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Where Are The Rich on the Laffer Curve Right Now?

The fiscal cliffhanger playing out in Washington is boring. Do I really believe two groups who agree they don’t want choice A are going to fail to come up with choice B? I don’t. The only way choice A happens is if one or both groups secretly want it.

 But let’s play along anyway, shall we?

 I keep hearing Republicans say that raising taxes on the rich will cause less production in the economy.

 But that’s not always the case, is it? According to the Laffer curve, there is an “optimal tax” where government can collect the most money without decreasing production (and therefore tax revenue). It’s right there at the top of the graph.

But the graph clearly means that before getting to the optimum tax rate, government can raise taxes without affecting production. Production only takes a hit on the far side of Arthur Laffer’s curve.

 So before we can declare that we will negatively affect production with higher taxes, aren’t we first required to determine where on the Laffer curve society’s producers are right now?  Are they climbing the hill, atop it or on the downside?

How do we know?

Disclaimer: Just because there exists an “optimal” tax doesn’t mean I think we should try to tax at that rate. If government can run with lesser taxes (or no income tax) it should, even if the tax rate is not at the top of Laffer’s curve.

  1. TeamAmerica

    AFAIK Christina Romer, Former Chair of the Council of Economic Advisers of Pres. Obama, and David Romer, her economist husband, have done research which showed that tax rates over 34% or 35%  cut tax revenue. My understanding is that with combined state and federal taxes many are already at the 35-45% rate. Further, she also notes “Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.”  

  2. Stephen Bishop

    The Laffer curve is illustrative and should not be taken as accurate.

    Tax rates are not a continuous value which slides up and down to make the curve. They go (usually) in steps of 1% and so the nice smooth curve will look pretty jerky.

    The main argument is that as tax revenues at 0% will be zero, and also at 100% ( as few will want to work to pay it – see USSR), and we know that at something like 20% say there will be a large tax revenue we can deduce that somewhere between 1% and 100% there will be a maximum with less return either side. That is the motivator for the curve.

    However if someone is taxed at a higher rate that will influence investment decisions ( unintended consequences because they don’t have the money to invest),  and from that there will be a corresponding reduction in other people’s tax income and possibly increase welfare expenditure.

    When the economy is booming increasing tax is OK as long as we accept the corresponding reduction in growth. When the economy is on its knees increases will only make things worse. That, I believe, is the conservative view.

  3. James Of England
    Tommy De Seno

    But that’s not always the case, is it?   According to the Laffer curve, there is an “optimal tax” where government can collect the most money without decreasing production (and therefore tax revenue).  It’s right there at the top of the graph.

     But the graph clearly means that before getting to the optimum tax rate, government can raise taxes without affecting production.  Production only takes a hit on the far side of Arthur Laffer’s curve.

    You’re getting “production” and “revenue” confused. The Laffer Curve shows that there are tax levels where revenue is not increased by an increase in rates, but does not show that there is a tax rate at which production is not reduced by tax hikes. Indeed, it is an assumption of the curve that no such point exists. A small edit to your post would greatly improve its clarity.

  4. Stephen Bishop

    Our posts were contemporaneous. Excellent point.

    James Of England

    Tommy De Seno

    But that’s not always the case, is it?   According to the Laffer curve, there is an “optimal tax” where government can collect the most money without decreasing production (and therefore tax revenue).  It’s right there at the top of the graph.

     But the graph clearly means that before getting to the optimum tax rate, government can raise taxes without affecting production.  Production only takes a hit on the far side of Arthur Laffer’s curve.

    You’re getting “production” and “revenue” confused. The Laffer Curve shows that there are tax levels where revenue is not increased by an increase in rates, but does not show that there is a tax rate at which production is not reduced by tax hikes. Indeed, it is an assumption of the curve that no such point exists. · in 0 minutes

  5. Indaba

    Stephen Bishop, you make the case.I have owned a business for the past 9 years and just quit and got a job and received my first pay check. The main reason i stopped was because of the amount of money I had to send to the government. I do not know if employers have to deduct the employee tax before paying a salary, but here in Canada, employers take off the tax and are required to send that to the government at regular times during the year. Plus I had to do VAT tax and all the other taxes, at regular times during the year.

    When you write the check to government that often, and you see a declining order book, it is demoralizing enough to fire most of the employees and get a high salary job instead until the economy looks better.

    I am in finance and I am so glad to have a salary, as the bankers are telling us they have never seen it look so bad as right now. I get to sleep well at night now. Taxes absolutely impact on business owners.

  6. LowcountryJoe

    This was never printed but I think it should have been. We really need to change the way we argue tax rates…the beast will always get fed and grow if we cling to this way of thinking.

  7. Daniel Sattelberger

    I second what James of England said.  I find the best way to look at this is of tax revenue as a simple equation:

    Tax revenue = (decimal) tax rate x Amount of taxable money

    If we accept that taxes do some damage to production, then an increase in the rate will lead to a decrease in the amount taxable.  The Laffer Curve points out that at a tax rate 0% you get no revenue because you aren’t taking any money.  At 100% you also get zero because there’s no point working if the government’s going to take it all, so the government is taking all of nothing.

    Taking these two points, it then notes that you clearly get some revenue at points in between; therefore, mathematically, there must be some rate between 0% and 100% that will bring in the maximum possible income.

    To put it another way, at some point the reduction in amount taxable overwhelms the fact that you are taking more of a smaller amount; that’s the peak of the Curve.

    Tim Groseclose discusses it here for Prager University.

  8. Guruforhire

    On the right.  The share of income to the wealthy is shrinking.

  9. John Hanson

    As others have said, the argument is confusing production with revenue.  They are not the same, and an income tax only has an indirect link to production. What does happen, is tax avoidance behavior, which in the case of an income tax biases companies to minimize costs.  The Laffer curve only shows that there is some maximum where Tax Revenues are maximized, but is not linked to production.   Introduction of cheaper means of production in response to higher taxes could increase or decrease production, and withoout a lot more information we don’t know.  What is will due, and not with any inflection point, is reduce the number of jobs needed to provide a given level of production, and this is what Republicans complain about.

  10. Fake John Galt

    From what I can tell from reading left leaning sites the left pretty much dismisses the Laffer Curve and views the right’s embracing of it simular to the ravings of lunatics.

  11. Tommy De Seno
    C
    TeamAmerica: AFAIK Christina Romer, Former Chair of the Council of Economic Advisers of Pres. Obama, and David Romer, her economist husband, have done research which showed that tax rates over 34% or 35%  cut tax revenue.

    I’m going to remain suspicious of the finding without rejecting it.  Laffer’s theory holds that the higher rate will affect behavior.  One of the variables then has to be recorded all the way down to the individual wealth producer.  Some will fight through more adversity than others based upon unmeasurable desire.  

  12. Tommy De Seno
    C
    James Of England

    You’re getting “production” and “revenue” confused. The Laffer Curve shows that there are tax levels where revenue is not increased by an increase in rates, but does not show that there is a tax rate at which production is not reduced by tax hikes. Indeed, it is an assumption of the curve that no such point exists. A small edit to your post would greatly improve its clarity. · 1 hour ago

    I disagree.  You are mixing apples and apples and trying to find a difference.  The graph charts a rise and fall in revenue.  The theory holds the revenue drop is a result not of the tax itself but changed behavior as a consequence of the tax:  a decision made by the wealth producer to exert less energy in producing wealth.  That has to correspond with a drop in production.  If it didn’t there would be no difference in the revenue collected.

    Unless you’ve developed a way to maintain production with less effort.  In that case you need to share it in a book and sell it on an infomercial.

  13. Tommy De Seno
    C
    Fake John Galt: From what I can tell from reading left leaning sites the left pretty much dismisses the Laffer Curve and views the right’s embracing of it simular to the ravings of lunatics. · 8 minutes ago

    Agreed and I don’t understand why because it’s math.  They are rejecting math.  I’ve always thought we should call them out on that.

  14. Tommy De Seno
    C
    John Hanson: As others have said, the argument is confusing production with revenue.  They are not the same, and an income tax only has an indirect link to production. What does happen, is tax avoidance behavior, which in the case of an income tax biases companies to minimize costs.  The Laffer curve only shows that there is some maximum where Tax Revenues are maximized, but is not linked to production.   Introduction of cheaper means of production in response to higher taxes could increase or decrease production, and withoout a lot more information we don’t know.  What is will due, and not with any inflection point, is reduce the number of jobs needed to provide a given level of production, and this is what Republicans complain about. · 11 minutes ago

    As  I already responded to James, no I’m not confusing the two.  I presumed the connection between changed investment behavior and production wouldn’t have to be explained but I appear to have been wrong about that.

  15. Nick Stuart

    I’m in favor of a bill of attainder that confiscates the entire wealth of Warren Buffet, Jim Sinegal and the Costco directors, Michael Moore, and every Obama-supporting rich leftist. They want the rich to pay more taxes, give them what they want.

  16. ConservativeWanderer

    What ever you tax, you get less of.

    Tax investment, you get less investment, and therefore fewer jobs.

  17. Brian Skinn
    Tommy De Seno

    I disagree.  You are mixing apples and apples and trying to find a difference.  The graph charts a rise and fall in revenue.  The theory holds the revenue drop is a result not of the tax itself but changed behavior as a consequence of the tax:  a decision made by the wealth producer to exert less energy in producing wealth.  That has to correspond with a drop in production.  If it didn’t there would be no difference in the revenue collected. · 38 minutes ago

    Tommy, I think you’ve oversimplified — productivity and taxable wages (and thus tax revenues) do not move strictly together.  Replacement of manpower with labor-saving devices (computerization, purchase of capital machines, etc.) is one example where the taxable wages paid from a given enterprise can decrease without necessarily a corresponding drop in productivity.

  18. Brian Clendinen

     

    I wish I could find it but National Review a few years back (on the Corner I think) had what the optimal tax rate would be for the poor, middle class, and rich per the laffer curve based on some research. To maximize revenue, the Rich needed to be in high 20′s%, the poor upper teens, and the middle class in the lower 20′s%. What that means is the poor and middle class should get their tax raised, the poor majorly,  and the rich should have their tax rates lowered to maximize revenues of the U.S. government (at least over the short term, who knows how that would affect long term growth).

  19. jhimmi

    All tax increases have a negative effect on production, but it’s a different graph.  If production were on the vertical axis,  the graph in the first quadrant would go to infinity along the y axis (zero tax) and to zero along the x axis (100% tax).

    So, again, this graph, and common sense, tells us every increase in taxes has a negative effect on production – why would a tax increase have a positive effect on production?  So, even though the change from 0% to 1% taxes might have the biggest negative effect on production, it also has the biggest positive effect on revenue.

    The other variable that should be considered is jobs and employment; reduced production equals reduced employment.

  20. Tommy De Seno
    C
    Brian Skinn

    Tommy De Seno

    I disagree.  You are mixing apples and apples and trying to find a difference.  The graph charts a rise and fall in revenue.  The theory holds the revenue drop is a result not of the tax itself but changed behavior as a consequence of the tax:  a decision made by the wealth producer to exert less energy in producing wealth.  That has to correspond with a drop in production.  If it didn’t there would be no difference in the revenue collected. · 38 minutes ago

    Tommy, I think you’ve oversimplified — productivity and taxable wages (and thus tax revenues) do not move strictly together.  Replacement of manpower with labor-saving devices (computerization, purchase of capital machines, etc.) is one example where the taxable wages paid from a given enterprise can decrease without necessarily a corresponding drop in productivity. · 22 minutes ago

    I agree with you that  there’s no precise cause and effect.  But ultimately there has to be an effect by higher taxes on production.  If not, the far end of the graph -  zero revenue at 100% tax rate -  wouldn’t make any sense.