Permalink to Where Are The Rich on the Laffer Curve Right Now?

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.

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Members have made 46 comments.

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  1. Profile photo of TeamAmerica Member

    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.”  

    • #1
    • December 5, 2012 at 2:04 am
  2. Profile photo of Stephen Bishop Member

    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.

    • #2
    • December 5, 2012 at 3:50 am
  3. Profile photo of James Of England Moderator
    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.

    • #3
    • December 5, 2012 at 3:50 am
  4. Profile photo of Stephen Bishop Member

    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

    • #4
    • December 5, 2012 at 3:51 am
  5. Profile photo of Indaba Member

    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.

    • #5
    • December 5, 2012 at 4:40 am
  6. Profile photo of LowcountryJoe Member

    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.

    • #6
    • December 5, 2012 at 4:51 am
  7. Profile photo of Daniel Sattelberger Inactive

    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.

    • #7
    • December 5, 2012 at 5:13 am
  8. Profile photo of Guruforhire Member

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

    • #8
    • December 5, 2012 at 5:27 am
  9. Profile photo of John Hanson Thatcher

    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.

    • #9
    • December 5, 2012 at 5:39 am
  10. Profile photo of Fake John/Jane Galt Member

    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.

    • #10
    • December 5, 2012 at 5:41 am
  11. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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.

    • #11
    • December 5, 2012 at 5:42 am
  12. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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.

    • #12
    • December 5, 2012 at 5:49 am
  13. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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.

    • #13
    • December 5, 2012 at 5:50 am
  14. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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.

    • #14
    • December 5, 2012 at 5:53 am
  15. Profile photo of Nick Stuart Thatcher

    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.

    • #15
    • December 5, 2012 at 6:09 am
  16. Profile photo of ConservativeWanderer Inactive

    What ever you tax, you get less of.

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

    • #16
    • December 5, 2012 at 6:27 am
  17. Profile photo of Brian Skinn Member
    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.

    • #17
    • December 5, 2012 at 6:41 am
  18. Profile photo of Brian Clendinen Member

     

    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).

    • #18
    • December 5, 2012 at 6:42 am
  19. Profile photo of Schwaibold Member

    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.

    • #19
    • December 5, 2012 at 7:02 am
  20. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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.

    • #20
    • December 5, 2012 at 7:06 am
  21. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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). · 24 minutes ago

    That’s far more palatable than one optimum rate for all. The behavior of folks with lesser resources is going to be different than those with more. Would love to see the article.

    • #21
    • December 5, 2012 at 7:08 am
  22. Profile photo of Tommy De Seno Contributor
    Tommy De Seno Post author
    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. · 6 minutes ago

    I agree that no tax will have a positive effect. But considering the desire to make money is strong, isn’t there some tax that would have no effect on behavior toward investment and production? Isn’t that the point of the left side of the graph?

    • #22
    • December 5, 2012 at 7:10 am
  23. Profile photo of Schwaibold Member
    Tommy De Seno
    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).

    I agree that no tax will have a positive effect. But considering the desire to make money is strong, isn’t there some tax that would have no effect on behavior toward investment and production? Isn’t that the point of the left side of the graph? · 1 minute ago

     I don’t think there is a tax that has ‘no effect’ . The left side of the graph has more to do with the rate of percentage change of the tax rate. In other words, from 1% to 2% tax, the tax rate doubles. So, if production were steady, tax revenue would double. But, production is adversely affected, probably significantly, but not enough to destroy all the gains made by DOUBLING the tax rate.

    However, if the tax rate is 50%, and you double it, production would go to near zero, or tax avoidance take over.

    • #23
    • December 5, 2012 at 7:24 am
  24. Profile photo of King Banaian Contributor

    I may post a separate piece on this tonight when I get time, but in the meanwhile Tim Groseclose had a post on this from September that informs this debate.

    • #24
    • December 5, 2012 at 7:54 am
  25. Profile photo of Lucy Pevensie Member

    I don’t have anything to add in answer to your question, but I do want to make a comment. I wish we could stop adopting the Left’s conflation of high-income people with “the rich.” The “rich” are people who have a lot of money, often by inheritance or marriage, not the people who are out working hard to bring in high incomes, except perhaps at the very highest income levels.

    • #25
    • December 5, 2012 at 7:59 am
  26. Profile photo of No Caesar Thatcher

    Regulations are a tax too. Any analysis of the level of taxation has to include the level of regulation too. We are well on the right hand side of the peak of the Laffer curve with regard to regulations and tax rates.

    • #26
    • December 5, 2012 at 8:02 am
  27. Profile photo of Waynester Inactive

    All taxes represent an opportunity cost to production & taxes on the high end of the income spectrum represent potentially the highest opportunity cost of all because those are the exact people who invest in the most productive areas, that is, those areas which represent the highest risk/reward ratios. Obviously some level of taxation is necessary to support those government functions which make a free market possible i.e., defense, enforcement of the rule of law (contracts),etc.

    • #27
    • December 5, 2012 at 8:04 am
  28. Profile photo of Fricosis Guy Coolidge

    My post 28 Days Later noted this as part of the problem with the Bush tax cuts. This dependence on tax revenue from high-earners (a la California) makes large deficits hard to avoid.

    To Tommy’s original question, we’ve deluded ourselves on the nature of the Laffer Curve. Reagan’s initial cuts were OK and the 1986 tax reform was solid. Kevin Williamson’s piece gets the basic problem right.

    The problem with magical supply-siderism is that it gives Republicans a rhetorical and intellectual framework in which to ignore spending.

    Tommy De Seno
    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%.

    That’s far more palatable than one optimum rate for all. The behavior of folks with lesser resources is going to be different than those with more. Would love to see the article. · 39 minutes ago

    • #28
    • December 5, 2012 at 8:11 am
  29. Profile photo of Daniel Halbach Inactive
    Tommy De Seno

    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.

    I disagree. Neither side has to secretly want it. It’s enough that one side or the other finds every other alternative to be worse. (Maybe that’s what you meant by “want it”?)

    BTW, the economic term for this is Pareto Optimal. It requires a firm status quo to pin the stubbornness to, which in this case is the cliff.

    • #29
    • December 5, 2012 at 8:24 am
  30. Profile photo of Fricosis Guy Coolidge

    Exactly… even worse, we’ve gone along with helping high-income people in rent-seeking industries — banking, insurance, pharma — shelter their income with special breaks while they extract wealth from the rest of us. Look at the parade of horribles on CNBC asking us to step back from the fiscal cliff, CEOs of Bank of America, Aetna, Goldman, etc.

    Lucy Pevensie: I don’t have anything to add in answer to your question, but I do want to make a comment. I wish we could stop adopting the Left’s conflation of high-income people with “the rich.” The “rich” are people who have a lot of money, often by inheritance or marriage, not the people who are out working hard to bring in high incomes, except perhaps at the very highest income levels. · 30 minutes ago
    • #30
    • December 5, 2012 at 9:01 am
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