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