I was thinking about which possible parts of economy are effectively destroyed in our society by having an income tax (as an analogy to Paul Graham's article saying that wealth tax would effectively destroy startups; previous shortform). And I think I have an answer; but I would like an economist to verify it.

Where I live, the marginal income tax is about 50%. Well, only a part of it is literally called "tax", the other parts are called health insurance and social insurance... which in my opinion is misleading, because it's not like the extra coin of income increases your health or unemployment risk proportionally; it should be called health tax and social tax instead... anyway, 50% is the "fraction of your extra coin the state will automatically take away from you" which is what matters for your economical decisions about making that extra coin.

In theory, by the law of comparative advantage, whenever you are better at something than your neighbor, you should be able to arrange a trade profitable for both sides. (Ignoring the transaction costs.) But if your marginal income is taxed at 50%, such trade would be profitable only if you are more than 2× better than your neighbor. And that still ignores the fixed costs (you need to study the law, do some things to comply with it, study the tax consequences, fill the tax report or pay someone to do it for you, etc.), which are significant if you trade in small amounts, so in practice you sometimes need to be even 3× or 4× better than your neighbor to make a profit.

This means that the missing part of economy are all those people who are better at something than their neigbors, but not 2×, 3×, or 4× better; at least not reliably. In an alternative tax system without income tax, they could engage in profitable trade with their neighbors; in our system, they don't. And "being slightly better, but not an order of magnitude better at something" probably describes a majority of population, which suggests there is a huge amount of possible value that is not being created, because of the income tax.

Even worse, this "either you are an order of magnitude better, or go away" system creates barriers to entry in many places in the society. Unqualified vs qualified workers. Employees vs entrepreneurs. Whenever there is a jump required (large upfront investment for uncertain gain), fewer people cross the line than if they could walk across it incrementally: learn a bit, gain an extra coin, learn another bit, gain two extra coins... gradually approaching the limit of your abilities, and getting an extra income along the way to cover the costs of learning. The current system is demotivating for people who are not confident they could make the jump successfully. And it contributes to social unfairness, because some people can easily afford to risk a large upfront investment for uncertain gain, some would be ruined by a possible failure, and some don't even have the resources necessary to try.

To reverse this picture, I imagine that in a society without income tax, many people would have multiple sources of income: they could have a job (full-time or part-time) and make some extra money helping their neighbors. The transition from an employer to an entrepreneur would be gradual, many would try it even if they don't feel confident about going the entire way, because going halfway would already be worth it. And because more people would try, more would succeed; also, some of them would not have the skills to go the entire way at the beginning, but would slowly develop them along the way. Being an entrepreneur would not be stressful the same way it is now, and this society would have a lot of small entrepreneurs.

...and this kind of "bottom-up" economy feels healthier to me than the "top-down" economy, where your best shot at success is creating a startup for the purpose of selling it to a bigger fish. I suppose the big fish, such as Paul Graham, would disagree, but that's the entire point: in a world without barriers to entry, you wouldn't need to write motivational speeches for people to try their luck, they could advance naturally, following their incentives.