Taxes, This is No Laffing Matter...
A general Republican philosophy is that cutting taxes will lead to increased investment, increased economic growth AND ultimately to increased tax revenue to the government. Empirical evidence, including the article(s) discussed here bear only part of that out. True, true and not necessarily true. Reducing taxes does increase the private sector investment and it does increase economic growth. The end result of this does not necessarily result in more money for the federal government. It depends.
In the midst of this debate is the Laffer curve. It is a visual approach to killing the golden goose. As the government taxes more and more, the people/companies start working less and less. If the government taxes at 100% it is very reasonable to expect zero output and zero tax revenues. At what point, then do you raise taxes so high that you kill off the productive and entrepreneurial spirit. At what point does the increase in taxes cause the government revenues to actually go down because people actually produce less, take more vacations (move to another country or lie/cheat about their taxes).
Here’s a great video about the famous Laffer Curve. But the source within it is what got me and a lot of other people thinking.
This video has the following description:
Published on Sep 9, 2012. If you raise taxes does it automatically follow that you'll raise more revenue? Is there a point at which tax rates become counterproductive? UCLA Economics professor, Tim Groseclose, answers these questions and poses some fascinating new ones.
And it references an article/research by Romer & Romer (2007, 2010) to establish the “hump” of the Laffer curve at 33%. Unfortunately, that’s not what the article by Romer & Romer say. Here’s the actual article (draft) and a great discussion about the video & the article by EconoCat (Penny Wise & Euro Foolish).
Note that Romer and Romer’s research does not include the Great Recession since it was written in 2007 based on statistics from prior years.
First, there is no evidence, certainly not in this article to suggest that 33% is the hump in the Laffer Curve. But Groseclose is right in that we, and our friends from other countries, seem to be discovering the hump. He says that his text book from (early) college thought the hump might be at 70%. I’ve always seen it drawn very symmetrically at 50%. Intuitively, 50% certainly works as a cutoff point; once the government wants to take half of whatever I make (in profits), I really become less motivated to make more. Plus, at that level, the disruptions to the economy (and the deadweight costs) become huge and disruptive... France, trying to institute a 75% top-end tax bracket (personal) has obviously failed, in more ways than constitutionally; actors, for example, simply move to another country (in Europe, where the tax rates are a paltry 50% or less). See Fouquet and Katz (2012).
At low rates of tax, say 5% to 15% there is typically very little disruption to the market (or economy). It doesn’t typically change investments to make otherwise good projects unprofitable, or significantly disrupt “normal” behavior. Probably 20% to 25% is more disruptive to a market (or the economy).
The findings of Romer & Romer (2007) do strongly suggest that tax increases do reduce economic output (and vice versa). There doesn’t really seem to be a direct tie of this output to the government revenues. The evidence strongly suggests that increasing taxes with the explicit purpose of long-term debt reduction works pretty well. Short-term change in the tax levels (to help through recessions and such) appear to be far less effective.
Ahah. The 2010 article that is the final version published by Romer & Romer (2010) looks much more readable with the graphs in place within the article. It seems a little stronger on the impact on output (GDP) from tax cuts. But it still does not take any steps to directly address the Laffer curve concepts of government revenue. As well, there is no indication, if each of the tax change occurs before the hump, or after it.
More on Taxes
One of the issues that I have with the whole Laffer curve thing, is effective rates, marginal rates and tax-code rates. The very high earners pay less than 30% income tax rates. It’s the middle and upper-middle class that get wacked with the highest tax rates.
We could easily have the tax code simpler, straight forward and at lower rates and still generate more income/revenue to the government. Laffer curve or no laffer curve. Also, not all taxes are created equal; and a big influence of the full impact of taxes is what’s done with the money raised.
It should not take the average person 20 hours to a week or more to do taxes. The costs associated with incomprehensible tax codes are huge.
No matter what you think is the “hump” in the Laffer curve, everyone everywhere has to appreciate that there is no tax rate that will solve our federal deficit. It the optimum (short-term or longer-term) is a little low, or a little higher, that still doesn’t make much difference in the federal deficit. At some point the out-of-control spending has to be addressed. At some point, the federal deficit has to be meaningfully reduced.
The Elephant in the Room, is NOT Tax Revenues…
One way to reduce the deficit is through growth. One is through increased tax revenues (this debate). One is through spending cuts and controlled fiscal discipline. The first two are closely tied obviously; and it depends somewhat how effective the government spending is as to how impactful that increased tax revenues are to the overall economy.
There’s no solution ever, however, without controlling spending. The out of control healthcare costs will (Medicare, Medicate and private) will bankrupt the nation within a decade or two. Check out the Debt Clock to get an idea of what our really deficit is; when you consider the unfunded mandates the US owes. The unfunded mandates of Social Security, Federal Drug program and Medicare are about $122T, fully 7 times our current GDP. The deficit we are always talking about ($16.4T) is only 1 times our GDP ($16.3T).
The problem is that the unfunded mandates are growing at a very fast rate, and they will continue to do so until/unless we address them. This is so non-sustainable that you don’t know whether to laugh or to cry. And, at this time, we have a lot of elected leaders fiddling in Rome – I mean D.C.
Check out the article by Hall & Knab (2012) entitled Social irresponsibility provides opportunity for the win-win-win of Sustainable Leadership.
It’s too bad we didn’t get a good, clear indicator of the hump in Laffer’s Curve. It would help settle the tax levels for countries, a point that only the foolish and the French would attempt to exceed. Then government could focus attention on the really important issues at hand and start to aim for sustainable practices.
Anything else would be, well, irresponsible.
References
Hall, E., & Knab, E.F. (2012, July). Social irresponsibility provides opportunity for the win-win-win of Sustainable Leadership. In C. A. Lentz (Ed.),
The Refractive Thinker: Vol. 7. Social responsibility (pp. 197-220). Las Vegas, NV: The Lentz Leadership Institute.
(Available from
www.RefractiveThinker.com, ISBN: 978-0-9840054-2-0)
Fouquet, H., & Katz, A. (2012, December 29). French court says 75% tax rate is unconstitutional. Bloomberg. Retrieved from http://www.bloomberg.com/news/2012-12-29/french-court-says-75-tax-rate-on-wealthy-is-unconstitutional.html
Romer, C. D., & Romer, D. H. (2010). The macroeconomic effects of tax changes: Estimates based on a new measure of fiscal shocks. American Economic Review, 100(3), 763-801. doi:http://dx.doi.org.ezproxy.apollolibrary.com/10.1257/aer.100.3.763
