The Laffer Curve and the Kimel Curve
by Mike Kimel
People always talk about the Laffer curve, but have you ever seen it estimated? Have you ever wondered why you don’t? If you’re a quant guy, you know the answer to that. Because if you’re a quant guy, at some point curiosity must have gotten the best of you. That means you pulled out some data and you plugged it into whatever piece of software happened to be handy. What happened next depends on what sort of a quant guy you are. If you’re the sort that let’s the numbers do the talking, you spotted the joke and probably left it at that. If you have a strong ideological leaning in a certain direction, on the other hand, you might have tried to “fix” it. You tried a few times, failed, and kind of just left it there as something to get back to some time, but no hurry because your ideology tells you what the answer should be.
Today, by coincidence, I got two e-mails asking me about the Laffer curve. And it occurred to me… maybe someone should let non-quant people into the joke. Because the only people really discussing it are those who are driven by ideology, whereas it should be afforded the Hauser’s law treatment.
So here’s how it works. Putting numbers to the Laffer curve pretty much comes down to estimating:
(1) tax collections / GDP = A + B*tax rate + C*tax rate squared + some other stuff if desired
A, B, and C are estimated statistically using a tool such as regression analysis.
If you plug in numbers, and find that B is positive and statistically significant and C is negative and statistically significant, then it turns out that you can trace out a quadratic relationship between tax collections / GDP and tax rates. i.e., tax collections / GDP is a function of tax rates that looks like an upside down U. If you increase tax rates when tax rates are “low,” growth will increase. On the other hand, to increase growth when tax rates are “high”, you have to decrease tax rates.
When you have such a shape, you look for the top of the upside down U and there’s your maximum.
So I started with the obvious:
(2) tax collections / GDP = A + B*tax rate + C*tax rate squared
In other words, the simplest version of (1) possible. I plugged in data. That would be current federal tax receipts, line 2 from NIPA table 3.2, divided by GDP, from the BEA, and the top marginal tax rate from IRS’ historical table 23. You can go all the back to 1929—that’s when the GDP and current federal tax receipts begin.
The problem is… the data isn’t quite amenable to shoehorning into the desired shape. The fit of the model sucks, B is negative, C is positive, and neither coefficient is significant at the ten percent level.But they aren’t so far off either.
All that together means that maybe, just maybe, a slightly better specified model might do the trick. The simplest solution… find another variable that has some explanatory power and throw it in. Well, I’m supposed to be on a hiatus from blogging, so I don’t want to spend a huge amount of time at this, but it occurs to me that year is probably such a variable. There’s a good chance that over time, tax collection has become a bit more efficient.
So I reran (2) as follows:
(3) tax collections / GDP = A + B*tax rate + C*tax rate squared + D*Year
Here’s what the results look like:
B and C have the wrong sign. That means you don’t get an upside down U, you get a U. Here’s what it looks like when graphed:
The low point in tax collections happens to be about 32%. In other words… if the top marginal tax rate is below 32%, cutting it further will raise tax revenues. On the other hand, if the top marginal tax rate is above 32%, to boost revenues you have to raise tax rates.
Now this is quick and dirty, and it has boundary issues (i.e., 100% tax rate collects more than 99% tax rate – would it really? well, the model is extrapolating because its never observed tax rates of 99% or 100% in the wild). I should also throw in a few more variables to improve the fit. Worse, there’s autocorrelation. That means the error terms are correlated. The correlation between the residuals at time and the residuals at time t+1 is 75%. That in turn violates one of the assumptions of OLS regression analysis. Its fixable, but its also ignorable for our purposes since what it means is that the coefficient estimates are probably “correct” but merely less significant than they appear. Regardless, you won’t get anything that bears even a remote resemblance to what you hear from the crowd who perennially cites the Laffer curve so authoritatively.
Which brings up another piece of the joke. In the end, tax collections don’t matter. Its nobody’s goal to maximize tax collections. Taxes only matter because they pay for certain government services. They also take money out of our pockets. So there’s a tradeoff. But we’re made better off if the government services taxes pay for generate more value than they cost us. And at least to some extent, you can measure that by whether they generate more growth than they cost us.
Now, it turns out that the optimal tax rate for growth is easy to calculate. The data cooperates very nicely. There is a relationship, an easy to estimate curve which I’ve modestly called the “Kimel curve.” And the high point in the Kimel curve is somewhere around 65%. Now, the Laffer curve analysis shows us that getting to the level of taxation that produces the fastest economic growth rates would also increase our tax collections… not a bad thing at all in an era of rapidly rising national debts.
Which brings us to the biggest Laffer curve joke of them all: ain’t no way the folks who like to talk about the Laffer curve would support that.
—
As always, if you want my spreadsheet drop me a line. I’m at my first name (“mike”) period my last name (“kimel” – that’s with one m only!!!) at gmail.
This is an insightful post. However, as a tax lawyer for 40 years (until 3 years ago), I would suggest some factors that might affect the validity of using historical data to estimate the increase in tax collections that would be produced by substantial increases in income tax rates.
1. The effective level of income tax enforcement is much lower now than it was over much of the period after 1929. It is true that electronic reporting makes tax enforcement more efficient, but audit coverage is drastically lower than it was in the first half of your period.
2. The increased complexity of the economic structure: expanded self employment, LLCs, disregarded entities, derivatives, expanded foreign business etc., provide greater opportunities for tax avoidance/evasion.
3. Tax avoidance is now efficiently marketed as a “product” by tax professionals and investment bankers, etc. Higher tax rates would only increase that.
4. Habits and norms have changed. After more than 30 years of the Regaen inspired anti-tax campaign, the public is less accepting of the fairness and legitimacy of higher tax rates.
I am not saying that a lot more tax revenue could not be raised. I am saying that it would require structural changes and would be much more complicated than just raising tax rates.
Sorry wkj, if you start your argument with …as a tax lawyer… it over already. First off, Mike’s argument is about statistics and econometric modeling. BTW, I remember this too from my graduate econometrics course — prof simply said: prove the laffer Curve, what we didn’t know was that he was running that test for the behavioral economics course… wanted to see the imapct of bias on econometric analyis.
This was a small course in the second year of my master’s prgram, professor knew us well and our bias too. Funny enough no one could get the damn curve to function (we sure did tried, used all the tricks to no avail)
Funny, funny. In one electronic breath, you tell wkj that being a tax lawyer invalidates anything (s)he has to say, and in the next, you write about bias affecting outcomes. Funny, funny.
In fact, wkj is extending consideration of an issue Kimel had already raised, that of tax “efficiency”. Kimel speculated that efficiency had improved. wkj’s response was that efficiency may have fallen. Kime’s point was that knowing that answer is important to statistics and econometric modeling. You seem to have missed that. Grad school won’t do any good if you don’t straighten up.
wkj,
You are correct, but there is the flipside. If memory serves, JFK started requring a single taxpayer ID be affixed to each entity’s documents. That has to have really creamed evasion, especially as the FIT or SSN caught on. Then there are are computers and databases.
Now… the effect (see the last line of the regression statistics) of the year is actually positive and significant, amounting to about a tenth of a percent of the GDP per year. Which means (much to my surprise, despite the awkward phrasing of the post) that the IRS is slightly beating PWC when it comes to enforcement, but PWC’s lobbying is getting its way when it comes to what the tax rates actually are.
frozeninthenorth,
Respectfully, I disagree with “if you start your argument with …as a tax lawyer… it over already. ” A different perspective is often useful. Of course, in the end, the data should trump everything, but the different perspective can help us hone the look at the data.
As to the rest of your comment… well, you and I are in agreement.
Mike,
I recall seeing the results of formal efforts at finding the peak of the Laffer curve a few years after Laffer first scribbled on a napkin. (Sorry, no reference handy.) The author did not report a problem with the shape of the curve, which means either that the problem was cured in the specification or that the author didn’t want to talk about it. Since reviews of the research didn’t mention a problem with the curve being upside-down, I’d guess he managed to specify the model in a way that solved the problem.
None of which is really the point. The finding of the authors was that, around 50%, there was a substantial range of marginal tax rates for which there was no statistically significant relationship with revenue. I believe (memory is a tricky thing) that rates had to be below 35% and above 72% to show a statistically significant relationship. Of course, statistical significance is not the be-all and end-all. Maybe at 40% and 65%, Laffer is still at work. However, the result does suggest that whining about tax rates below 35% is silly, as far dealing with fiscal imbalance is concerned. Your own work suggests that the whole “job creator”-tax linkage is also just hot air.
Exactly, computer based matching of employer reported and employee reported income has effectively increased “automated audit” to 100% for regular earned income.
That’s not to say there isn’t a substantial portion of the economy that is underground and not reported by both employer and employee (for instance, restaurants, salons, spas, etc where a substantial portion of payments and compensation are still made in cash and tips, even more common in certain immigrant and urban communities).
But while services have been growing as a part of the economy, the normal method of payment for services has moved to credit and debit, which significantly decreases your opportunity for undetectable evasion of taxes.
frozeninthenorth: “Funny enough no one could get the damn {Laffer} curve to function (we sure did tried, used all the tricks to no avail)”
Gee, maybe I have misunderstood the Laffer curve, one simple enough to illustrate on a cocktail napkin. Here is the argument, as I thought I understood it.
Given a tax rate of 0, no tax is collected. Big duh! Given a tax rate of 100%, an unknown non-negative amount of tax, T100, is collected, but under reasonable assumptions, such as tax evasion by various means, we can assume that the amount, T, of tax collected at some rate R < 100% is greater than T100. Therefore there is a tax rate, R0, between 0 and 100% at which a maximum amount of tax is collected, Tmax > T100. At some rate, R1 > R0, a tax, T1, will be collected such that T1 < Tmax. QED.
kharris,
There are always to torture the data to get results that are desirable. Most people aren’t trained in statistics so they won’t necesarilly see the heroic measures being taken to get those results or why they’re bogus. Entities like Heritage and AEI wouldn’t exist otherwise. But even folks liek Mankiw and Barro who are willing to, er, violate the Geneva conventions when it comes to treating the data seem to draw the line at actually producing a Laffer curve.
Thus, it is possible the person you recall was a percursor to Kevin Hassett. Or its possible he/she didn’t actually estimate the curve, or estimated, found tht it wasn’t significant and focused on a non-quadratic relationship. I don’t know.
I do know that, as you said, tax rates don’t have quite the effect people think. It is a pity… it would be really nice if we could all pay less in taxes and have much faster economic growth and more revenue collected to boot. Life is always more fun in the world where we get to eat a free lunch while riding a pony, or a unicorn. And some people get paid very well to prove that is the way the world works.
Minor nit:
Using tax/GDP is not the best measure, I think, to evaluate the Laffer curve, because increasing the tax rate should, in Laffer’s argument — IIUC –, reduce GDP. After all, if GDP = 0 and tax = 0, tax/GDP is indeterminate. The Laffer curve is about the amount of tax collected itself, not tax/GDP, right?
@ Mike:
Oh, I understand the problems with not using tax/GDP. Also, historically I doubt if taxes have had any appreciable negative effect on GDP. (That’s one reason why I think that the Laffer curve is irrelevant, except as a rhetorical device. ;))
As I said, a minor nit. 🙂
One possible nit with Laffer:
In practice, we are talking about the top marginal tax rate. In that case, the assumptions made when the top marginal rate approaches 100% become less reasonable. In fact, a top marginal rate on, say, the top 0.1%, of over 100% may raise the most taxes. Yes, more than confiscatory. But at that level of income, income is largely about keeping score. Paying more than 100% tax could be a status symbol. Consider potlatch. 🙂
Min,
The problem is, over time real GDP (whether per capita or not) has grown. It has a tendency to grow in general though I believe for all observations in which top marginal tax rates were below 28% its been negative. Ditto for one of the three years in which real the top rate was equal to 28%. From a statistical analysis perspective, you’d end up with the mother of all unit root (nonstationarity) problems, and the usual solutions don’t make intuitive sense here.
Well, I guess… I guess you could maximize growth in tax collections (adjusted for inflation) subject to tax rates. One of the explanatory variables would have to be growth in real GDP since presumably faster growth also generates more taxes being collected.
I’d have to give this some thought but I don’t think it would rescue Laffer.
Mike,
My first (of very few) guest posts at Angrybear.
http://www.angrybearblog.com/2006/11/m-jeds-post-on-demographics-and-tax.html
The question raised about the influence on growth truly is a confounding factor, but not necessarily in the way Laffer would claim. Laffer assumes that rising tax rates hurt growth, but that up to a certain point, taking more of output as taxes outweighs the danage to growth. That’s central to the argument. However, if that is not true, then Laffer has a problem at lower and middling rates that he isn’t willing to admit to. If taxes support growth through the lower range of the curve, then using revenue/GDP actually masks some of the revenue-increasing benefits of higher tax rates by boosting the denominator. You raised the issue of the impact of tax rates on growth as a related issue, but in fact, it is a central issue to the argument.
It is quite possible that higher tax rates raise welfare while rasing revenue. If so, then libertarian arguments against “loss of liberty” end up standing on a very narrow ledge. The loss of liberty occurs only in the necessity of filing taxes when taxed at something close to the optimal rate. In an economic sense, “liberty” is increased because we have more resources with which to make private decisions.
Mike,
First of all, Art Laffer did not invent the “Laffer Curve.” The idea goes back before the United States even existed, and was argued extensively during the formation of the Founding documents of this country. The term “Laffer Curve” came from a Journalist who witnessed a meeting between Art Laffer, Donald Rumsfeld, and Dick Cheney in 1974, while Art Laffer tried to explain the realtionship between tax rates, tax revenue, behavior changes, and existing tax structure. The point of the meeting was for Rumsfeld to pick Art Laffer’s mind on how to make Gerald Ford’s “WIN-Whip Inflation Now” Plan effective.
Secondly…..I can’t for the life of me understand the Left’s perspective that revenue increases will come from more taxation when the economy is so fragile, especially with never taking into account that even massive taxation increases cannot generate the revenue needed to solve any of our spending and budget issues. I am always left to believe that it is the Class Warfare that trumps their thinking, I don’t want to feel that way, but the Left really leaves me no other choice but to believe that.
Laffer says:
“The “Laffer Curve” itself does not say whether a tax cut will raise or lower revenues. Revenue responses to a tax rate change will depend upon the tax system in place, the time period being considered, the ease of movement into underground activities, the level of tax rates already in place, the prevalence of legal and accounting-driven tax loopholes, and the proclivities of the productive factors. If the existing tax rate is too high–in the “prohibitive range”–then a tax-rate cut would result in increased tax revenues. The economic effect of the tax cut would outweigh the arithmetic effect of the tax cut.”-Art Laffer 2004
Keyens wrote:
“When, on the contrary, I show, a little elaborately, as in the ensuing chapter, that to create wealth will increase the national income and that a large proportion of any increase in the national income will accrue to an Exchequer, amongst whose largest outgoings is the payment of incomes to those who are unemployed and whose receipts are a proportion of the incomes of those who are occupied.”
“Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more–and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.” – John Maynard Keynes (The Collected Writings of John Maynard Keynes)
m. jed,
Over the past few years, I have slowly come to painfull realization… something I believed back then is not necesarilly true. A lag of the dependent variable is not always a solution to a unit root problem. I tend to agree with 2slugbaits comment (the second one on that thread) now.
I’m also a bit leary about using absolute numbers – or even logs of those numbers – as the dependent variable. These days I’d ask you to redo the growth one with % change in real GDP as the dependent. Maximizing a series when that series is nonstationary is something experience has taught me to avoid.
If you still have the data give it a whirl.
Mike,
“The problem is, over time real GDP (whether per capita or not) has grown. It has a tendency to grow in general though I believe for all observations in which top marginal tax rates were below 28% its been negative.”
Since 1980 the average increase:
In Adjusted GDP is 2.55% per year,
In Adjusted Revenue is 1.76% per year,
In Adjusted Spending is 3.10% per year.
How could you possibly believe that any change in the revenue side can affect the bottom line at all without a change in spending or a change in average economic growth? We have a spending problem not a revenue problem, and we have for a long time. It is obvious that we will never be able to generate enough revenue to keep up with the baseline spending, growth in government, growth in debt, and fund our entitlement programs. Something has to give….and you should be shouting that from the tree tops, instead of waisting your time on this Class Warfare game.
Darren you somehow forgot that we balanced the budget before W was elected. Thanks to policies in the 1990s that raised taxes and limited spending increases. W increased spending (wars, remember) and significantly cut taxes and viola! An agenda to continue and even increase multiple tax cuts for high-earners, enhance taxes on low-earners, and reduce spending on government-provided services (including insurance payments that are owed), is what I call “class warfare.”
Darren,
I’ve noted before, I don’t really much care who says what. I don’t argue by authority. I’ve shown what data shows if you follow a few simple steps. I made it clear enough that you can replicate it if you choose. I make my spreadsheets available. Tell me where the analysis or the data or the conclusion is wrong. But don’t give me opinion, not Laffer’s and not Keynes’. Because one can always find an authority who will say something, no matter how inane.
Besides, I am not saying that the bolded sentence of Keynes’ is wrong. I’ve noted where I think the analysis has a problem and why. But I also note that it won’t kill the U shape.
Darren: “I can’t for the life of me understand the Left’s perspective that revenue increases will come from more taxation when the economy is so fragile”
That is not the Left’s perspective.
PJR,
Hauser Law dictates that the maximum revenue to be gained 19% of GDP. It does mean that it has to be that number to maximize revenue. During the Bush years the average was 17.55%. The average since 1950 is 18%. Bush inherited a recession, and the revenue to GDP recovered back to the trend line at 18.5% by 2007. When Bush came to power he inherited a 3% loss in GDP and a 7% loss in revenue. According to your position, a tax increase should have continued that trend, but that trend was severely reversed on all fronts including unemployment rates better than Clinton’s despite 9/11, and two wars…..how did this happend?
The significant tax cut was on the lower and middle class. The total revenue lost from tax cuts on the upper bracket was very small. In other words the majority of the revenue lost came from the lower end not the top end. Your position does not allow you any room to adjust, and it is easily refuted.
The laffer curve is another example of the Steven Forbes strategy. Let the puppets fight each other. The laffer curve has been shown to be a tautism, not even a postulation, let alone a theory. But extremely useful as a political connivance.
The genius of the #OWS movement is to focus the spotlight on things like the laffer curve, TBTF, the Ivy League, etc.
The laffer curve is another example of the Steven Forbes strategy. Let the puppets fight each other. The laffer curve has been shown to be a tautism, not even a postulation, let alone a theory. But extremely useful as a political connivance.
The genius of the #OWS movement is to focus the spotlight on things like the laffer curve, TBTF, the Ivy League, etc.
Focus on Herman Cain, now. His ideas are obviously ridiculous whilw the sell out Ben Bernanke, as the Chairman of the US Federal Reserve, steals your savings.
Mike,
The major problem is that one assumption makes the entire analysis bunk. That assumption is, that people actually paid the ridiculous rates of the past. They clearly did not, and there is plenty of evidence to back that up.
The system in the past was set up to shape behavior much more so than today, and many-many loopholes were built into it. Also, the overwhelming majority of the population did not make enough money to be considered in any of these brackets. The third issue is that you once again you go back to 1929, that really distorts everything…..i know why you consistantly do it, and to be quite frank, I think it really weakens your position.
In reality, there is no valid comparison with anything the Laffer Curve represents. the Laffer Curve is strictly Revenue vs. Tax Rate……and there is no numbers on it for a reason. As Laffer pointed out above….the curve is only relevant to what the current economic situation is at the moment. The Laffer curve can be applied to all taxes whether individual or corporate or capital gains……I do not see that flexibility here.
But the main problem really is how unrealistic a 65% tax is on the upper brackets, not only is it never going to happend but, just threatening to do it could knock revenue, employment, and GDP off it’s feet.
This is not the first instance that the “Forbes 400” has used a black person to convince us puppets that our future hangs on the decisions of “our dear leaders”.
Colin and Michael Powell, Condolezza Rice, ?
WHO SAYS that nothing is collected at a tax rate of 100%. That is the Ayn Rand assumption, accepted as an article of faith on the right. But, seriously, who says? Drop that premise, please.
A tax rate of 100% could mean that we are all fed, housed, have health care, and trips on cruise ships whenever we want. Or it could mean we are all in prisons, forced to work. Either way…
IMHO, the FDIC should take one bankrupt bank, Citigroup, and nationalize it. The moment is perfect. The stock market will rise (right?), the value of the Federally backed bonds would fall (rigfht ?). Allow the free market to value the private stocks and bonds as they should be. After all, this is a captalist society that hates government intervention.
Oh yeah. Cut off Michelle Bachman’s federal agricultural sibsidy and her husband’s “pray not to be gay business”.
Mike–I appreciate your response to my comments. I agree that information reporting creams evasion for wages (and also for interest and dividends received by individuals), but non-wage business income is not subject to effective income reporting and thus is much harder to track without audit boots on the ground. My own view is that the factors referenced in my point 2 have made it easier to hide or obscure that category of taxable income.
Also, with regard to whether the IRS is beating PWC, have you tried to track the definitional divergences between taxable income and GDP?. For example, capital gains on investments are a significant component of taxable income, but I don’t think they affect GDP. If growth of capital gains outpaces growth in GDP, wouldn’t that push up your tax/GDP efficiency ratio and thus (falsely) suggest that the IRS is winning?
“Mike–I appreciate your response to my comments. I agree that information reporting creams evasion for wages (and also for interest and dividends received by individuals), but non-wage business income is not subject to effective income reporting and thus is much harder to track without audit boots on the ground. My own view is that the factors referenced in my point 2 have made it easier to hide or obscure that category of taxable income.”
I propose a top marginal tax rate of 65%, beginning at 35% for people making $200K and peaking at people making $500k, then a flat. Standard deductions. Get rid of the BS of investment tax credits, capital gains taxed at the same rate as wage rates. Period
Mike–Does your calculation of efficiency adjust for increases in income inequality? As the share of taxable income that is received by the top 10% increases and the share received by the bottom 90% decreases, there will be a corresponding increase in the proportion of total taxable income that is taxed at the highest marginal rate. Such a shift has clearly taken place over the last 40+ years and, by itself, would tend to give a false picture of increased efficiency.
PJR’s law dictates that Darren’s comments come from a different factual world than observed by PJR. It has been consistently true empirically–this is not a judgment of any kind, only an empirical observation that currently lacks a validated theoretical basis. In this other world, that the unemployment rate dropped 53 percent under Clinton, and rose 45 percent under Bush, is viewed as “advantage Bush.” Also in this world, income tax rate cuts saving at most $850 for the majority of taxpayers are described as a significant, but rate cuts saving tens and hundreds of thousands of dollars for high earners are described as very small. And in this world, Hauser’s Law (which you completely mangled, so maybe we should call the new law the Hauser-Darren Law) “dictates” political decisions, too. Okay.
Min’s thought came to my mind too. I think that min is proposing you combine your estimated Laffer urve with your estimated Kimel curve. You implicitly do this in the rest of the post. The result is worse for Laffer than your first estimate.
Anyway, there are two ways to Kimilize your Laffer curve
1) ratio of tax receipts to GDP-(-10) that is the ratio of taxes collected to lagged GDP.
2) What unit root in GDP ? Look the US data don’t reject the unit root against the alternative that GDP is stationary around an exponential trend, but they don’t reject stationary around a trend either (this is impossible since “stationary” is onsistent with “very persistent”). So how about tax receipts as a fraction of crude vulgar old fashined trend GDP (just the e to the fitted value of log GDP on time). The only real problems with this approach is that it will make Hoover and Bush Jr receipts look horrible and WW-II receipts look wonderful. The Kimel curve makes it clear that the case for Laffer is weakened if, instead of diciding by GDP, you take out a trend.
I’m pretty sure that following the min-me proposal you will get (apparently) statistically signficant evidence that Laffer got it backwards.
Oh on 100% marginal rates, Sweden once had effective marginal rates of 103% for some income range (combined taxes up and benefits down). They collected money. The claim that 100% taxes mean 0 revenue has been tested and is false.
Min,
You’ve basically said to nit ‘OK, nice evidence, but here’s the theory’. The theory of the Laffer Curve is surely wrong if the evidence doesn’t agree with it, right? Doesn’t matter if the argument seems intuitive.
Darren,
Mike has just poresented you with abunch of evidence and you’ve replied with:
a) Theory
b) Accusations of class warfare
c) Unfounded assertions that tax increases will not solve budget problems
How is your last sentence true? You’ve just internalised it and are arguing against evidence to the contrary.
Darren,
“The major problem is that one assumption makes the entire analysis bunk. That assumption is, that people actually paid the ridiculous rates of the past. “
Oh, come on. I’m tired of this. When I write posts looking at the percent of income people paid, there’s always someone telling me I should look at marginal rates. When I look at marginal rates, someone tells me loook at the percent of income actually paid. The post you want written, I’ve written many times. And it makes about, say, 10% of the book Presimetrics to boot.
Besides that… at no point am I assuming that anyone paid that rate. I’ve stated that the data shows the opposite in numerous posts and in the book Presimetrics. Why would I assume the opposite without even so much as a statement?
“The third issue is that you once again you go back to 1929, that really distorts everything…..i know why you consistantly do it, and to be quite frank, I think it really weakens your position. “
Ah yes. When I don’t go back to 1929 I get accused of cherry picking. When I use every single point available I have some other nefarious purpose. What, pray tell, is my nefarious purpose this time around.
“In reality, there is no valid comparison with anything the Laffer Curve represents. the Laffer Curve is strictly Revenue vs. Tax Rate……and there is no numbers on it for a reason. As Laffer pointed out above….the curve is only relevant to what the current economic situation is at the moment.”
Fine. And I can state, without any support whatsoever, that the world is shaped like a tuna fish sandwich, without the tuna, the bread, or the mayo. Or the plate. Or the table. And that’s just the way it is right now. And no, I won’t provide any support for that statement whatsoever.
“But the main problem really is how unrealistic a 65% tax is on the upper brackets, not only is it never going to happend but, just threatening to do it could knock revenue, employment, and GDP off it’s feet. “
That’s not what the tuna fish sandwich that isn’t there theory says. Seriously, if you’re going to make unsupported statements, you’re going to find the rest of us can do it too.
wkj,
There are other factors supporting your conention as well… e.g., municipal bond income isn’t even counted as income, plus its easier to move assets abroad.
I’ve done some looks at measures of enforcement and payments over time… here’s an old one: http://www.angrybearblog.com/2006/09/enforcement-and-who-pays-taxes.html
Its probably something I should look at again. I’m not sure why the sign is positive in the table, except that I think technology is trumping (or at least, on average over time has been trumping) the ability to cheat.
“ For example, capital gains on investments are a significant component of taxable income, but I don’t think they affect GDP. “
I have to think about this statement. I don’t have anything to say about it at this time. Apologies.
Ron,
“Get rid of the BS of investment tax credits, capital gains taxed at the same rate as wage rates.”
I would tend to agree… I don’t have data for this, but I don’t see the gains. That said, I suspect a bigger problem might be simply what constitutes as “income” and what constitutes “expenses.”
wkj,
No, I do not take that into account. Interesting point. Something to consider.
The evidence is not about (what I think is) Laffer’s claim.
Robert Waldmann: “Oh on 100% marginal rates, Sweden once had effective marginal rates of 103% for some income range (combined taxes up and benefits down). They collected money. The claim that 100% taxes mean 0 revenue has been tested and is false.”
Thanks for that info. 🙂 🙂 🙂
It’s a matter of whether the evidence agrees with laffers claim, and apparently it doesn’t.
What do you think that Laffer’s claim is?
Hauser’s law is crap.
It has been covered here: http://www.angrybearblog.com/2010/11/hausers-law-is-extremely-misleading.html
Robert,
1. Why lag tax receipts by 10? I’m not sure I get that.
2. GDP trends upward. GDP may be stationary around a trend (maybe) but its certainly not stationary in and of itself. You have to detrend it somehow.
Since posting the above comment, I’ve been looking for the data to do it myself. $#@% Census site. I’ve e-mailed the help people there… hopefully they’ll respond.
Don’t detrend GDP. Detrend revenue. A simple first difference would do it. You’re left with a series that represents variability of revenue around a growth trend, which you can compare to tax rates.
You gave an interesting analysis, but I’m not sure it really proves what you are trying to say. First of all, the Laffer curve is a thought experiment and a rigorous empirical relationship. The analysis basically assumes there is only one tax rate applied to income and it is constant across all income groups. If you have 0% taxes, then you collect no tax revenues, if you collect 100% taxes, then you might collect some revenues but you severely impact economic activity, there must be a place between 0% and 100% that would maximize revenues. In terms of logic, I don’t think anyone can disagree with that. The point he is trying to illustrate isn’t about tax revenues, so much as it is about the impact that tax revenues can have on growth.
Nevertheless, we live in a world with a complicated tax code structure. If we raised the marginal tax rate on more than 10mn dollars labor income a year to 100%, then you probably would only see a small impact on growth since those earning would instead scale back. However, most people would be unaffected. So its reasonable to assume that there would be an asymmetric effect in a world with different marginal tax rates.
Hence, the most relevant question is more just one of the impact of the tax burden on the economy (not one of tax revenues against tax rates). The best way to do this would be with a panel of GDP and tax revenue to GDP data for OECD countries over the past 20 or 40 years. Basically you would want to test whether countries whose tax burden has risen subsequently have slower growth. If it is true (and I believe it has been done, but I can’t find a source now), then that supports the basic thrust of the Laffer curve.
Whilst everyone is busy diddling themselves with spreadsheets and theory, try reading TREASURE ISLANDS by Nicholas Shaxson. It will explain why the tax evasion some are writing of is siphoning off the taxable revenues that should be balancing the expenditures vs revenues. I’m especially sure the tax attorneys will enjoy it.
John Hall,
“The point he is trying to illustrate isn’t about tax revenues, so much as it is about the impact that tax revenues can have on growth. “
The problem is this… if you’re correct, he’s taking the indirect route. I on the other hand went ahead and estimated it directly. (See the link to the “kimel curve” in the post.) I’ve also had a bunch of other such posts. The growth maximizing number is somewhere around 60%, give or take about ten percent.
And no, I don’t think the best way to do this is a panel because X% tax rates in Sweden or Denmark are a different creature than the same tax rates in Greece or Italy. In one case X% means people pay X%. In the other case, it means nothing. And that’s not even getting to Ireland, or the Bahamas, whose entire national business model is built on tax evasion by transfer pricing.
I have a vague recollection that the study you mentioned was done by Kevin Hasset. That ought to tell you something.
If only tax policy existed in a vacuum… Is it conceivable that there are policies which impact taxable gross / GDP / capita? Is it conceivable that fluctuating gross income share between fields/brackets/industries impacts revenues?
Perhaps the problem is that we keep trying to think of a revenue equation with endogenous “output” trying to optimize exogenous “marginal rate”… I’d contend the correlations are much larger with other policy factors and taxable gross is somewhat collinear.
If we worried less about tax policy and more about growth oriented policy and bubble-mitigation policy that things would level out in the medium term… instead we focus on tax rate policy because that’s the easiet to politicize and polarize…. or are you actually suggesting that aggregate output is most highly dependant on marginal tax rates?
In response to Matthew’s comment just above, which has provoked a sense of deja vue (all over again?), I’ll repeat myself here. I said this four days ago. I’ve deleted the first copy so as not to clutter the space.
Maybe a layman’s simplified approach to the issue of taxation would be best. Taxation is the result of the need to create a revenue stream for the purpose of paying expenses. In the case of taxation, as most of us think of it, the expense to be paid is what ever the cost of government happens to be. All of the machinations regarding measured predictions of the effect of taxation are putting the cart in front of the horse. Taxation isn’t for the purpose of pushing an agenda. The amount of taxes required has to be determined by the cost of the process of government. All speculation ceases regarding what percentage to tax in that case. The future effect of the tax rate can be argued ad infinitum with enough statitical manipulations to spin the dome off of the Capital. What can’t be as easily distorted is the cost of running the government. Yes, one can fudge some of that data, but it is that kind of data that is the only unambiguous part of all of the speculation regarding the effect of taxation on future economic performance.
Argue about what to spend those taxes on all you like. That’s a socio-political debate. Then raise taxes to pay for what is the result. It isn’t that complicated unless you only want to keep the focus of the argument away from the relationship between taxation and government spending. Even then the debate has to start with the needs rather than the means by which those needs are to be met. The one sure thing is that the means are there and the needs of the many have for too long been secondary to the interests of those who control the wealth.
Cahal,
“Mike has just poresented you with abunch of evidence”
Ahhh…Sorry, but he did no such thing. His grapgh is a tortured mess.
Jack,
“Then raise taxes to pay for what is the result.”
You can’t just keep raising taxes to pay for spending increases. At some point the system breaks down due to changes in behavior, which is the heart of the debate. Mike failed here because he beleives that a 65% tax is reasonable. Talk to anybody in the business world, and they would laugh you into the street.
“The one sure thing is that the means are there and the needs of the many have for too long been secondary to the interests of those who control the wealth.”
First of all, this is not factually correct. You tax the top bracket at 100% and you will do little at solving the deficit and debt issue, mainly because of the consequence of doing so.
“You can’t just keep raising taxes to pay for spending increases” The strawman
Who said that spending shold be increased? There’s lots of fat in military spending and corporate welfare. Those farm subisdies the Michelle’s family enjoys seem unnecessary and the Medicaid payments to her hubby for his laying on of hands therapy is certainly a gross misuse of public funds. See Darren, I’m on your side.
“Talk to anybody in the business world, and they would laugh you into the street.” The Village Idiot
Aree they laughing because they know they have a strangle hold on the Congress? Why would we expect “business world” inhabitants to willingly pay their share of their own support? The idea of democratic government Darren is for the Cogress to represent the mass of the people rather than just two or three percent at the top of the wealth scale. The political class the our country, however, seems to believe that they themselves are better served by playing the roles of vassals in service to an aristocracy of capital. So we have a lot of citizen education ahead of us before we can expect any serious change to take place.
“You tax the top bracket at 100% and you will do little at solving the deficit and debt issue, mainly because of the consequence of doing so.” The Purveyor of Deceit & Deception
Now you’re building a strawmansion on top of a mountain of discredited right-wing connivance.
There are no tax policy proposals that suggest a 100% bracket. The highest have been below 40%. The most any of our wealthy Congressional reps seem able to conceive of is to roll back the system to 2001 when the “temporary Bush tax legislation” went into effect.
Jack,
“There’s lots of fat in military spending and corporate welfare.”
Fine….cut it all…I do not know of one person that disagrees with this. There is plenty of room in the defense, homeland security, r & d, and specific branch military budgets to cut. The problem is you can cut it all out and it still isn’t enough money to accomplish anything……So in other words, you can’t claim to be refuting a Strawman arguement…with a Strawman arguement.
“pay their share of their own support?”
They already pay an overwhleming share of the burden. Asking them to pay more does no good. It is just Clss Warfare, in which the middle and lower class pay the ultimate price for it. Just another case of many. where “Liberal Feel Good Intentions” end up in disaster. The main contribution of Wealthy people is not the tax money paid to the government, it is creation of wealth itself, and the creation of economic growth in the overall economy. A lack of understanding can easily explain why you beleive raising taxes is even an option.
“There are no tax policy proposals that suggest a 100% bracket.”
It wasn’t the point. The point was that we can not tax our way to growth, nor can we tax our way to a deficit neutral budget, and the reason is simple…..the United States has overspent for so many years while undercutting it’s ability to grow the country does not have the Demographic or Idelogical pedigree to change course. Ulitmately, if we do not change course soon we will be left with one option, and one option only…….and that is Grow or Die!
It’s an awful lot better than yours.
“The problem is you can cut it all out and it still isn’t enough money to accomplish anything…”
Uh oh, wrong again. That all depends on what you want to accomplish. If the goal is only to eliminate social programs that are essential to the maintenance of the working class then cutting mili=tary spending and corporate welfare may not be sufficient. It, on the other hand, the goal is to restore sanity to government spending and reduce the deficit a bit then you are, as usual, wrong.
“They already pay an overwhleming share of the burden.”
To that idiotic comment I can only say, Bull shit. Relative to what the top 2 or 3 percent take out in income and have stashed away as capital, they pay little and cetainly not enough. If you take the lion’s share of the earnings you should expect to pay the elephant’s share of the taxes as taxes are only a small share of income.
“It is just Clss Warfare, in which the middle and lower class pay the ultimate price for it.”
Now you’re really starting to sound like a right wing ass. Yes, its class warfare and the working and middle class is losing every skirmish and battle.
“The main contribution of Wealthy people is not the tax money paid to the government, it is creation of wealth itself, and the creation of economic growth in the overall economy.”
What you leave out is that the wealth that may have been created over the past three decades has eluded the working class which is only falling back in terms of real income, ie money to spend.
“The point was that we can not tax our way to growth,…”
No, the point is to tax the wealth and income of the nation to a point which supports the work of the government, including what may be necessary to assist the working class as it sees its own income share dessimated by the machinations of the owners of the economy.
Your asinine comments read like the grail of the Chicago School of Economics, none of whose theories of economic growth and development has been validated by reality ovber the past fifty years. Do you light candles to the memory of John D. each night as you grovel at the misguided concepts of Friedman et al?
The fact that business people would object to a 65% tax rate in no way means that a 65% tax rate would be inefficient. It merely means that most folks see their own interests are paramount. Doesn’t tell you a thing about the actual result.
I’m not sure why you asked me that, but he said the relationship between tax rates and growth would be an upside down U. But it is the opposite.
He obviously did present a bunch of evidence. Why are you arguing that black is white?
Cahal,
Obviously, your not quite up to speed on the conversation. Let me see if I can explain this to you.
The analysis Mike is providing is not proof positive that at 65% growth is optimal. Of course, everyone appreciates his attempt to find an optimal tax rate for the upper brackets, but the main problem is that Mike is using historical data of growth strictly based on Marginal Tax Rates, and there is no way of knowing what the actual Effective Tax Rates were per bracket going back as far as he has. The main problem with this is:
1.) Mike can not do a comparison with what the Laffer Curve is doing. Its Apples and Oranges. The Laffer Curve is a realtionship, thats why there is no numbers on it, and it can applied at any point in time. We are either taxing too little to be opitmal, or we are taxing too much…….if it were possible you could apply the theory everday, and change the tax code on a daily basis…Of Course, that is totally unreasonable to do that. The Laffer Curve also applies to other taxes, besides just the individual income tax, which Mike chose to analize.
2.) Majority of the Individuals in the Upper Brackets did not pay the rate they were designated to pay, based on loopholes and the ease of cheating
3.) The tax code in the past was desinged to shape behavior even more so than today.
4.) There are cultural and technological difference that are signifigant when defining what caused growth. Mike even recognizes this in his post.
5.) He has made little if any distinction between growth and revenue increase from the Upper bracket individuals and the all the rest of the tax payers
6.) In the past there was little income inequality. Sure there has always been Super Wealthy, but the overwhleming majority of revenue came from an overwhelming majority of the middle class. In other words……there really were very few people in the upper tax brackets, and the majority of those people did not actually pay the rates as there were written in the tax codes.
‘Mike can not do a comparison with what the Laffer Curve is doing. Its Apples and Oranges. The Laffer Curve is a realtionship, thats why there is no numbers on it, and it can applied at any point in time. We are either taxing too little to be opitmal, or we are taxing too much…….if it were possible you could apply the theory everday, and change the tax code on a daily basis…Of Course, that is totally unreasonable to do that. The Laffer Curve also applies to other taxes, besides just the individual income tax, which Mike chose to analize. ‘
You seem to be saying that no empirical evidence can refute the theoretical relationship between tax and revenue. Based on this, I honestly don’t think it’s worth replying to the rest of what you say. Sorry.
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The author did not do any analysis on the Laffer curve. The Laffer curve is defined to show the relationship between tax revenues and tax rates. This article did tax revenues / GDP and tax rates.
The author did all of this work only to not even get the basic definition of the Laffer curve correct. What happens if higher tax rates actually lower GDP? His analysis shows an upward sloping right side of the curve but that might actually mean LESS tax revenue. His chart just shows that tax revenue would be a higher % of GDP as rates rose. It says nothing about whether or not real tax revenues have increased.
Jack:
Welcome to Angry Bear. First time comments go to moderation to weed out spammers and advertising. This post is from 2011 and I am certain no one will see your comment except for myself and the author if he checks his emails and the address is the same today. I do not believe you will find many proponents of the Laffer Curve here. I suspect we will not see much of a revenue increase from this last tax decrease and the next pres will be left with a “yuge” deficit the same as Obama was when he took office.
Lets see if Mike responds. He is pretty knowledgeable.