When does the Laffer Curve kick in, if at all?

[SenorBeef]

Rather than hijack this thread (http://boards.straightdope.com/sdmb/showthread.php?t=525757), I'm opening a seperate discussion on the Laffer curve here.

The Laffer Curve (http://en.wikipedia.org/wiki/Laffer_curve) is the idea, typically associated with supply side economics, that at some point your tax rate becomes high enough as to disincentivize work (or certain kinds of taxed income), therefore less work is done, less revenue is generated, and even with your higher tax rate you actually take in less revenue. This is obviously disastrous - you get less productive work and less tax revenue, and everyone is worse off.

But the only empirical analysis I've ever read on the subject came from an obvious biased source. The concept seems logical enough - but is it something we have to worry about when discussing taking the top marginal income rates from the low 30s to the high 30s, or is it something that only takes effect at much higher rates?

Dick Dastardly asserted (http://boards.straightdope.com/sdmb/showpost.php?p=11386766&postcount=97):

Well, we had 90% tax rates in the 1950s, that mythical time for conservatives when America was the real America, the way things should be and that they'd like to return to. So it couldn't have been that bad back then. The 1950s did also feature 5-8% yearly GDP growth too so clearly high tax rates didn't affect economic growth negatively compared with tax rates/GDP gropwth over the last thirty years.

If we put the marginal rate up to 50%, back to where it was under Reagan, we'd get much greater revenues and it would help reduce the deficit. Tax cuts especially since 2000 have been catastrophic for revenues, long term-deficits, national debt etc.

and (http://boards.straightdope.com/sdmb/showpost.php?p=11386790&postcount=99):


Clinton raised the marginal rate to just under 40% in 1992. The entire GOP voted against it and we were warned of economic catastrophe, huge drops in GDP, tax revenues etc. Instead we got the best economic growth for decades, record investment and balanced the budget.

Bush cut the top rate in 2001 and we were told the usual supply-side snake oil about how well it would work. Instead tax revenues fell catastrophically causing huge long term problems and the weak economic growth petered out very quickly, creating the need for something to give us economic growth to hide the failure of the tax cuts. And lo and behold we got the biggest asset bubble in history.


What did the rich do in the 50s? Keep working as they were and accept their taxation rate as a patriotic duty? Find different sources of income that wouldn't be taxed at that rate? Was investment down across the board? What harm did the extreme tax rate cause?

So in the 50s, when we had a very oppressive 90% top marginal tax rate, the economy still very quickly. In the 90s the marginal rate was higher than it was now, and our tax revenues and general economic growth were far better than they are currently.

So, is the Laffer curve BS? Or at least something that doesn't take effect until rates far above what we're currently at? I'm willing to be convinced. This seems like a subject that can be cleanly solved by economic analysis.

[SenorBeef]

To add: Other countries have higher top marginal tax rates than us. Do they experience reduced revenue based on that? It seems to me that government is interested in maximizing their income far more than punitively attacking the rich - if raising their tax rates actually did decrease their revenue, they'd move away from it immediately. After all how would they benefit from the situation?

[Gangster Octopus]

It's not the Laffer Curve is BS, it is that the Laffer Curve is laughably simplistic. The desing of a full tax code menas you simiply cannot equate a "tax rate" with an amount of income as it relates to our current tax situation. Now, if you has a simple tax code, where income was easily measured and tax rates were simply applied, then it is undeniably true, although where that sweet spot is exactly, who knows.

[Maeglin]

So, is the Laffer curve BS? Or at least something that doesn't take effect until rates far above what we're currently at? I'm willing to be convinced. This seems like a subject that can be cleanly solved by economic analysis.

It is actually not so clean. The important question in policy is whether the taxation deadweight loss parabola (fine, ok, Laffer curve) can be used to justify any one of a number of tax rate decisions. The intuition is very simple and requires a little algebra. But one of the real problems empirically is that it is not smooth. Most of the time, we have no good way of knowing where we actually are on the curve. So unless you are already at one of the extremes, this idea is a very poor guide to setting tax policy.

[Voyager]

When Kennedy cut the marginal tax rate, there was an economic upturn, but I don't know if the increased revenue matched the loss of taxes. I never read about a deficit issue, so it couldn't have been too bad.

There are negative consequences. When England had a high marginal rate, there were many tax exiles, who'd rather live in Switzerland than pay 90%. This was only slightly offset by the song about it, Taxman.

The Laffer curve is just a trivial application of the mean value theorem. If you get no tax revenue at 0 tax, and none at 100% (since no one would work) and you get tax revenue between these points, there must be an optimal tax rate, above which you don't get optimal revenue. If you are above this, cutting will increase revenues. It appears that to Republicans this point is always slightly lower than where we are today.

Given all the other factors involved in a tax cut, I'm not sure you can figure it out. If I remember, the market response to the Clinton tax increase was increased investor confidence since Washington finally seemed to know what it was doing. I don't think factors like this are included in the Laffer Curve calculation.

So, the answer to the question seems to be somewhere over where we are and under where we were in the '50s.

BTW, the prosperity in the '50s could be attributed in no small part to lack of competition, and selling to a world in need of products which was just ramping up industrial production after much of it was destroyed in WW II. The reason for the big tax was to repay the massive debt accumulated during WW II, much bigger than anything we see now, even after the stimulus package - so maybe patriotism had something to do with it.

[DanBlather]

The Laffer curve is not just about the dis-insentibe to work, it also take into account that money paid in taxes is not available for re-investment. Still, it's a bunch of crap and so over-simplified as to be useless.

[Dick Dastardly]

Some more numbers from the other thread to help us understand this issue better :

US Federal Tax Revenues Since 1990 :

These numbers are all in hundreds of billions :

1990
1,032.1

1991
1055.1

1992
1,091.3

*Clinton tax increase*

1993
1154.5

1994
1,258.7

1995
1,351.9

1996
1,453.2

1997
1579.4

1998
1,722.0

1999
1,827.6


2000
2,025.5

So you can see the 35% increase over the Bush year in the thing you linked is totally disastrous. Historically tax revenues roughly double every ten years, something you can see at the link below. Clinton's would have increased another 30+% had he not cut taxes for the middle/lower earners to (slightly) make up for the redistribution of wealth from them to high eaners over the previous decade.

Anyway Bush took office in 2001 and enacted tax cuts which were backdated to the start of that financial year. If the Laffer curve and increased-revenues-when-the-top-rate-is-cut-under-50% is correct then tax revenues should be on target to roughly double plus we see some of that Laffer increase on top of the doubling, right? Here are the numbers, again in hundreds of billions$ :

2000: 2025.5

*Bush tax cut*

2001 : 1991.4

2002 : 1853.4

*Bush tax cut*

2003 : 1782.5

2004 : 1880.3

2005 : 2153.9

2006 : 2407.3

2007 : 2568.2

And the official 2008 number isn't out yet but it'll obviously be below the 2007 number due to the recession, financial meltdown etc.


http://209.85.229.132/search?q=cache...es&hl=en&gl=uk


From the actual evidence over the past twenty years it's clear that if there is any merit to the Laffer idea, the ideal marginal rate is definitely north of 40%, and certainly 50% won't cause any harm to economic growth but would evenrually balance even the current budget.

[Der Trihs]

The Laffer curve is just a trivial application of the mean value theorem. If you get no tax revenue at 0 tax, and none at 100% (since no one would work) and you get tax revenue between these points, there must be an optimal tax rate, above which you don't get optimal revenue. If you are above this, cutting will increase revenues. It appears that to Republicans this point is always slightly lower than where we are today. Exactly; it's a talking point not a useful model for where taxes should be. It doesn't offer any numbers; without a means of knowing where on the curve the ideal spot is, or even of knowing the shape of the curve it's useless.

[MOIDALIZE]

The reason for the big tax was to repay the massive debt accumulated during WW II, much bigger than anything we see now, even after the stimulus package - so maybe patriotism had something to do with it.

That seems to be a dead concept among many people in this country, unless it involves wrapping pointless moralizing in the American flag.

[Shodan]

When Kennedy cut the marginal tax rate, there was an economic upturn, but I don't know if the increased revenue matched the loss of taxes. I never read about a deficit issue, so it couldn't have been too bad.
The US budget deficit roughly doubled 1961-1962 (as a percent of GDP). There was a small surplus in 1960, but the US budget was in deficit thru out the Kennedy administration (cite (http://www.presidency.ucsb.edu/data/budget.php)).

Regards,
Shodan

[billfish678]

The real problem is IMO is any data we currently have would be useless. Every economic era is different.

Now, maybe in the future, when our technology and economy have been similiar and stable for long periods of time, you could actually experiment with taxation to define the curve. Right now, IMO anybody could probably spin the data we have any way they wanted.

[brickbacon]

The Laffer curve is just a trivial application of the mean value theorem. If you get no tax revenue at 0 tax, and none at 100% (since no one would work)

This may be a stupid question, but is there any evidence that the latter part of this is true? People work for free all the time. In fact, people often pay for unpaid internships in some situations. People in the suburbs often pay to pick their own fruit, etc. I get why few would work (on a macro level), but is there any reason to think nobody would work, thus resulting in zero tax revenue.

...and you get tax revenue between these points, there must be an optimal tax rate, above which you don't get optimal revenue.

Do you think the rate is based on the actual number, or what people feel is fair, and reasonable? Seems to me like that optimal rate is a moving target that depends on what they can wrap their heads around, and who taking the money.

[begbert2]

This may be a stupid question, but is there any evidence that the latter part of this is true? People work for free all the time. In fact, people often pay for unpaid internships in some situations. People in the suburbs often pay to pick their own fruit, etc. I get why few would work (on a macro level), but is there any reason to think nobody would work, thus resulting in zero tax revenue.If you felt a desire to work for free, you could just actually work for free - rather than having your employer hand your wages to the government. I'm sure your employer would prefer that arrangement as well.

[Gangster Octopus]

This may be a stupid question, but is there any evidence that the latter part of this is true? People work for free all the time. In fact, people often pay for unpaid internships in some situations. People in the suburbs often pay to pick their own fruit, etc. I get why few would work (on a macro level), but is there any reason to think nobody would work, thus resulting in zero tax revenue.

Well, people might work, but what's the point of getting paid?

[Fotheringay-Phipps]

The concept seems logical enough - but is it something we have to worry about when discussing taking the top marginal income rates from the low 30s to the high 30s, or is it something that only takes effect at much higher rates?One thing you need to consider is that you can't focus on the federal income tax rate and ignore state (& city, in some cases) income taxes as well as withholding taxes, since these are as much a part of a person's decision to work as the federal rate is.

This is particularly significant when comparing to other countries or other time periods.

[smiling bandit]

Interestingly, the point of the laffer Curve is that you DON'T want to maximize government revenue. At least not for the long-run. Hear me out. At low ends of the curve, you get increased investment, although it doesn't actually make up (to the government anyway) the loss in revenue. However, it does mean that in the short run you can raise taxes for specific, large projects. Like World War II or creating moon colonies.

On the other end of the scale, crushing taxes force people to slave away in terror lest something bad happen. They don't work much, and they aren't very productive or interested, but they have too many worries to spend time trying to overthrow the government. (In Soviet Russia, Economy work in You!)

[brickbacon]

If you felt a desire to work for free, you could just actually work for free - rather than having your employer hand your wages to the government. I'm sure your employer would prefer that arrangement as well.

I do work for free. Not exclusively, of course, but a few people I know do. I'm not saying 100% taxation would be a fair or practical situation, just that I think the analogy may be false in an absolute sense. If that is indeed true, doesn't that introduce a wrinkle to the underlying assumption.

Well, people might work, but what's the point of getting paid?

True. But when I hear people making the Laffer curve speech, it seems that the underlying assumption is that people only work for money, thus if there is no monetary gain, people will not work. This seems demonstrably false.

Since supreme court justices are guaranteed their salary, even after retirement, why do they continue working? My point is that if money is not the central reason most people work, then maybe tax rates are not as important as they seem in terms of incentives.

[begbert2]

I do work for free. Not exclusively, of course, but a few people I know do. I'm not saying 100% taxation would be a fair or practical situation, just that I think the analogy may be false in an absolute sense. If that is indeed true, doesn't that introduce a wrinkle to the underlying assumption.Naah, the issue isn't that people won't work for free, it's that they won't pay the government while they work for free. There is no incentive for the employee to ask for a wage if they won't get any of it, and there is incentive against the employer offering a wage, since it costs them money and won't incentivize employment. So logically, at 100% taxation, while work may continue, wages will not, resulting in the 0% tax income at the extreme end of the curve.

[smiling bandit]

True. But when I hear people making the Laffer curve speech, it seems that the underlying assumption is that people only work for money, thus if there is no monetary gain, people will not work. This seems demonstrably false.

Since supreme court justices are guaranteed their salary, even after retirement, why do they continue working? My point is that if money is not the central reason most people work, then maybe tax rates are not as important as they seem in terms of incentives.

How do I put this? You are either deliberately or accidentally being obtuse. Nearly everyone on earth must work to survive. As in, we do not eat if we do not work, and our entire livelihood is dependant on that. The fact that a tiny handful of people are lucky enough to avoid this is irrelevant. And it is well-established that tax rates heavily influence investment and labor markets, because we have studies which specifically analyze this over time.

[Voyager]

This may be a stupid question, but is there any evidence that the latter part of this is true? People work for free all the time. In fact, people often pay for unpaid internships in some situations. People in the suburbs often pay to pick their own fruit, etc. I get why few would work (on a macro level), but is there any reason to think nobody would work, thus resulting in zero tax revenue.

It's an absurd extreme, but I suspect that in a 99.9% tax rate situation most economic activity would be bartering or black market - so the revenue would be fairly close to 0.


Do you think the rate is based on the actual number, or what people feel is fair, and reasonable? Seems to me like that optimal rate is a moving target that depends on what they can wrap their heads around, and who taking the money.
Optimal only in the sense of revenue generation. Fairness has nothing to do with it. Where the optimal point is might depend on that, but not its existence.

BTW here (http://ncseonline.org/NLE/CRSreports/economics/econ-47.cfm) is a table of income tax revenue as a percentage of GDP. from 1941 - 1999. The Kennedy cut doesn't seem to have changed anything much. The decline in 1958 - 1959 was due to the recession, no doubt. You can see the decline after the Reagan cuts, and the increase after the Clinton increase.

I stand corrected about the Kennedy deficit. Still, I don't remember lots of angst about it, and can't imagine where the spending increases came from. Apollo? The run up to Vietnam? Closing the missile gap? (Yes, I know that didn't exist.)

[Voyager]

How do I put this? You are either deliberately or accidentally being obtuse. Nearly everyone on earth must work to survive. As in, we do not eat if we do not work, and our entire livelihood is dependant on that. The fact that a tiny handful of people are lucky enough to avoid this is irrelevant. And it is well-established that tax rates heavily influence investment and labor markets, because we have studies which specifically analyze this over time.

Yes. People who do unpaid internships are supported by parents or spouses who do work. People who pay to pick fruit aren't really working - they are paying for getting fruit without the middleman, which they consider fresher than what they can buy, and maybe for the experience. They may or may not be getting it cheaper than in the store, but I suspect they devalue the worth of their labor.

[villa]

Back in the dim and distant past when I was an undergrad (late '80's) the empirical evidence in the UK suggested that higher marginal tax rates had differing effects on different people, unsurprisingly.

Lower income individuals saw a very small, negative impact. This was predominately explained by a shift away from taxed work into the black ecomony. There was a larger negative impact on incentives among the rich. Middle income earners saw an incentive effect similar in size to that of high earners, but higher taxes created a positive incentive to work. People worked more with higher tax rates presumably because of a target level of tax home income. The more of a pay check that went to the state, the more people had to work to tax home that target income.

There was also a split between men and women. Married women saw a greater disincentive effect than married men.

Sorry - I have no cites for this, and it is all coming from memory. It suggests, as many other people have, that the Laffer Curve is a simplification, and a demonstrative, and has little value itself in planning tax policy.

[foolsguinea]

History shows that with marginal rates between 40% & 70%, higher taxes, paired with higher social spending, boost the economy more than lower tax & spending rates, as your examples demonstrate. Taxes below 40% are depressive by comparison.

Why is this? Some Wild Guesses follow.

First, the more a top earner has to give away, the more productive he has to be to gain great wealth. Higher taxes are an incentive to productivity at the captain-of-industry level.

Second, the redistribution of income across the society gives more purchasing power--ergo more consuming power--to the lower-paid working class. This is pure economic stimulus; you can sell more washing machines, more shoes, more vacation packages, etc., to people who suddenly have the money to pay for them than to those who have enough already.

Lower taxes on the captains of finance, on the other hand, serve to leave that class with more capital to--do what, exactly? Not consume, they already have all the material wealth they require. No, it frees up funds to buy other people's businesses. And so we see the contraction of the bourgeoisie, & the expansion of the proletariat.

So, yeah, despite what people want to think, high taxes on the very highest earners may be a very strong boost to the economy as a whole & a useful protection to the middle class in particular.

[Miltonyz]

In my experience the existence of the Laffer Curve isn't really a controversial subject in economics. My base level Macro Economics went into some detail on it. I think the problem is that where we are on the curve is unknowable and so subject to politics. I think that people learn some of the basics of economics and think these are hard and fast rules. The laffer curve is one of a billion things that can have an effect on the economy.

Let's say tomorrow we find the magic number is 25%. We cut taxes to 25% and this has a positive effect on the economy. At the same time there could be a natural disaster, increases in protectionism, loss of consumer cofidence etc. etc. and the economy ends up contracting for the year. This doesn't mean that we were wrong about the positive effects of the tax rate, other factors conspired against it. At the same time the fact that the economy did so well in the 50's even with an 90% tax rate doesn't mean that such a high rate did not have a negative effect. Or since I have to admit I don't know, maybe the 90% was the best place for us to be. It also seems to me that where we should be on the curve would be constantly moving with the economy and situation.

[begbert2]

It suggests, as many other people have, that the Laffer Curve is a simplification, and a demonstrative, and has little value itself in planning tax policy.Actually it just proves that the laffer curve is an average/aggregate/simplification, as you say - just like literally everything else in economics. Unsurprisingly this fact is no comment one way or the other on the usefulness of it in determining tax policy.


Now, the fact that we have no semblance of a way to calculate the Laffer curve for any given population - now that might be a reason for it to have little value in planning tax policy.

[MOIDALIZE]

Naah, the issue isn't that people won't work for free, it's that they won't pay the government while they work for free. There is no incentive for the employee to ask for a wage if they won't get any of it, and there is incentive against the employer offering a wage, since it costs them money and won't incentivize employment. So logically, at 100% taxation, while work may continue, wages will not, resulting in the 0% tax income at the extreme end of the curve.

Or, alternatively, they'll take a wage but engage in tax evasion.

[begbert2]

Or, alternatively, they'll take a wage but engage in tax evasion.All roads lead to Rome.




(Rome in this case being "a 100% tax rate causes 0% taxation.")

[brickbacon]

How do I put this? You are either deliberately or accidentally being obtuse. Nearly everyone on earth must work to survive.

But that is not true. I'm not being obtuse; I understand the theory, and the point you are making. It's a thought experiment. Clearly, a 100% tax rate is not possible. However, I just think the assumptions the curve is based on help justify a model that does not accurately reflect reality.

The reality is there would never be a 100%, across the board tax rate, however, someone might purpose a 100% tax rate on incomes over $100 million with a net wealth of over $1 billion. I sincerely doubt it would happen, but let's say it does. Now you, an investment banker who loves his job, makes 2% of the funds you control. This has resulted in an average income of $150 million/year. Then the tax rate comes into effect. Do you stop working? Do you stop working once you have made your $100 million? In the real world, I think many people would not dramatically change their behavior. I could be wrong, but I think after a certain point, money is not the primary motivator, so taxation rates are subordinate to things like respect and status.

That was essential what I was trying to understand with my initial question. At a certain point, after practical considerations are taken into account, taxation rates seem like they shouldn't matter as much as many other factors for some people. The assumption seems to be that money represents the same type of incentive to all people, and that that is the only reason people work. I think it's clear some people would still work, and give all their money to the government if they believed the government was doing a good job.

As in, we do not eat if we do not work, and our entire livelihood is dependant on that. The fact that a tiny handful of people are lucky enough to avoid this is irrelevant.

Well, presumably, a government that takes 100% of your money would provide you with food, shelter, etc. I don't think it's irrelevant because there are plenty of lucky people who never have to work, and they, disproportionately control our economy.

And it is well-established that tax rates heavily influence investment and labor markets, because we have studies which specifically analyze this over time.

So then why is there no agreement on what the optimal rate is, or the effect tax rates will have in the real world? Can you provide a link to any study that has correctly, and reliably predicted the effect a modification in the tax rate has had?

[begbert2]

But that is not true. I'm not being obtuse; I understand the theory, and the point you are making. It's a thought experiment. Clearly, a 100% tax rate is not possible. However, I just think the assumptions the curve is based on help justify a model that does not accurately reflect reality.

The reality is there would never be a 100%, across the board tax rate, however, someone might purpose a 100% tax rate on incomes over $100 million with a net wealth of over $1 billion. I sincerely doubt it would happen, but let's say it does. Now you, an investment banker who loves his job, makes 2% of the funds you control. This has resulted in an average income of $150 million/year. Then the tax rate comes into effect. Do you stop working? Do you stop working once you have made your $100 million? In the real world, I think many people would not dramatically change their behavior. I could be wrong, but I think after a certain point, money is not the primary motivator, so taxation rates are subordinate to things like respect and status.I'm pretty sure that's not what's meant by being at the far end of the Laffer curve, which I suspect is based on the total percentage of your money that the Government takes, meaning that at 100% taxation, you get no money at all.

That said, I suspect that if there was a 100% tax on incomes above a given amount, employers would rapidly adjust wages to cap at that amount. Bonuses, on the other hand, are driven by the same activities that are incentivized by promises of promotion and status, so the people who earn them might still do the work and still earn the excess bonuses - but I would be unsurprised if the company capped the bonuses to levels where the employee would actually get some of it. (And then give them the rest in non-cash income - that is, tax evasion.)

[Voyager]

Second, the redistribution of income across the society gives more purchasing power--ergo more consuming power--to the lower-paid working class. This is pure economic stimulus; you can sell more washing machines, more shoes, more vacation packages, etc., to people who suddenly have the money to pay for them than to those who have enough already.

Lower taxes on the captains of finance, on the other hand, serve to leave that class with more capital to--do what, exactly? Not consume, they already have all the material wealth they require. No, it frees up funds to buy other people's businesses. And so we see the contraction of the bourgeoisie, & the expansion of the proletariat.

Especially because it is often the case that businesses that get too big become inefficient, as we saw in the conglomerate fad of a few decades back. Too many different businesses lead to dilution of management attention. Too many of the same business under one roof lead to the problems of monopolies.

What happens if the rich don't buy businesses? They then chase high return investments, that will become riskier and riskier until we get a collapse, or they can drive up the price of stock as more investors bid for shares. As you implied, it is pointless to invest in real production when the consuming masses have no money.

On the other hand, too high taxes drive money into unproductive tax shelters.

[Hellestal]

The problem with the Laffer Curve isn't the curve itself, which is an interesting thought experiment even though it has no real practical use. We shouldn't even be targeting a maximization of short-term government revenue anyway. Our policy concerns should be more utilitarian than that, greatest good for the greatest number, long term growth, etc.

The real problem is the knuckleheads out there that propagate the idea that it's actually valid and relevant. At least one conservative magazine has instituted, as editorial policy, the position that the Laffer Curve is in effect at American levels of taxation (http://meganmcardle.theatlantic.com/archives/2007/10/i_take_it_all_back.php). Shame that McArdle doesn't name names in the link. Her desire to avoid burning bridges might be good for her future income stream, but it would've be handy to know which magazine was so utterly bereft of integrity and principles.

[smiling bandit]

But that is not true. I'm not being obtuse; I understand the theory, and the point you are making. It's a thought experiment. Clearly, a 100% tax rate is not possible. However, I just think the assumptions the curve is based on help justify a model that does not accurately reflect reality.

Of course a 100% tax rate is possible. It's simply stupid, but it's bene done numerous times. And Laffer curves do model reality. It's simply that there are a lot of factors going itno it and there's way to determine where you are on it except via experimentation.

The reality is there would never be a 100%, across the board tax rate, however, someone might purpose a 100% tax rate on incomes over $100 million with a net wealth of over $1 billion. I sincerely doubt it would happen, but let's say it does. Now you, an investment banker who loves his job, makes 2% of the funds you control. This has resulted in an average income of $150 million/year. Then the tax rate comes into effect. Do you stop working? Do you stop working once you have made your $100 million? In the real world, I think many people would not dramatically change their behavior. I could be wrong, but I think after a certain point, money is not the primary motivator, so taxation rates are subordinate to things like respect and status.

No "could" about it. You are wrong. This has actually been observed in actual concrete practice numerous times. People will simply stop earning money (or creating wealth) once it's taxed too high.

Well, presumably, a government that takes 100% of your money would provide you with food, shelter, etc. I don't think it's irrelevant because there are plenty of lucky people who never have to work, and they, disproportionately control our economy.

That's a whole lotta presumption. A government with a 100% tax rate has no incentive to expand services.

So then why is there no agreement on what the optimal rate is, or the effect tax rates will have in the real world? Can you provide a link to any study that has correctly, and reliably predicted the effect a modification in the tax rate has had?

There's no agreement, because most of the people who want to raise taxes have ulterior motives, no common sense, or have no economic understanding. Take your pick. In a more practical sense, we have no yet invented a mathematical formula which defines the optimum tax rate. We can only put it in a reasonable range based on experience.

[Captain Amazing]

In case anybody wants an original source, here's Laffer describing his theory:

http://www.heritage.org/Research/Taxes/bg1765.cfm

[athelas]

First, the more a top earner has to give away, the more productive he has to be to gain great wealth. Higher taxes are an incentive to productivity at the captain-of-industry level.By the same token, taxing you a lot should make you more productive, assuming you live above the subsistence level (in which case you'd become malnourished and less productive). Want to give it a try? I warn you that it hasn't worked out well in the past.

What separates the "captain of industry" from a comfortable middle-class worker? Your explanation makes no logical distinction between the two, except that you want the captain to fall in social status and the middle-class worker to rise.Lower taxes on the captains of finance, on the other hand, serve to leave that class with more capital to--do what, exactly? Not consume, they already have all the material wealth they require. No, it frees up funds to buy other people's businesses. And so we see the contraction of the bourgeoisie, & the expansion of the proletariat.You seem to think that investment is a zero-sum game, in which nobody opens up new factories or upgrades their computers, but only passes around poker chips leaving nobody better off. In that case then the same thing applies to investments from anyone who's saving money, and we should all give up the silly exercise and put money under our pillows instead.

Of course this is hogwash. What your arguments are really trying to do is to make the money of the rich illegitimate, and the money of the poor legitimate, by making poorly-reasoned arguments about how they not only don't do any good by investing it, but mysteriously actively harm everyone else. As Milton Friedman said (http://www.youtube.com/watch?v=I0Ocv8aMBjk&feature=PlayList&p=5CC1AE4884B72A47&index=3)(start at 6:00): what do you suppose the standard of living in the US would be if the amount of capital in the country was what it was 100 years ago, before these infernal rich people started building those pesky factories and computers?

[IdahoMauleMan]

In my experience the existence of the Laffer Curve isn't really a controversial subject in economics. My base level Macro Economics went into some detail on it. I think the problem is that where we are on the curve is unknowable and so subject to politics. I think that people learn some of the basics of economics and think these are hard and fast rules. The laffer curve is one of a billion things that can have an effect on the economy.

Let's say tomorrow we find the magic number is 25%. We cut taxes to 25% and this has a positive effect on the economy. At the same time there could be a natural disaster, increases in protectionism, loss of consumer cofidence etc. etc. and the economy ends up contracting for the year. This doesn't mean that we were wrong about the positive effects of the tax rate, other factors conspired against it. At the same time the fact that the economy did so well in the 50's even with an 90% tax rate doesn't mean that such a high rate did not have a negative effect. Or since I have to admit I don't know, maybe the 90% was the best place for us to be. It also seems to me that where we should be on the curve would be constantly moving with the economy and situation.

Well put.

We also seem to be...well, at least it seems that way to me....restricting ourselves to wage income in this discussion. Taxes on capital gains and dividends are also important factors to consider.

As people earn more wealth, they shift their economic focus more to investments and away from wage-earning income. And there are wildly differing risk profiles associated with each: 3 different risk examples are (1) wage-earning activity, (2) investment in a mature industry that pays dividends (e.g. an electric utility), and (3) investment in entrepreneurial ventures with a significantly higher risk profile.

The tax rates on the wages, dividends and capital appreciation (respectively) will affect the rewards of each approach and therefore raise/lower the risk hurdle for investment in each.

In theory, you could probably raise the marginal rate on income to 50% or more, but if it was accompanied by a drop in capital gains tax rates, and dividend tax rates, you could end up with a net increase in investment and job creation, as more energy from high earners was focused in that direction. You might also experience a drop in income tax revenue.

Dividends, in particular, suffered from punitive double-taxation (and to some degree, still do) in past years, which incented companies to hoard cash on their balance sheets, where it was often squandered. A freer disbursal of dividends makes management much more accountable to shareholders who will ensure that the company has a damn good reason for keeping the cash instead of paying it back to investors.

This is sort of what you saw after the Bush tax cuts.

[Shodan]

First, the more a top earner has to give away, the more productive he has to be to gain great wealth. Higher taxes are an incentive to productivity at the captain-of-industry level.Right - just like we put weight onto a thoroughbred horse to make it run faster. The more you add, the faster they go. All other things being equal.

ISTM that we should raise taxes on the poor, therefore - this will make them more productive, and therefore more in demand for jobs.

Regards,
Shodan

[Algher]

Here is what some researchers have to say about the impact of taxes on GDP:

The results of this more reliable test indicate that tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent.

http://www.nber.org/cgi-bin/printit?uri=/digest/mar08/w13264.html

[Miltonyz]

We also seem to be...well, at least it seems that way to me....restricting ourselves to wage income in this discussion. Taxes on capital gains and dividends are also important factors to consider.

As people earn more wealth, they shift their economic focus more to investments and away from wage-earning income. And there are wildly differing risk profiles associated with each: 3 different risk examples are (1) wage-earning activity, (2) investment in a mature industry that pays dividends (e.g. an electric utility), and (3) investment in entrepreneurial ventures with a significantly higher risk profile.

The tax rates on the wages, dividends and capital appreciation (respectively) will affect the rewards of each approach and therefore raise/lower the risk hurdle for investment in each.

In theory, you could probably raise the marginal rate on income to 50% or more, but if it was accompanied by a drop in capital gains tax rates, and dividend tax rates, you could end up with a net increase in investment and job creation, as more energy from high earners was focused in that direction. You might also experience a drop in income tax revenue.

Dividends, in particular, suffered from punitive double-taxation (and to some degree, still do) in past years, which incented companies to hoard cash on their balance sheets, where it was often squandered. A freer disbursal of dividends makes management much more accountable to shareholders who will ensure that the company has a damn good reason for keeping the cash instead of paying it back to investors.

This is sort of what you saw after the Bush tax cuts.

This is an interesting point. Right now our tax policy greatly favors long term market investing. Investing in a business venture will have to exceed the rate of return of the market and the serious increase in the tax rate incurred. The double taxation involved in dividends doesn't seem to solve any issues and just deincentives companies towards offering them.

[foolsguinea]

ISTM that we should raise taxes on the poor, therefore - this will make them more productive, and therefore more in demand for jobs.Thoroughbreds. Right.

In this analogy, who's the horse, who's the jockey, & who's the owner of the horse?

[begbert2]

Thoroughbreds. Right.

In this analogy, who's the horse, who's the jockey, & who's the owner of the horse?That's not how analogies work.

[athelas]

foolsguinea, you still have not answered my questions in post 34 (http://boards.straightdope.com/sdmb/showpost.php?p=11388048&postcount=34). Might want to do that before snarking on tangents.

[Lumpy]

One oversimplification of the Laffer Curve is the presumption that taxation is a dead loss- the government steals your money and you're that much worse off for it. In reality governments use tax revenue to pay for useful things like security, schools, public infrastructure, etc. that economically are externals to the profitability of a business. Even welfare can arguably be better than having mobs of rioting poor people torch cities on a recurrent basis. One argument for universal health care is that US companies are having to compete with companies based in countries where the government picks up the health care tab. As one person put it in a 60 Minutes interview about France, the taxes there are very heavy "but we get to live in France".

[athelas]

Lumpy, the idea of deadweight loss is not that taxation is taking from individuals to give to the government - if that was all that was happening then it would be called a transfer. Deadweight loss is when people don't do something that they would have done if the tax did not exist. For example, if I am willing to pay up to $12 for a $10 T-shirt, but there's a $5 tax on it, then I won't buy it, even though I could have paid up to $12 and made myself, the manufacturer, and the government all better off. There are clear analogies to purchases as a whole, and to hours of labor.

[athelas]

One argument for universal health care is that US companies are having to compete with companies based in countries where the government picks up the health care tab.That is a poor argument, because companies are simply giving part of their pay in the form of health insurance coverage. If there was a national healthcare system, then they would convert this part of pay back to dollars...but then taxes would have to be higher to pay for healthcare, leaving national competitiveness unchanged. (Indeed most jobs where you can relocate between countries are high paying, in which case the workers would be worse off because UHC advocates favor progressivity, ie socking the rich.)

If you think that UHC can make healthcare cheaper but not lose quality, then that would axiomatically improve welfare, but the proposals on the table, such as HR 3200, do not do that. (And saying "Well, France manages it" is flawed because of different populations. What matters is the relevant tradeoffs we face.)

[IdahoMauleMan]

One oversimplification of the Laffer Curve is the presumption that taxation is a dead loss- the government steals your money and you're that much worse off for it. In reality governments use tax revenue to pay for useful things like security, schools, public infrastructure, etc. that economically are externals to the profitability of a business. Even welfare can arguably be better than having mobs of rioting poor people torch cities on a recurrent basis. One argument for universal health care is that US companies are having to compete with companies based in countries where the government picks up the health care tab. As one person put it in a 60 Minutes interview about France, the taxes there are very heavy "but we get to live in France".

I would argue that your position is the gross oversimplification, not the Laffer curve. And either charmingly naive or intentionally disingenious.

It assumes there was no better alternative for investment than what the government used the money on....which is laughable on its face.

For example, the Federal Dept of Education didn't even exist until the 1970s. Since it's inception, it has spent $100s of billions of taxpayers money. I would argue that it has accomplished nothing, and probably has made matters worse.

For arguments sake, lets say that $300 billion in constant dollars has been spent on the Dept of Education. That's $300 billion that could have been saved and invested, and instead it was squandered. Do you know what $300 billion could do in the pockets of smart entrepreneurs, savvy business bankers, or successful venture capitalists? Create oodles of jobs, that's what.

Your post also assumes that the tax dollars spent on public education are generating more educational 'value' than if they were simply returned to the citizens, who then spent their own money on educational options via their own choice or vouchers. The atrocious state of the public schools in just about any major city, where per capita student expenditures often top $15,000-$20,000 per year, should put this assumption to rest.

Finally, your welfare point takes the alarming position that taxpayers must somehow bribe their fellow citizens not to become lazy thugs, take to the streets, and threaten their life and liberty via extortion. What that says about the nature of people on welfare would play right into the hands of Pat Buchanan or any right-wing conservative. I'm going to guess that's not what you meant. But that's the logical conclusion from your post.

In short, your post assumes that the government creates value superior to what private investment could create, and that everyone on welfare is a latent criminal, just waiting to go on a murderous spree if not sated into a state of permanent government dependency.

If that's the case, we should just give the government all of our money, since that would create more jobs, more wealth and a better society. The Soviet Union and Mao's China tried that already. It didn't work.

[Hellestal]

Lumpy, the idea of deadweight loss is not that taxation is taking from individuals to give to the government - if that was all that was happening then it would be called a transfer. Deadweight loss is when people don't do something that they would have done if the tax did not exist. For example, if I am willing to pay up to $12 for a $10 T-shirt, but there's a $5 tax on it, then I won't buy it, even though I could have paid up to $12 and made myself, the manufacturer, and the government all better off. There are clear analogies to purchases as a whole, and to hours of labor.That doesn't seem to contradict what Lumpy was saying.

There is a deadweight loss to taxation, but there are similar distortional effects from the underproduction of other goods which the government could provide. That's the essential idea behind public goods (http://en.wikipedia.org/wiki/Public_good) and other markets with positive externalities (http://en.wikipedia.org/wiki/Externalities#Positive).

I would argue that your position is the gross oversimplification, not the Laffer curve. And either charmingly naive or intentionally disingenious.

It assumes there was no better alternative for investment than what the government used the money on....which is laughable on its face.It isn't laughable when you put it in a realistic context.

You can pull a hypothetical entrepreneur out of the air to wave around, but I can then point to the recent example of people using their private funds to bid up asset bubbles to dangerously high levels. There certainly is a better use for a lot of the money that the government spends, but there's also a better use for investment than building houses no one wants to buy. That private markets are efficient in many situations does not mean that the government isn't sometimes a better choice.

More than that, you don't have to believe that poor people are inherently "lazy thugs" or any such ridiculous nonsense to recognize that desperate people will act in desperate ways, and that providing some stability to the system is good for everyone. Suggesting a few relatively modest measures to ensure stability doesn't require a Soviet state, and it's a silly false dilemma on your part to suggest otherwise.

[IdahoMauleMan]

You can pull a hypothetical entrepreneur out of the air to wave around, but I can then point to the recent example of people using their private funds to bid up asset bubbles to dangerously high levels. There certainly is a better use for a lot of the money that the government spends, but there's also a better use for investment than building houses no one wants to buy. That private markets are efficient in many situations does not mean that the government isn't sometimes a better choice.



The housing bubble was directly caused by an excess of borrowed money. As all unsustainable asset bubbles are.

Those bubbles were not created by people putting their own capital at risk. They were created through leverage, by borrowing, and by offloading assets to Freddie and Fannie to 're-use' their capital for more borrowing.

The fractional reserve system, the cost of borrowing for banks, and the creation of Freddie and Fannie were all created by, managed by, and regulated by, the government.

[Dick Dastardly]

The housing bubble was directly caused by an excess of borrowed money. As all unsustainable asset bubbles are.

Those bubbles were not created by people putting their own capital at risk. They were created through leverage, by borrowing, and by offloading assets to Freddie and Fannie to 're-use' their capital for more borrowing.

The fractional reserve system, the cost of borrowing for banks, and the creation of Freddie and Fannie were all created by, managed by, and regulated by, the government.

Fannie and Freddie weren't exactly a crucial factor in the housing bubble and weren't responsible for the meltdown of the financial system, they're just another playa. Government did not create fractional reserve banking, bankers did. Banks have always paid a borrowing cost from their bondholders/investors and each other before the advent of central banking. F and F were indeed created by the government but aren't relevant in this at all really. The problem we have isn't government, it's the absence of government. If government was doing its job everything would be chill.

[Hellestal]

The housing bubble was directly caused by an excess of borrowed money. As all unsustainable asset bubbles are.

Those bubbles were not created by people putting their own capital at risk. They were created through leverage, by borrowing, and by offloading assets to Freddie and Fannie to 're-use' their capital for more borrowing.If I lend money to an organization that puts that money at risk, then yes, I am putting my own capital at risk. Asking another person to gamble it for me does not change the underlying nature of the risks that were taken.

And the Fannie & Freddie complaint is just a red herring, as Dick Dastardly has already noted. F&F did not lead the revolution. They were followers, drawn into the subprime world by dwindling market share after their initial refusal. They were pressured to adapt to adverse market conditions, and in doing so, they did make the situation worse, but it was Wall Street that originally screwed up by doping up on so many poor loans and skewing the market, as even a cursory look at the timeline will show.

F&F were moving (http://economistsview.typepad.com/economistsview/2008/09/once-again-it-w.html) away (http://economistsview.typepad.com/.shared/image.html?/photos/uncategorized/2008/09/24/gse.gif) from the market just when it was starting to get dangerous, at least until they felt they had no other choice but to take the same plunge that Wall Street was doing. This New York Times article (http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=2&hp=&oref=slogin&pagewanted=all) has the same information, with a bit of spicy drama added:“You’re becoming irrelevant,” Mr. Mozilo [of Countrywide] told Mr. Mudd [of FannieMae], according to two people with knowledge of the meeting who requested anonymity because the talks were confidential. In the previous year, Fannie had already lost 56 percent of its loan-reselling business to Wall Street and other competitors.

“You need us more than we need you,” Mr. Mozilo said, “and if you don’t take these loans, you’ll find you can lose much more.”Emphasis added.

Fannie had lost so much market share precisely because it was smarter than Wall Street at the beginning and knew how worthless these loans were. This commendable resolve eventually dissolved, and they joined the bandwagon, which of course contributed to our present problems. But those problems were started by market failures in the financial system, which is to say, people using their private capital poorly.The fractional reserve system, the cost of borrowing for banks, and the creation of Freddie and Fannie were all created by, managed by, and regulated by, the government.The fractional reserve system, as already pointed out, was created by banks. It was regulated by the government after the bankers fucked up and lost all their depositors' money (which was gold deposits, back in the day). This happens to be a regular pattern: the government steps in to regulate after private markets cause extensive damage to countless people.

And the cost of borrowing is only indirectly set by the government in its control of the federal funds rate through its open market operations. Banks charge a premium on their own loans above and beyond the base rate based on the risk of the loan and other profit-related factors. The Fed isn't directly responsible if all of Wall Street decides that the loans they're slicing and dicing are magically low risk because, hey, home prices always go up. That was a failure of the market to correctly determine the risk of the shit loans they were giving out. And the entire reason that these institutions had such unwieldy leverage was that regulators like Alan Greenspan thought the companies could look after themselves and their shareholders' value without governmental oversight. This belief in the efficiency of the financial markets is the same reason why he felt comfortable in keeping the federal funds rate so low.

He was wrong to do so, and his mistake demonstrated that the financial markets don't actually function efficiently without adequate regulation.

This important lesson is further emphasized by the stark contrast between the unregulated shadow banking system, which caused our crisis, and normal depositor institutions, regulated by the FDIC, which remained relatively stable.

[Sam Stone]

The problem with this thread is that there seems to be an unstated assumption that the correct policy is to maximize the amount of revenue government can extract from society.

The real question is, 'what is the appropriate size of government?' Only when you know that can you reasonably talk about the best way to raise revenue to pay for it. If your attitude is simply that so long as you can extract money from the economy you should do so, you're opening the door for a very large government.

There is very strong evidence that government should be significantly smaller than it is now. If you plot economic performance against the size of government for all the OECD nations, you see a very strong correlation between larger government and reduced economic performance - even as low as government sizes of around 25% of GDP, which the majority of governments exceed today.

This relationship also holds when you study the economic growth rates of individual states - states with smaller governments as a percentage of GDP outperform the ones with larger governments. And the same relationship also holds with Canadian provinces.

So there are really two questions here. The first is how big government should be in the first place, and the second is how progressive the tax system should be to pay for that government.

As far as progressive taxes go, revenue maximization isn't the only thing to consider. There are good reasons to believe that it's very dangerous to have a taxation structure in which a majority of the voting population pays little to no tax. Once you get to that point, there is very little incentive for lower and middle class people to vote to restrain the size of government.

As of today, the top 1% of people in the U.S. pay over 40% of all taxes - the highest percentage in history. And a disturbingly large percentage of the voting population pays no tax at all. This is a dangerous combination.

Finally, looking at the effect of high marginal rates in the 20th century are not necessarily indicative of what will happen with high marginal rates today. Capital is much more fluid now, and the economy is more globalized, and therefore the rich will find it much easier to move their money to lower-tax jurisdictions. In addition, deadweight losses from business taxes are much more likely to put the taxed businesses at a competitive disadvantage in a more globalized world.

[Hellestal]

The problem with this thread is that there seems to be an unstated assumption that the correct policy is to maximize the amount of revenue government can extract from society.I would disagree that that is an unstated assumption (http://boards.straightdope.com/sdmb/showpost.php?p=11387793&postcount=31) in this thread.The problem with the Laffer Curve isn't the curve itself, which is an interesting thought experiment even though it has no real practical use. We shouldn't even be targeting a maximization of short-term government revenue anyway. Our policy concerns should be more utilitarian than that, greatest good for the greatest number, long term growth, etc.I also wouldn't agree that there's "strong evidence" about the relationship between government size and economic growth, although I'm not going to summarily dismiss the idea.

Countries, and I'd guess even individual states, which can afford larger governments also tend to be the most developed, and so are already pushing at the boundary of growth. It's possible for a developing country like China to grow 10% a year with the right institutional set-up, but the US will not manage that sort of growth again absent another technological revolution.As of today, the top 1% of people in the U.S. pay over 40% of all taxes - the highest percentage in history. And a disturbingly large percentage of the voting population pays no tax at all. This is a dangerous combination.That's incredibly misleading for two reasons.

First, everybody pays taxes. A goodly chunk dodges federal income tax, but they sure as hell don't all dodge FICA, property taxes, state income taxes, sales taxes, etc. Yeah, federal income taxes are progressive, but that progressive structure is mitigated (http://lanekenworthy.net/2009/01/05/how-progressive-are-our-taxes/) somewhat by the effect of other federal and state taxes.

And next, saying that 1% of the population is paying 40% of taxes is almost entirely meaningless without knowing what percentage of the national income those people are raking in. If these one-in-a-hundred types are paying 40% taxes, but also taking home with them 40% of everything made in the USA, then they're paying a flat tax. Which in practical terms favors the rich, when you consider that the marginal value of an extra dollar is a lot less for Bill Gates than it is for a struggling low-income family. Because of this, there are arguments that can be made that taxation should be even more progressive than it currently is.

[Sam Stone]

I also wouldn't agree that there's "strong evidence" about the relationship between government size and economic growth, although I'm not going to summarily dismiss the idea.

Countries, and I'd guess even individual states, which can afford larger governments also tend to be the most developed, and so are already pushing at the boundary of growth. It's possible for a developing country like China to grow 10% a year with the right institutional set-up, but the US will not manage that sort of growth again absent another technological revolution.That's incredibly misleading for two reasons.


When I addressed this in another thread, I pointed out that the relationship even holds between equally developed countries. For example, the U.S. vs Canada, Australia vs New Zealand, various countries in Europe. It holds even when both countries have fairly large governments (i.e. countries with governments that consume 40% of GDP outperform countries where the government is 50% of GDP).

And again, the correlation exists between the U.S. states and Canadian provinces.

Government brings with it a lot of deadweight losses, which is why big governments under-perform smaller governments.

First, everybody pays taxes. A goodly chunk dodges federal income tax, but they sure as hell don't all dodge FICA, property taxes, state income taxes, sales taxes, etc. Yeah, federal income taxes are progressive, but that progressive structure is mitigated (http://lanekenworthy.net/2009/01/05/how-progressive-are-our-taxes/) somewhat by the effect of other federal and state taxes.

People keep bringing up FICA taxes, but since those are ostensibly supposed to be a personal retirement savings program, I don't see that they are relevant. Property taxes largely go to paying for local services. We're talking about federal government programs here, and the pernicious effect of a system whereby the majority of people voting for federal benefit programs do not pay federal income taxes.

And next, saying that 1% of the population is paying 40% of taxes is almost entirely meaningless without knowing what percentage of the national income those people are raking in. If these one-in-a-hundred types are paying 40% taxes, but also taking home with them 40% of everything made in the USA, then they're paying a flat tax. Which in practical terms favors the rich, when you consider that the marginal value of an extra dollar is a lot less for Bill Gates than it is for a struggling low-income family. Because of this, there are arguments that can be made that taxation should be even more progressive than it currently is.

You're talking about 'fairness', whereas I'm talking about a problem of incentives. Totally different issues.

[Hellestal]

When I addressed this in another thread, I pointed out that the relationship even holds between equally developed countries. For example, the U.S. vs Canada, Australia vs New Zealand, various countries in Europe. It holds even when both countries have fairly large governments (i.e. countries with governments that consume 40% of GDP outperform countries where the government is 50% of GDP).That sounds interesting. I'd like to look at your cite.People keep bringing up FICA taxes, but since those are ostensibly supposed to be a personal retirement savings program, I don't see that they are relevant. Property taxes largely go to paying for local services. We're talking about federal government programs here, and the pernicious effect of a system whereby the majority of people voting for federal benefit programs do not pay federal income taxes.You're asserting a pernicious effect, not demonstrating it. And there are excellent reasons to believe it's a bunch of hooey.

Tax incidence is what it is. In the end, you're trying to argue that a large segment of the population will have a substantially different attitude toward the government because the money from their monthly paycheck is disappearing from this box instead of that box. This is a risible belief, born from momentary convenience. There's no reason at all for me, or anyone else, to believe it's true. All you've got is the ostensible rationale for different lines on our payslips based on a long past political compromise that very few people remember or care about. Frankly, I doubt most people even pay attention to state versus federal, let alone FICA versus federal withholding.You're talking about 'fairness', whereas I'm talking about a problem of incentives. Totally different issues.I'm talking about efficiency. I'm just approaching it from a different angle.

If you need to tax, then you should minimize the cost of that tax, and given the vast disparities of income that exist between people, calculating this cost accurately would have to take into account the diminishing value of additional dollars. Is that the only concern? No, of course not. There's deadweight loss, long-term growth, and so on and so forth. This is just one piece in the puzzle, but it is still relevant, a fundamental part of human nature, otherwise we'd all treat a 100% chance of 5 million exactly the same as a 50% chance of 10 million. We don't do that, and there's no need to rely on abstract notions of 'fairness' to recognize that the first windfall is much, much more valuable than doubling it. It's just how people work.

[Dick Dastardly]

When I addressed this in another thread, I pointed out that the relationship even holds between equally developed countries. For example, the U.S. vs Canada, Australia vs New Zealand, various countries in Europe. It holds even when both countries have fairly large governments (i.e. countries with governments that consume 40% of GDP outperform countries where the government is 50% of GDP).

And again, the correlation exists between the U.S. states and Canadian provinces.

Government brings with it a lot of deadweight losses, which is why big governments under-perform smaller governments.





Of OECD countries I think Norway has the second-highest GDP per capita after the US, and Mexico comes closest to the US in terms of taxes as a percentage of GDP. You can also look at countries like Burma or Somalia which have a really low level of taxation/GDP but who aren't doing very well economically.



Comparing ststes or provinces within a country is disingenuous, it's the kind of thing the Heritage Foundation or Cato do to claim lower taxes create jobs. You're obviously going to get some states that attract new jobs by offering less costs to businesses for locating there and you can easily write something that passes for an academic study claiming that low taxes/less government create economic growth, but it's just companies shopping for the best deal within a certain country, they're still locating in that country.


Business wants to locate in wealthy high-infrastructure countries with big markets for their goods and lots of people who can afford them making America the number one destination of companies who are expanding from their own country for the first time, closely followed by the EU. The costs of doing business are not generally a factor in this as they're immeaurably outweighed by the potential profits of locating in a relatively high-tax environment like America rather than a low-tax environment like Pakistan. In low-infrastructure countries trying to become big global players like India, the lack of national infrastructure that you find in low-tax revenue nations is actually seen as a problem, and they're all busily growing their tax base to provide more national infrastructure.

[Dick Dastardly]

And in general even the lowest quintil pay about 20% of their earnings in taxes. People in the highest quintile pay a little more, while the top 1% take home well over a third of national earnings and havr doubled their share of national income since Reagan. It's a certainty that these people have to start paying more taxes at some point in the future, there's just no other option.

EDIT: spelling, had a couple of drinkies :)

[athelas]

Of OECD countries I think Norway has the second-highest GDP per capita after the US, and Mexico comes closest to the US in terms of taxes as a percentage of GDP.First off, to not acknowledge that Norway is an extreme case that rightfully ought to be left off of any comparison is just plain wrong. Norway has a huge amount of oil and gas wealth per capita, and is also socking awa (http://www.nytimes.com/2007/05/04/business/worldbusiness/04norway.html?ex=1335931200&en=7f2abf5b2406f2e6&ei=5090&partner=rssuserland&emc=rss)y a lot of money for the day when their oil will run out, and it is running out. The notion that this huge amount of per capita GDP is somehow due to the high tax model is absurd. Same goes for their surpluses, plus the ability to sustainably fund lots of social programs.

Secondly, it makes no sense to compare countries at different levels of economic development, when what we're looking at is the growth effect of economic policy. So instead of your bizarre pairings, I nominate Sweden, Denmark, and Finland vs Ireland, Hong Kong, and Singapore. For a comparison among large-population countries, I nominate the US, UK, and Australia vs France, Germany and Italy.

[ralph124c]

It is true; the Laffer Curve is a phenomenological explanation of what happens. It readil explains the huge growth of the "underground" economy-where wages are paid, and work performed, all without taxation. Why is there so much cash in circulation? It is because tradesmen will readily give you a huge discount, if you pay in cash. As taxes rise, the government wil try to circumvent the underground economy-they will probably try to eliminate the $100 bills-but the UE will continue to grow. I just got an estimate on a tiling job-the guy would take 50% less for cash-retty good verification of the truth of the Laffer Curve.

[Dick Dastardly]

First off, to not acknowledge that Norway is an extreme case that rightfully ought to be left off of any comparison is just plain wrong. Norway has a huge amount of oil and gas wealth per capita, and is also socking awa (http://www.nytimes.com/2007/05/04/business/worldbusiness/04norway.html?ex=1335931200&en=7f2abf5b2406f2e6&ei=5090&partner=rssuserland&emc=rss)y a lot of money for the day when their oil will run out, and it is running out. The notion that this huge amount of per capita GDP is somehow due to the high tax model is absurd. Same goes for their surpluses, plus the ability to sustainably fund lots of social programs.

Secondly, it makes no sense to compare countries at different levels of economic development, when what we're looking at is the growth effect of economic policy. So instead of your bizarre pairings, I nominate Sweden, Denmark, and Finland vs Ireland, Hong Kong, and Singapore. For a comparison among large-population countries, I nominate the US, UK, and Australia vs France, Germany and Italy.

So take Denmark instead of Morway then. Same high taxes, same cradle-to-grave welfare system, same economic growth.

http://ic.pressflex.com/249.pressflex.net/images//924.photo.jpg


And just because a country has lots of oil doesn't mean anything. Arab countries have most of the world's oil and almost no taxes but their combined GDP is less than Spain's.

Ireland has the same taxation level as the UK. Using Hong Kong and Singapore, two tiny states but huge commercial and banking hubs as examples is much less fair than using Norway as an example. The bottom line is that there's no correlation between taxes and economic growth.

[smiling bandit]

Both Norway and Denmark (which has its own considerably natural resources) have extremely high social cohesion, and unified and highly educated populace, and relatively few international obligations. In short, as nations, they are successful on a small scale. Quantity is a Quality all its own.

And if Europa Universalis teaches us anythihng, it's a whole 'nother ball of wax to match that as a large, diverse, economically complex country.

[Nava]

The reality is there would never be a 100%, across the board tax rate, however, someone might purpose a 100% tax rate on incomes over $100 million with a net wealth of over $1 billion. I sincerely doubt it would happen, but let's say it does. Now you, an investment banker who loves his job, makes 2% of the funds you control. This has resulted in an average income of $150 million/year. Then the tax rate comes into effect. Do you stop working? Do you stop working once you have made your $100 million? In the real world, I think many people would not dramatically change their behavior.

No "could" about it. You are wrong. This has actually been observed in actual concrete practice numerous times. People will simply stop earning money (or creating wealth) once it's taxed too high.

Grey money is one of the problems (or is that a feature, not a bug?) of the Spanish economy. Many people get part of their income in taxable "white," part in "black," either from a different or a single source. I'm talking about people at all levels of the economy, from bricklayers to heads of corporations or politicians.

From an employee's point of view, advantages of maximizing black:
+ less taxes,
+ easier to suckle on the government's teat, from government-sponsored housing to college fellowships

Disadvantages:
+ some government benefits (for example unemployment) are calculated based on white,
+ if your employer cuts off black, your choices are "suck and grunt" or the classified ads

For an employer, advantages:
+ employers who pay black are also charging black; also some taxes (the employer's part of Social Security) are based on white pay. So, less taxes
+ it's a blackmail tool

Disadvantages for the employer:
+ double accounting is a female dog, it really complicates things
+ and it's illegal. Just. A bit. Illegal. One of the fastest ways to make anybody angry is to touch his income, the government doesn't like it when you do it to them, either.


Note that something like a student who gets pocket money from tutoring isn't considered "black," unless the student also has a second job which would make that pocket money taxable.

[IdahoMauleMan]

Grey money is one of the problems (or is that a feature, not a bug?) of the Spanish economy. Many people get part of their income in taxable "white," part in "black," either from a different or a single source. I'm talking about people at all levels of the economy, from bricklayers to heads of corporations or politicians.

From an employee's point of view, advantages of maximizing black:
+ less taxes,
+ easier to suckle on the government's teat, from government-sponsored housing to college fellowships

Disadvantages:
+ some government benefits (for example unemployment) are calculated based on white,
+ if your employer cuts off black, your choices are "suck and grunt" or the classified ads

For an employer, advantages:
+ employers who pay black are also charging black; also some taxes (the employer's part of Social Security) are based on white pay. So, less taxes
+ it's a blackmail tool

Disadvantages for the employer:
+ double accounting is a female dog, it really complicates things
+ and it's illegal. Just. A bit. Illegal. One of the fastest ways to make anybody angry is to touch his income, the government doesn't like it when you do it to them, either.


Note that something like a student who gets pocket money from tutoring isn't considered "black," unless the student also has a second job which would make that pocket money taxable.

Thanks for the post. I also observed this when I lived there.

Not sure what point you're arguing here, but I would argue that is another point in favor of the Laffer curve. In your example above, people are forgoing certain things (some leverage over their employers for certain things, and government benefits) and taking on some risk in exchange for a greater portion of their earnings, now.

They have changed their behavior based on tax rates and confiscation, which is the whole argument behind the Laffer curve.

[Nava]

I'm giving an example of a society where it's pretty much viewed as normal to evade taxes. If earning 1 more cent in white puts you into a higher tax bracket, you may be "better off" by getting that extra cent as black - and many people do.

Of course, then they complain when their unemployment or retirement aren't so big, but since I've always worked white you can imagine my answer to that.

[Nava]

Sorry, got interrupted.

Tax evasion isn't "0 or 100%." This partial tax evasion allows people to get better bring-home than if they work white, but it isn't as glaringly evident as not declaring income at all. It's a way to work in a X% tax system while paying a smaller % that they deem more acceptable. The way brickbacon talks, it sounds as if (s)he is thinking in black and white terms, either you get paid in white or you don't get paid at all. There's other options, including grey and trades.

[IdahoMauleMan]

Sorry, got interrupted.

Tax evasion isn't "0 or 100%." This partial tax evasion allows people to get better bring-home than if they work white, but it isn't as glaringly evident as not declaring income at all. It's a way to work in a X% tax system while paying a smaller % that they deem more acceptable. The way brickbacon talks, it sounds as if (s)he is thinking in black and white terms, either you get paid in white or you don't get paid at all. There's other options, including grey and trades.

Agreed.

But I would argue that grey and trades are also done because of tradeoffs that people make with regards to risk and reward. They are changing their behavior to avoid taxes. If taxes were lower, and more reasonable, they would not.

That is the whole point behind the Laffer curve.

[Dick Dastardly]

Both Norway and Denmark (which has its own considerably natural resources) have extremely high social cohesion, and unified and highly educated populace, and relatively few international obligations. In short, as nations, they are successful on a small scale. Quantity is a Quality all its own.

And if Europa Universalis teaches us anythihng, it's a whole 'nother ball of wax to match that as a large, diverse, economically complex country.

Denmark and Norway get that whole social cohesion and high education levels as a result of their high spending on infrastructure.

The EU isn't a big country, it's a union of nearly twenty, some at different stages of economic development to others, all with different languages, etc.

[Nava]

Agreed.

But I would argue that grey and trades are also done because of tradeoffs that people make with regards to risk and reward. They are changing their behavior to avoid taxes. If taxes were lower, and more reasonable, they would not.

That is the whole point behind the Laffer curve.

I so love it when we all agree!

[foolsguinea]

What separates the "captain of industry" from a comfortable middle-class worker? Your explanation makes no logical distinction between the two, except that you want the captain to fall in social status and the middle-class worker to rise.For much the same reason that we try to calm down manics & cheer up depressives--& give mood levelers to the bipolar.

The objective is to remove the abuses & temptations of gross inequality-- the kind of orders-of-magnitude wealth disparity that ends up harming competition.You seem to think that investment is a zero-sum game, in which nobody opens up new factories or upgrades their computers, but only passes around poker chips leaving nobody better off. In that case then the same thing applies to investments from anyone who's saving money, and we should all give up the silly exercise and put money under our pillows instead.Do I? I don't mean to give that impression. But I do think hostile takeovers, buyouts, & stock speculation are appropriation, not productive investment. Or do you suppose that when you buy stock the company owned gets a cut?

More to the point, I believe that government spending can be planned investment as you describe, in the welfare of the country as a whole. Are you someone who thinks that's just zero-sum reshuffling?Of course this is hogwash. What your arguments are really trying to do is to make the money of the rich illegitimate, and the money of the poor legitimate, by making poorly-reasoned arguments about how they not only don't do any good by investing it, but mysteriously actively harm everyone else. As Milton Friedman said (http://www.youtube.com/watch?v=I0Ocv8aMBjk&feature=PlayList&p=5CC1AE4884B72A47&index=3)(start at 6:00): what do you suppose the standard of living in the US would be if the amount of capital in the country was what it was 100 years ago, before these infernal rich people started building those pesky factories and computers?Do you actually suppose that they were built by the previous era's captains of finance? The tech companies became rich because they supplied goods & services. They didn't supply goods & services because they were rich; why would the already filthy rich need to provide any innovation?

[Sam Stone]

But I do think hostile takeovers, buyouts, & stock speculation are appropriation, not productive investment. Or do you suppose that when you buy stock the company owned gets a cut?

I don't think you understand the role that hostile takeovers and buyouts play. To state that they do not contribute to productivity means you don't understand the parts of a modern economy.

Hostile takeovers may be predatory, but they serve the same purpose as predators do in the wild - they cull the herd of the sick and the weak. Companies, just like animals, often grow old and die. They lose their vision, they use up their resources, they get weighed down by years of bureaucratic sclerosis and bad investments. How do these companies end? They can either end by muddling along until they go into Chapter 7 and get broken up for their assets - while damaging the companies and creditors that were connected to them. What you'd rather have happen is for economic scavengers to peruse the carcass and decide if there is anything valuable left, and if there is to take over and make the hard cuts and changes that old management can't make - because it were responsible for them.

As for buyouts, these are most definitely productive in the aggregate. Companies often have 'holes' in an otherwise solid business plan. They have a great set of products, but are missing key ingredients. So they buy companies which possess them, on terms mutually agreed to by both sides. Therefore, both companies believe that they are gaining something by merging. And if that particular melding of two companies into one results in added quality or efficiencies of production, then everyone wins, including the economy as a whole.

As for stock speculation, it is a pretty important part of the price mechanism. It's also a great predictive tool. It helps maintain liquidity in stocks during recessions, helping to keep the economy moving. Think about how unstable oil prices would be without a futures market. When futures prices go up, it affects consumption and investment in production now. It gives us a lead time. When they go down, they signal that companies should prepare to deal with the upcoming price change. This greatly improves the efficiency with which we deal with resources, for example.


More to the point, I believe that government spending can be planned investment as you describe, in the welfare of the country as a whole. Are you someone who thinks that's just zero-sum reshuffling?

I just think it's mind-bogglingly naive to believe that 1/6 of the economy can be effectively managed by the collection of stooges and morons that currently inhabit the halls of the Congress. You believe in the concept of government planning, so you want to believe that the current planners are sophisticated thinkers creating smart, innovative policy.

Let me ask you: Would you have an example of just such a policy passed by the U.S. government in oh, twenty years? One that's not a patchwork of compromises and payoffs to special interests? Or perhaps we could set the bar lower - a major piece of legislation this August body has even read?

You believe in the government as an ideal. I look at it for what it is right now. You have a government that is running your country into the ground. Both parties. They are so in bed with special interests that some laws are written by lobbyists and passed unread.

Have you ever been involved in project management? Have you ever had to plan a project that is going to take multiple years? It's very difficult. It takes a lot of time.

This government wants to overhaul health care, and is pressuring Congress to pass a bill before they've read it, with barely a month of deliberation - none of which is spent actually addressing the merits of the bill, but in stumping for or against it.

Just how likely do you think it will be that whatever is cooked up is going to be some model of efficiency? Would you bet Grandma's life on it?

The tech companies became rich because they supplied goods & services. They didn't supply goods & services because they were rich; why would the already filthy rich need to provide any innovation?

Can you name a billionaire who hasn't continued spending his money on causes or promoting innovation?

You might want to re-think your position on the motivations of the rich if you ever get to visit Carnegie Hall.

You might want to rethink your position on the innovation provided by the rich after learning about the activities of Jeff Bezos, Paul Allen, Richard Branson, Warren Buffet, Dennie Sanford, or Bill Gates.

Donations to charity or the arts or sciences average in the tens of billions of dollars per year from just the top 20 or so richest people.

The rich are also important to innovation because they are the early adopters. They stimulate the best medical research, because they'll pay for the results. They buy the best cars and the highest technology, and it trickles down to everyone else.

In a socialist system, who are the early adopters? Who are the people for whom $30,000 computers and carbon fiber yachts can be built? How is technology proven out at the bleeding edge? Sure, you can have government science programs, but you won't have anything like the incredible creative energy that competition brings.

[IdahoMauleMan]

The objective is to remove the abuses & temptations of gross inequality-- the kind of orders-of-magnitude wealth disparity that ends up harming competition.Do I? I don't mean to give that impression. But I do think hostile takeovers, buyouts, & stock speculation are appropriation, not productive investment. Or do you suppose that when you buy stock the company owned gets a cut?



There is so much gobbledy-gook and nonsense in the above paragraph, one scarcely knows where to begin.

1. How does an order-of-magnitude wealth disparity harm competition? Take a look at the Top 30 companies in the United States, by market capitalization. Or just look at the Dow Jones 30. A large % of those companies didn't even exist when you were born. These are multi-billion dollar companies, employing tens of thousands of people.

The titans of yesteryear were named GM, Bethlehem Steel, and Sears Roebuck & Co. They had 'orders of magnitude' more wealth than their competition. What's happened to them?

The titans of today are named Wal-Mart, Cisco and MicroSoft. All of those companies were created from scratch in our lifetime, by aggressive entrepreneurs.

The only thing that harms competition is government protection.

2. Hostile takeovers and buyouts are most certainly productive investment. Why would the shareholders of those companies sell to the 'hostile taker-overer' or buyout firm, if they didn't think they were getting more value? Nobody was forced to sell. They sold because that created a better opportunity to get more value for their dollar.

The reason hostile takeovers usually occur is because management is squandering shareholder's resources, and the shareholders have had enough. Sort of like what happens in Congress from time to time....we hope.

If I were you, I would switch to another topic quickly. It's obvious you don't have the slightest idea what you're talking about.

[foolsguinea]

I had this gargantuan reply to Sam Stone, but it got eaten. Suffice it to say that historically, it's not "private competition" that pushed science forward, & the Cold War governments with their central planning & massive tax bases did pretty well in that regard. But I guess Canadians just reverse-engineer our stuff & think it was invented in somebody's garage rather than by military-industrial complexes.

[Rand Rover]

My take on the Laffer Curve is that it really can't be used to show that total tax revenue WILL decrease if marginal rates are increased. Rather, it is only a tool to show that total tax revenue MAY decrease if marginal rates are increased.

So, I think it's just a "don't count your chickens" lesson for those who too hastily do the mental math of applying their desired new marginal rate to the total tax base that existed in a previous year with a different marginal rate.

[Voyager]

2. Hostile takeovers and buyouts are most certainly productive investment. Why would the shareholders of those companies sell to the 'hostile taker-overer' or buyout firm, if they didn't think they were getting more value? Nobody was forced to sell. They sold because that created a better opportunity to get more value for their dollar.

Ah, so the housing bubble made perfect sense? If you own stock in a company, and someone doing an LBO is going to give you more than it is worth on the market today, are you going to care if the deal makes sense?

The reason hostile takeovers usually occur is because management is squandering shareholder's resources, and the shareholders have had enough. Sort of like what happens in Congress from time to time....we hope.

Sometimes true, but sometimes the purchaser is selling a bill of goods. Consider the newspaper takeover that is killing the Tribune company. No matter how they were doing, an LBO that saddled the company with a mass of debt is driving them to destruction far faster than they would have gone without it.

You are trivializing how difficult it is to make a deal work. Even mergers, where both parties agree, are tough because of culture clashes. I believe I've read some literature on how buyouts usually cost more than their value, because there is a certain amount of ego involved, and projections for growth driving the initial deal, which are probably optimistic, get stretched when the purchaser has to increase the price. Like with the recent private equity buyout of Chrysler (not hostile) it is easy for a purchaser to convince himself he can come in and fix all the mistakes of the idiots running the company - only to find out it is not that easy.

If I were you, I would switch to another topic quickly. It's obvious you don't have the slightest idea what you're talking about.

Nor do you. Tell me, if corporations are so run by their stockholders that CEO compensation is reasonable, how do these same stockholders avoid kicking out the CEOs and boards who screw up the company so badly that it needs to be taken over. I'm not disputing that the CEOs screw it up - that is evident. But the same conditions leaving CEOs who are doing a bad job in also cause them to get paid far more than they are worth in many cases.

[Voyager]

My take on the Laffer Curve is that it really can't be used to show that total tax revenue WILL decrease if marginal rates are increased. Rather, it is only a tool to show that total tax revenue MAY decrease if marginal rates are increased.

So, I think it's just a "don't count your chickens" lesson for those who too hastily do the mental math of applying their desired new marginal rate to the total tax base that existed in a previous year with a different marginal rate.

Or in mathematical terms, we don't know what the first derivative of the curve is at our current position. Pretty feeble grounds to justify massive tax cuts, eh?

[Hellestal]

Or in mathematical terms, we don't know what the first derivative of the curve is at our current position.We have every reason to believe it's positive and would still be positive even at marginal rates of over 45% (http://www.fivethirtyeight.com/2009/07/harvard-professor-says-some-stupid.html) (Nate Silver link).

Of course, that by itself doesn't automatically mean that raising taxes is a good idea.

[IdahoMauleMan]

We have every reason to believe it's positive and would still be positive even at marginal rates of over 45% (http://www.fivethirtyeight.com/2009/07/harvard-professor-says-some-stupid.html) (Nate Silver link).

Of course, that by itself doesn't automatically mean that raising taxes is a good idea.

Thanks for the quote. I couldn't get access to the link in the article, because it requires a subscription.

I won't challenge the 45% figure at the moment, but I will note that the effective rate that drives a taxpayer behavior is a combination of

- Federal income taxes
- State income taxes
- FICA and Medicare
- Other taxes (property, auto, sales)

That's what the taxpayer sees.

So just because the top marginal rate on Federal income is 35% or 39%, doesn't necessarily mean that you can jack it to 45% without consequences. If the person in question lives in California, for example, he could be seeing an effective rate of 55+% or higher.

[Really Not All That Bright]

There are negative consequences. When England had a high marginal rate, there were many tax exiles, who'd rather live in Switzerland than pay 90%. This was only slightly offset by the song about it, Taxman.
Britain is a special case- British nationals (and those of most Commonwealth states) automatically had right of abode in most other Commonwealth states- the Bahamas, for instance.

This made it awfully easy for a Briton to become a tax exile.

[smiling bandit]

Britain is a special case- British nationals (and those of most Commonwealth states) automatically had right of abode in most other Commonwealth states- the Bahamas, for instance.

This made it awfully easy for a Briton to become a tax exile.

Perhaps, but if your plan relies on people shutting up and taking the taxes up and arse while you make it hard for people to emigrate... it's not a very good plan.

[Really Not All That Bright]

Perhaps, but if your plan relies on people shutting up and taking the taxes up and arse while you make it hard for people to emigrate... it's not a very good plan.
All plans rely on people shutting up and taking it.

[IdahoMauleMan]

All plans rely on people shutting up and taking it.

I would disagree. I, for one, am happy to pay reasonable taxes to support a common defense, a judiciary, and the few things around the edges that involve externalities about which I've discussed before.

I would also be happy to have the income tax be mildly progressive, so that the wealthier pay more.

But that involves far, far less government than we have today. It requires a top tax rate of 20% or so. Which I think most people don't view as excessively confiscatory.

It's when taxes start to get ridiculously confiscatory that the government needs the population to 'shut up and take it'. And if the taxpayers don't want to, and change their behavior accordingly, we get back into the Laffer curve argument.

[Really Not All That Bright]

But that involves far, far less government than we have today. It requires a top tax rate of 20% or so. Which I think most people don't view as excessively confiscatory.

It's when taxes start to get ridiculously confiscatory that the government needs the population to 'shut up and take it'. And if the taxpayers don't want to, and change their behavior accordingly, we get back into the Laffer curve argument.
People apparently don't view top marginal rates above 50% as excessively confiscatory either.

[Voyager]

People apparently don't view top marginal rates above 50% as excessively confiscatory either.

Doesn't movement along the curve to avoid taxes only happen at the extremes? I always thought that the argument for more tax revenue after a tax cut was greater economic activity, not that people would stop cheating on their taxes. I'm not saying I buy, it but you have to give them their due.

[IdahoMauleMan]

People apparently don't view top marginal rates above 50% as excessively confiscatory either.

At least one does. And I'd be willing to bet, probably two or three.