Where’s the High Point on the Laffer Curve? And Where Are We?
Anti-taxers love to haul out the legendary napkin-inscribed Laffer curve to demonstrate that lower taxes would yield more government revenue. But this ploy only works because they assume that we’re at or past the high point — that higher taxes would move us down the right slope. (Note the cross-marks-the-spot in the image here?)
But where are we really, relative to that high point? James Kwak gives us an answer, based on a great recent paper by Christina and David Romer (emphasis, interjections, mine):
…an [income] elasticity of 0.19 [from the Romer paper] implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.
This is obviously not to say that we should be taxing at that level — only that Laffer-curve arguments are ridiculous because we’re nowhere near the high point.
Kwak adds another key insight about the paper:
Second, remember that this is a study of the super-rich: not the top 1%, but the top 0.05%. These are the people whom one would expect to have the highest income elasticity, precisely because they don’t need the marginal dollar. Elasticities tend to be lower for ordinary people because they need to cover their expenses.
So we’re even father from the peak than suggested by the .19 elasticity.
Takeaway:
…when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes.
Hat tip Karl Smith and Mark Thoma.
Cross-posted at Asymptosis.
A couple of questions:
1) Do we want to maximize tax revenues, in the first place?
2) Do we want the super-rich to make more money? Reagan claimed that high taxes kept him from making more movies. Was that a bad thing? I don’t mean to suggest that he was not a good actor. But if Reagan made fewer movies, might that not mean that other actors made more movies?(OC, we must avoid the lump of acting fallacy. ;))
And paying their congress people.
No, we do not want to maximize tax revenues. That is why we arenot proposing an 84% tax rate.
Reagan was well known for remembering things that were not quite true. Are you sure is memory of this was accurate?
Basically it is like this. If Taxes are to low, the wealthy don’t invest enough. If the current top marginal rate doubled, the wealthy wouldn’t be paying much more than they are now, but they would be forced to put money into their business aventures. Basically it is a “regulatory” tool how the government can move wealth from the wealthy to the non-wealthy via jobs.
If I grossed 700,000 and didn’t want to pay a 70% tax rate, the government may offer me a 40-50% reduction if I invested in solar energy for example, for that fiscal year.
Basically higher taxes shake some wealthy savings into the economy, boosting the savings of the non-wealthy, reboosting the wealthy. Some believe this is why the Great Contration ended. After taxes were hiked after 1931, the economy stopped contracting signifigently by the summer of 1932 and drifted to FDR’s spending programs later in 1933.
I am surprised this doesn’t have its own Laffer Curve philosophy.
@Traditional Conservative:
Boy have you got that right! Higher taxes on rich people — especially on finanncial returns — encourages real investment. They got nowhere else to go…
TC I agree. Strategies to avoid or postpone paying extremely high taxes can be a good thing for the country, as when business owners use more of their receipts to improve their businesses rather than buy ornate furnishings for their summer-season mansions. Or when charitable contributiions go up. Additionally, even if a wealthy person decides to work less and make less taxable income because the marginal tax rate is high, that does not automatically mean a lesser contribution to society. Maybe that person donates time and expertise to a charity, or mentors or teaches. Or becomes a great artist so-recognized long after death. Or makes fewer movies and uses the extra time to pursue politics (that might not be everyone’s favorite example).
And then you have to look at the variables that you never thought about in this context.
for example
if all the manufacturing jobs have been off shored… where is this investment going to go. remember that china has a huge trade surplus and more money than it knows how to invest.
except in U.S. treasuries, which allows the gov’t to run a deficit
oh, it all gets so confusing.
why don’t we just collect the taxes to pay our bills so the Republicans can shut up about deficits except when the Republicans are in control, when, as we know, deficits don’t matter.
Frankly, I remain unconvinced that all those hard working millionaires are “contibuting to society.”
It is higher than zero, which is what half the country is paying. Lets start there and broaden the paying base.
yup
i don’t believe that about half the country. unless half the country is destitute.
but just to be sure, i am all in favor of the poor paying “their” share… and a graduated income tax after that “according to ability to pay”. not confiscatory. not “soak the rich.” but just a reasonably graduated tax up to the point where the country pays its bills. unless a good argument is made for the country not paying its bills. in which case i expect the deficit hawks to shut up.
oh… and “it’s bills” includes whatever it takes to keep the destitute from starving or freezing. though i would prefer we spent a little more on finding work for them, and such education as we are clever enough to give them that would improve their lives.
oh… and “its bills” includes whatever it takes to keep the destitute from starving or freezing. though i would prefer we spent a little more on finding work for them, and such education as we are clever enough to give them that would improve their lives.
Yup the reason much of the country doesn’t pay income tax goes back to standard, personal and dependent deductions. And Rick Santorum has proposed to triple the dependent child exemption.
Broadening the tax base means: for the lowest two quintiles killing personal exemptions, for the next two eliminating mortgage interest and property tax deductions.
That is the math. Which one are you suggesting? Or both?
Historically tax credits as opposed to actual direct welfare spending were conservative ideas, think Reagan, Kemp, and ‘Negative Income Tax’ generally. They all come from the Right. EITC removes people from the tax rolls while limiting their enrollment on the welfare rolls. WHICH WAS THEIR POINT. Complaining about the effects of substituting so called incentives for direct transfers because the incentives had their arithmetically predictable result is close to babbling. By and large the reshaping of the tax code since 1980 has been a conservative project. Reagan and his boys made this bed, over to you on how to remake it.
Actuallly, the portion of the populaiin that pays no feredal income tax is very close to 50% – something in the high 40’s.
Mike Kimel’s work suggests a max tax rate in the 65-70% range to maiximize GDP growth.
It is still far below the revenuw maximizing level, though it is far feom clear to me why we would want to avoid doing that.
Cheers!
JzB
JzB,
Yes, but as I recall, the Laffer curve is actually inverted: http://www.angrybearblog.com/2011/10/laffer-curve-and-kimel-curve.html
jazz
so why am i paying taxes?