addition, because the
economic cost of the tax rises with the square of the
tax rate, the efficiency gains from reducing tax rates are
larger when tax rates are higher to begin with.