If the government raises the tax rate on you and all of your friends, and then divides up all the tax revenue and dumps it from a helicopter, what do you get? Well, none of the money gets wasted, so the tax hike doesn't have a direct income effect (there's a small indirect one I'll ignore here).
If the tax hike is used for pure redistribution from the "average person" back to the "average person," then the tax hike doesn't make the "average person" poorer: The government is taking money out of everyone's right pocket and slipping it into their left.
But if the income effect is gone, what's left? The disincentive to work: The pure substitution effect.
So here's Prescott's Big Idea:
If higher taxes are wasted, then a tax hike has a small, ambiguous effect on employment.
If higher taxes are spent wisely, then a tax hike causes a big fall in employment.
Not quite what you expected, was it?
I wonder if it's true. (Emphasis in original.) Via Tax Rates, Efficient Government, and Jobs: Prescott's Surprise, Garett Jones | EconLog | Library of Economics and Liberty.