Where’s the High Point on the Laffer Curve? And Where Are We?

March 3rd, 2012

Anti-taxers love to haul out the legendary napkin-inscribed Laffer curve to demonstrate that lower taxes would yield more government revenue. But this ploy only works because they assume that we’re at or past the high point — that higher taxes would move us down the right slope. (Note the cross-marks-the-spot in the image here?)

But where are we really, relative to that high point? James Kwak gives us an answer, based on a great recent paper by Christina and David Romer (emphasis, interjections, mine):

…an [income] elasticity of 0.19 [from the Romer paper] implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.

This is obviously not to say that we should be taxing at that level — only that Laffer-curve arguments are ridiculous because we’re nowhere near the high point.

Kwak adds another key insight about the paper:

Second, remember that this is a study of the super-rich: not the top 1%, but the top 0.05%. These are the people whom one would expect to have the highest income elasticity, precisely because they don’t need the marginal dollar. Elasticities tend to be lower for ordinary people because they need to cover their expenses.

So we’re even father from the peak than suggested by the .19 elasticity.

Takeaway:

when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes.

Hat tip Karl Smith and Mark Thoma.

Cross-posted at Angry Bear.

How Much Do Taxes Matter? | The Baseline Scenario.

  1. FredB
    March 3rd, 2012 at 11:58 | #1

    I have an idea. Let’s tax all economists at 84% for a while and see what happens.

  2. Foppe
    March 3rd, 2012 at 14:16 | #2

    Huh? Are you really considering taking the Laffer curve seriously at all? Might I recommend Mirowski’s 1982 article “What’s Wrong with the Laffer Curve?” as a useful antidote? :)

  3. March 3rd, 2012 at 14:48 | #3

    Link, Foppe. Link.

    It is all wrong, I think, the cut taxes slash raise taxes, big ender slash little ender, endless slash mindless debate. We need a totally different approach. Like this:

    What’s the most a person could be worth, as a year’s income? Pick a reasonable number.
    What’s the least a person needs for a year, to be above poverty level? Pick a reasonable number.
    Now the tax rates:
    Below the “least” number, the tax rate is zero.
    Above the “most” number, the tax rate is 100%. Not 38% or 84% or 99%, but 100%.
    For the range in between, pick one tax rate.

    The “least” number is our new standard deduction.
    The effective tax rate is progressive, not flat.
    And by setting a “most” number we prevent the value of the dollar from falling endlessly.

    The Laffer curve, applied to things other than taxes, is really rather interesting.

  4. March 3rd, 2012 at 14:59 | #4

    @The Arthurian “And by setting a “most” number we prevent the value of the dollar from falling endlessly.”

    Now that’s an interesting notion. Explain!

  5. March 4th, 2012 at 08:39 | #5

    We always think of inflation as related to printing money. Of course, it isn’t printing, but spending that affects prices. And when there is spending, there is income.

    I’m thinking of inflation in relation to the most income a person could possibly be worth for a year. Like those wall street guys, for example.

    The way things have always been, everybody always wants a little more income. But if there is no upper limit on how much someone can make, there is no lower limit on the value of the dollar, for a man is worth only so much — no matter how highly he values himself!

    I love football, but I still remember Joe Namath being in the news because he was getting such an outrageous salary when he first went pro. And what he got is probably nothing, by today’s standard for the NFL.

    If there was some cap on maximum income — and there is already a minimum: you can’t earn less than zero — then there would be a fixed range for possible incomes, and incomes would distribute themselves within that range according to… free market principles or something .

    Presently, it is open-ended.

  6. DonB
    March 14th, 2012 at 21:40 | #6

    Income above some level becomes more an ego thing, a measure of the person’s RELATIVE STANDING. If the amount a CEO receives is less than another CEO receives, there is incentive for him/her to want more irrespective of his contribution to the company.

  7. Patrick M
    May 7th, 2012 at 22:45 | #7

    “when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes.”

    That tax avoidance is part of what make the laffer peamuch lower than 84% in the real world. The above was debunked in a comment on the link site:

    “What you are observing in your last paragraph is that if you raise tax rates but make loopholes available to avoid them, then the higher rates don’t produce an incentive effect (other than more intensive use of the loopholes). To which I say “Duh!”. Then you’re suggesting that this somehow proves that if we were to introduce higher rates that did bite (via eliminating the loopholes), those rates wouldn’t produce an incentive effect either.It would be unfair to the sophomores I know to describe the logic error here as ‘sophomoric’. “

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