Question of the Week: Quit Dodging the Issue and Tell Us the Revenue-Maximizing Point on the Laffer Curve

I feel like I’m on the witness stand and I’m being badgered by a hostile lawyers. Readers keep asking me to identify the revenue-maximizing point on the Laffer Curve.

But I don’t like that question. In the past, I’ve explained that the growth-maximizing point on the Laffer Curve is where enough revenue is raised to finance the legitimate – and limited – functions of government.

And one of the earliest posts on this blog explained that we don’t want to maximize tax revenue.

But I still get versions of this question, including a few that accuse me of dodging the issue.

So what the heck, I may as well give an answer to the question. But I won’t give my answer. Instead, I’ll provide the analysis of a Nobel Prize winner.

James Mirrlees won the Nobel Prize in Economics in 1996 and he’s researched this issue, starting with a left-of-center perspective.

Many economists, including Mirrlees, want to use the tax system to achieve a higher degree of equality than would otherwise obtain. This means taking a substantial amount of the additional income of high-income people, which would imply high marginal tax rates on them. But when the government imposes such high marginal tax rates on the highest-income people, it reduces the incentive of the most productive people to be productive. …Economists have long wanted to figure out the optimum, but until Mirrlees’s work no one had been able to solve it.

And what did Mirrlees find? Well, notwithstanding his own preferences, he calculated that the tax rate should be no higher than 20 percent.

Mirrlees started with no presumption against high marginal tax rates. Indeed, he has been an adviser to Britain’s Labour Party, which for decades imposed marginal tax rates in excess of 80 percent. But Mirrlees found that the top marginal tax rate should be only about 20 percent; and moreover, it should be about the same 20 percent for everyone. In short, Mirrlees’s work justified what is now known as a “flat tax,” more appropriately called a “flat tax rate.” Mirrlees wrote, “I must confess that I had expected the rigourous analysis of income taxation in the utilitarian manner to provide arguments for high tax rates. It has not done so.”

Not only a rate of 20 percent, but a flat tax!

Too bad the Labour Party politicians don’t listen to his advice. Heck, the Conservative Party politicians don’t follow his advice either.

But at least we have a rigorous estimate of the revenue-maximizing point on the Laffer Curve.

Though I hasten to add that it’s not the ideal tax rate. As the risk of being repetitive, the tax system should only fund the legitimate functions of government. For much of our history, the government only consumed about 10 percent of economic output and we didn’t need any broad-based tax. So you know where I stand.

That being said, it’s clearly destructive to have tax rates that are above both the growth-maximizing level and the revenue-maximizing level. And that’s where we stand now.

For more information, here’s my video on the Laffer Curve.

And if you want to learn specifically why Obama’s class-warfare agenda is misguided, here’s my Laffer-Curve-lesson-for-Obama post.

P.S. The Tax Foundation has estimated that the revenue-maximizing corporate tax rate is 14 percent.

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California’s One-Man Laffer Curve

I’ve already condemned the foolish people of California for approving a referendum to raise the state’s top tax rate to 13.3 percent.

This impulsive and misguided exercise in class warfare surely will backfire as more and more productive people flee to other states – particularly those that don’t impose any state income tax.

We know that people cross state borders all the time, and it’s usually to travel from high-tax states to low-tax states. And we’ve already seen some evidence that the state’s new top tax rate is causing a loss of highly valued jobs.

This mobility of labor and talent is one of the reasons why California is going to get a very painful lesson about the Laffer Curve.

Politicians (with help from short-sighted voters) can raise tax rates. But they can’t force people to earn income.

Now it looks like one of the super-rich is fed up and looking to make himself less vulnerable to California’s kleptocrats.

Here are some excerpts from an ESPN story.

Phil Mickelson said he will make “drastic changes” because of federal and California state tax increases. …The 42-year-old golfer said he would talk in more detail about his plans — possibly moving away from California or even retiring from golf… Mickelson said. “I’ll probably talk about it more in depth next week. …There are going to be some drastic changes for me because I happen to be in that zone that has been targeted both federally and by the state and, you know, it doesn’t work for me right now. So I’m going to have to make some changes.” …”If you add up all the federal and you look at the disability and the unemployment and the Social Security and the state, my tax rate’s 62, 63 percent,” said Mickelson, who lives in Rancho Santa Fe. “So I’ve got to make some decisions on what I’m going to do.”

He’s actually overstating his marginal tax rate. I suspect it’s closer to 50 percent.

California politicians got too greedy and now they may get 13.3 percent of nothing

But so what? It’s still outrageous and immoral that government is confiscating one-half of the income he generates.

Heck, medieval serfs were virtually slaves, yet they only had to give at most one-third of their output to the Lord of the Manor.

I hope he’s serious and that he escapes from the Golden State’s fiscal hell-hole.

And if he does, what will it mean for California government finances?

Well, here’s what Wikipedia says about his income.

According to one estimate of 2011 earnings (comprising salary, winnings, bonuses, endorsements and appearances) Mickelson was then the second-highest paid athlete in the United States, earning an income of over $62 million, $53 million of which came from endorsements.

Now let’s bend over backwards to make sure we’re not exaggerating. Notwithstanding the Wikipedia estimate, let’s assume his annual taxable income will be only $40 million for 2013 and beyond.

With a 10.3 percent top tax rate, California would collect about $4.12 million per year. And Mickelson apparently thought that was tolerable.

But guess how much the politicians will collect if he leaves the state? I’m tempted to say zero, but they may still get some revenue because of California-based tournaments and other factors.

Find Phil Mickelson

I can say with great confidence, however, that California won’t collect $5.32 million, which is probably what the politicians assumed when they seduced voters into approving the 13.3 percent tax rate.

After all, that assumption only works if Mickelson is willing to be a fiscal slave for Jerry Brown and the rest of the crooks in Sacramento.

As such, I’ll also state with certainty that California’s politicians won’t collect $4 million if Mickelson leaves for another state. Or $3 million. Or $2 million. Or even $1 million.

The best they can hope for is that Mickelson decides to stay in the state while also reducing his taxable income. In that scenario, the politicians might still pocket a couple of million dollars.

Not as much as they collected when the tax rate was 10.3 percent, and far less than what they erroneously assumed they would get with a 13.3 percent rate.

Regardless of Mickelson’s ultimate decision, California is going to be in trouble because most rich people – whether they’re golfers, celebrities, investors, or entrepreneurs – have considerable control over the timing, level, and composition of their income. And they can afford to move.

This is why you don’t want to be on the downward-sloping portion of the Laffer Curve. Everyone’s a loser, both politicians and taxpayers.

So we’re going to see the Laffer Curve get revenge on California and I’ll be first in line to say “serves you right, you blood-sucking parasites.”

If you want more information, here’s my video on the Laffer Curve.

And if you want to watch the full three-part series, they’re all included in this Laffer Curve lesson that I put together for the President. He seems oblivious to real-world evidence, but others may find the information useful.

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Based on a Review of Studies Looking at the Impact of Taxes on Growth, Academic Research Gives Obama a Record of 0-23-3

How do you define a terrible team? No, this isn’t going to be a joke about Notre Dame foolishly thinking it could match up against a team from the Southeastern Conference in college football’s national title game (though the Irish win the contest for prettiest make-believe girlfriends).

I’m asking the question because a winless record is usually a good indication of a team that doesn’t know what it’s doing and is in over its head.

With that in mind, and given the White House’s position that class warfare taxation is good fiscal policy, how should we interpret a recent publication from the Tax Foundation, which reviews the academic research on taxes and growth and doesn’t find a single study supporting the notion that higher tax rates are good for prosperity.

None. Zero. Nada. Zilch.

Twenty-three studies found a negative relationship between taxes and growth, by contrast, while three studies didn’t find any relationship.

For those keeping score at home, that’s a score of 0-23-3 for the view espoused by the Obama Administration.

This new Tax Foundation report is also useful if you want more information to debunk the absurd study from the Congressional Research Service that claimed no relationship between tax policy and growth. Indeed, the TF report even explains that serious methodological flaws made “the CRS study unpublishable in any peer-reviewed academic journal.”

So what do we find in the Tax Foundation report?

…what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy. In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth.

And what does this mean?

…results support the Neo-classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages. Taxes on income and wages reduce the incentive to work. Progressive income taxes, where higher income is taxed at higher rates, reduce the returns to education, since high incomes are associated with high levels of education, and so reduce the incentive to build human capital. Progressive taxation also reduces investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.

To be blunt, the report’s findings suggest the Obama White House is clueless about tax policy.

…there are not a lot of dissenting opinions coming from peer-reviewed academic journals. More and more, the consensus among experts is that taxes on corporate and personal income are particularly harmful to economic growth… This is because economic growth ultimately comes from production, innovation, and risk-taking.

Here’s my cut-and-paste copy of the table summarizing all the academic research.

So what’s the bottom line? The Tax Foundation report concludes with the following.

In sum, the U.S. tax system is a drag on the economy.  Pro-growth tax reform that reduces the burden of corporate and personal income taxes would generate a more robust economic recovery and put the U.S. on a higher growth trajectory, with more investment, more employment, higher wages, and a higher standard of living.

In other words, America would be more prosperous with a simple and fair system such as the flat tax.

Too bad the political elite is more focused on maintaining (or even exacerbating) a corrupt status quo, even if it means less prosperity for the nation.

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Do Higher Tax Rates Hurt Growth?

Because of Obama’s class-warfare tax hike and additional tax increases by kleptocrats at the state level, many successful taxpayers will now lose more than 50 percent of any additional income they generate for the American economy.

I discuss the implications of this punitive tax policy in this CNBC interview.

Normally, this is the section where I highlight certain points I made, or bemoan the fact that I failed to mention an important fact or overlooked a key argument. Today, though, I want to address the do-taxes-impact-growth issue raised by Robert Frank.

More specifically, I want to debunk the Congressional Research Service study that he indirectly mentioned about two minutes into the segment. This is the report that asserted that it doesn’t matter if we impose high tax rates on investors, entrepreneurs, small business owners, and other “rich” taxpayers.

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

The good news is that I don’t really need to debunk this CRS study because Steve Entin already has undertaken that unpleasant task. Writing for the Tax Foundation, Steve points out some rather fatal flaws in the CRS study.

The study makes no effort to determine the channels through which the tax changes ought to work to affect the economy, looks at the wrong measure of progress over the wrong time frame, and takes inadequate account of what other tax or economic events are occurring at the same time that might mask the results. …Other changes in taxes and other influences on the economy occurring at the same time can easily hide or counteract the effect of the top tax rate changes alone. It is often impossible to hold other things constant to allow one to see the impact of the single item one wants to assess. When these other influences are omitted from the model, the “missing variables” problem poisons the results. …one should look at the long-term change in the capital stock and the ultimate level of output, not the short-term rise in investment and the short-term change in the growth rate. If one looks only at the growth rate, and not at the level of GDP, one could conclude that the tax rate change has only a temporary benefit, when in fact it is permanently helpful. …Looking only at the amount of investment triggered in the year following the tax change misses the point. The same holds true in the opposite direction for a tax increase. It takes years to retire through attrition the excess capital made redundant by a tax increase. Looking only at the change in investment in the year after the tax cut, rather than the cumulative increase in the stock of capital over time, misses about 95 percent of the impact. You can’t predict this fall’s apple crop by counting the number of seedlings planted this spring. The CRS study omits important variables and poisons its results by not holding other factors constant. The variables it does examine are indirectly related to the relationship one should be studying, but the study does not follow them for long enough to get the whole picture. The study is as weak now as it was when it was first issued. Grade: F.

By the way, the Wall Street Journal pointed out that the author of the CRS study is not exactly dispassionate and neutral on these matters.

You won’t be surprised to learn that Mr. Hungerford has donated to the Obama campaign and Senate Democrats and worked as an economist at the White House budget office under Bill Clinton.

In closing, I did address the taxes-growth issue last year. I wasn’t debunking the CRS study, but I was exposing the errors in some very similar analysis by a writer for the New York Times.

Here’s the key passage from that post.

Yes, lower tax rates are better for economic performance, just as wheels matter for a car’s performance. But if a car doesn’t have an engine, transmission, steering wheel, and brakes, it’s not going to matter how nice the wheels are.

In other words, I was focusing on the fact that you can’t accurately and honestly examine tax policy without looking at the impact of other public policy issues.

I made that point in the CNBC interview, of course, though it’s unclear whether the message got through.

But I think the Clinton years and Bush years make my point. Bill Clinton was bad on tax policy in 1993, but was good on almost everything else (including a cut in the capital gains tax rate in 1997), whereas George W. Bush was okay on tax policy, but was bad on just about everything else.

So here are a couple of very simple questions.

1. Given what we now know about the increase in economic freedom under Clinton and the loss in economic freedom under Bush, is anybody surprised that the economy did better under Clinton than it did under Bush?
2. Does anybody think that the economy prospered under Clinton because he raised tax rates in 1993?
3. Does anybody think the economy was anemic under Bush because he lowered taxes in 2001 and 2003?

Depending on how you answer those questions, you may be qualified to work at the Congressional Research Service.

But if you understand that it’s important to look at the overall burden of government when measuring the impact of public policy on economic performance, then…well, I’m not sure whether I can promise anything other than you’ll have the satisfaction of knowing that you’re intellectually honest and economically literate.

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Class Warfare Tax Policy Causes Portugal to Crash on the Laffer Curve, but Will Obama Learn from this Mistake?

Back in mid-2010, I wrote that Portugal was going to exacerbate its fiscal problems by raising taxes.

Needless to say, I was right. Not that this required any special insight. After all, no nation has ever taxed its way to prosperity.

We’re now at the end of 2012 and Portugal is still saddled with a weak economy. And the higher taxes haven’t resulted in less red ink. Indeed, according to the Economist Intelligence Unit, government debt has jumped from 93 percent of GDP in 2010 to 124 percent of GDP this year.

Why did higher taxes backfire in Portugal? For the same reasons that higher taxes have failed in Greece, Spain, Bulgaria, France, Italy, the United Kingdom, and so many other nations.

• Higher taxes undermine incentives for productive behavior, thus reducing an economy’s potential for growth. This means less economic output, which also means a smaller tax base. This Laffer Curve effect doesn’t necessarily mean less revenue, but it certainly means that tax increases rarely raise as much money as initially projected.
• Higher taxes usually are a substitute for the real solution of spending restraint (i.e., Mitchell’s Golden Rule). Politicians oftentimes refuse to reduce the burden of government spending because of an expectation of additional tax revenue. Heck, in many cases, higher taxes trigger an increase in the size and scope of the public sector.

So did Portugal learn any lessons from this failed experiment in Obamanomics?

Hardly. Indeed, the government plans to double down on this approach – even though it’s increasingly apparent that higher tax burdens won’t translate into much – if any – additional tax revenue. Here are some excerpts from a report in the Financial Times.

Lisbon plans to lift income tax revenue by more than 30 per cent, raising the effective average rate by more than a third from 9.8 to 13.2 per cent. Anyone receiving more than the minimum wage of €485 a month, including pensioners, will also pay an extraordinary tax of 3.5 per cent on their income. …the steep tax increases facing many families have made the outlook for 2013 – the third consecutive year of austerity, recession and rising unemployment – the grimmest yet. Total tax revenue has fallen considerably below target this year, forcing the government to implement additional austerity measures… The coalition will be relying on increased state revenue to account for about 80 per cent of the fiscal adjustment required in 2013 – a reversal of the original bailout plan, in which consolidation was to be achieved mainly through spending cuts.

Amazing. The government imposes huge tax hikes, which don’t generate any positive results. Yet even though “tax revenue has fallen considerably below target,” confirming that there are significant Laffer Curve issues, the government chooses to repeat the snake-oil fiscal therapy of higher taxes.

Anybody want to guess what’s going to happen? The answer, of course, is that this will further dampen incentives to generate income and comply with the government’s fiscal demands.

The latest increases have stretched the tax system to the limit, says Carlos Loureiro, a tax partner at Deloitte. “The current model is exhausted. We need to do something different,” he says. “Any further increase in tax rates is unlikely to result in increased revenue.” Income from value added tax, the government’s biggest source of tax revenue representing about 36 per cent of the total, has been falling since 2008, despite a sharp increase in the rate – the main rate is now 23 per cent. Both the government and the European Commission have acknowledged the risks of depending on increased tax revenue, which is more growth sensitive, to meet fiscal targets and contingency spending cuts amounting to 0.5 per cent of national output have prepared in case of another tax shortfall.

I almost want to laugh at the part of the excerpt which notes that tax revenue “has been falling…despite a sharp increase in the rate.”

Maybe it’s time for these fiscal pyromaniacs to realize that revenues might be falling because rates are higher. In other words, Portugal not only isn’t at the ideal point on the Laffer Curve (collecting the amount of revenue needed to finance legitimate activities of government), it may even be past the revenue-maximizing part of the curve.

To be fair, there are lots of factors that determine economic performance, so higher tax burdens are just one possible explanation for why the tax base is shrinking or stagnant.

The one thing we can state with certainty, though, is that Portugal’s fiscal problem is too much government spending. The failure to address this problem then leads to very unpleasant symptoms, such as lots of red ink and self-destructive class-warfare tax policy.

If all that sounds familiar, that’s because it’s also a description of what President Obama is proposing for the United States.

Ummm…shouldn’t they be targeting politicians?

P.S. I don’t want to imply that Portugal is a total basket case. True, I’m not optimistic about the country’s future, but at least some lawmakers now acknowledge that Keynesian spending was a big mistake. And there are even signs that Portuguese officials are beginning to realize that lower tax rates should be part of the solution. But good policy may be impossible since so many people now have a moocher mentality.

P.P.S. At the risk of bearing bad news to close the year, research from both the Bank for International Settlements and the Organization for Economic Cooperation and Development shows the United States actually faces a bigger long-run fiscal challenge than Portugal.

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Once Obama’s Policies Are Implemented Next Year, U.S. Capital Gains Tax Rate Will be 70 percent Higher than Global Average

Back in September, I shared a very good primer on the capital gains tax from the folks at the Wall Street Journal, which explained why this form of double taxation is so destructive.

I also posted some very good analysis from John Goodman about the issue.

Unfortunately, even though the United States already has a very anti-competitive system – as shown by these two charts, some folks think that the tax rate on capital gains should be even higher.

And it looks like they’re going to succeed, either because we go over the fiscal cliff or because Republicans acquiesce to Obama’s punitive proposal.

But this won’t be good for American competitiveness. Here’s some of what my colleague Chris Edwards just wrote about the issue.

Nearly every country has reduced tax rates on individual long-term capital gains, with some countries imposing no tax at all. …If the U.S. capital gains tax rate rises next year as scheduled, it will be much higher than the average OECD rate. …Capital gains taxes raise less than five percent of federal revenues, yet they do substantial damage. Higher rates will harm investment, entrepreneurship, and growth, and will raise little, if any, added federal revenue. …Figure 1 shows that the U.S. capital gains tax rate of 19.1 percent in 2012 is higher than the OECD average rate of 16.4 percent.  These figures include both federal and average state-level tax rates on long-term capital gains. Next year, the expiration of the Bush tax cuts will push up the U.S. rate by 5 percentage points, and the new investment tax imposed under the 2010 health care law will push up the rate another 3.8 percent. As a result, the top U.S. capital gains tax rate will be 27.9 percent, which will be far higher than the OECD average. The federal alternative minimum tax and other provisions can increase the U.S. capital gains tax rate even higher.

The worst country is Denmark, at 42 percent, followed by France (32.5 percent), Finland (32 percent), Sweden and Ireland (both 30 percent), and the United Kingdom and Norway (both 28 percent).

Every other developed nations will have a capital gains tax rate below the United States level. And even some of those above the U.S. level often have provisions that spare many taxpayers from this pernicious form of double taxation.

Some countries have exemptions for smaller investors. In Britain, for example, individuals can exempt from tax the first $17,000 of capital gains each year. Eleven OECD countries do not impose taxes on longterm capital gains, nor do some jurisdictions outside of the OECD, such as Hong Kong, Malaysia, and Thailand.

The nations on the list that don’t tax capital gains are Belgium, Czech Republic, Greece, Luxembourg, Mexico, Netherlands, New Zealand, Slovenia, South Korea, Switzerland, and Turkey.

I’m not surprised to see Switzerland on that list since that nation has some very sensible fiscal policies. And the Netherlands, notwithstanding its welfare state and long-run fiscal challenges, is very focused on global competitiveness.

But who would have thought Greece had any good policies?!? Or Belgium? Though maybe that’s one of the reasons why many successful French taxpayers are choosing that nation as a refuge.

Heck, even Russia has abolished its capital gains tax.

In his paper, Chris also gives a good explanation of the underlying tax theory in the capital gains tax debate. Simply stated, the statists like the “Haig-Simons” approach because it justifies class-warfare tax policy.

To maximize growth, we should “tax the fruit of the tree, but not the tree itself.” That is, we should tax the flow of consumption produced by capital assets, not the capital that will provide for future consumption. A Haig-Simons tax base—which includes capital gains—taxes the tree itself.  Why does a Haig-Simons tax base garner support if it is impractical and anti-growth? It appears to be because the liberal idea of “fairness” includes heavy taxation of high earners. Since high earners save more than others, they would be taxed heavily under a Haig-Simons tax base. …Today, many economists favor shifting from an income to a consumption tax base… Under a consumption tax base, savings would not be double-taxed, and capital gains would not face separate taxation because the cashflow from realized gains would be taxed when consumed. With regard to “fairness,” a Haig-Simons tax base penalizes frugal people and rewards the spendthrift. That’s because earnings are taxed a second time when saved, while immediate consumption does not face a further tax. That makes no sense because it is frugal people—savers—who are the benefactors of the economy since their funds get invested in the new businesses and new capital equipment that generates growth.

The right approach is to have a “consumption tax base,” which simply is another way of saying that income shouldn’t be taxed more than one time (as shown in this flowchart).

My video elaborates on all these issues and explains why the right capital gains tax rate is zero.

Writing about the death tax yesterday, I mentioned that it also is a perverse form of double taxation. And just as with the death tax, it’s worth noting that all the major pro-growth tax reform plans  – such as the flat tax or national sales tax – also have no capital gains tax.

It’s bad enough when the IRS gets to tax our income one time. They shouldn’t be allowed more than one bite of the apple.

P.S. Chris makes a very important point about higher capital gains taxes collecting little, if any revenue. Simply stated, there’s a large Laffer Curve effect since investors can choose not to sell an asset if the tax penalty is too high.

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Will Obama Learn from England’s Laffer Curve Mistake?

Obama’s main goal in the fiscal cliff negotiations is to impose a class-warfare tax hike.

He presumably thinks this will give the government more money to spend, but recent evidence from the United Kingdom suggests that he won’t get nearly as much money as he thinks.

Why? Because there’s this thing called the Laffer Curve. It shows that it is naive to believe that there is a linear relationship between tax rates and tax revenue. To accurately predict what will happen to revenues when there is a change in tax policy, you also have to estimate what will happen to taxable income.

And when you’re trying to stick it to the “rich,” you need to understand that they have tremendous control over the timing, level, and composition of their income. So unlike the rest of us, they can respond very easily when the government goes after them.

The Wall Street Journal opines on what recently happened across the Atlantic.

A funny thing often happens on the way to soaking the rich: They don’t stick around for the bath. Take Britain, where Her Majesty’s Revenue and Customs service reports that the number of taxpayers declaring £1 million a year in income fell by more than 60% in fiscal 2010-2011 from the year before. That was the year that millionaires became liable for the 50% income-tax rate that Gordon Brown’s government introduced in its final days in 2010, up from the previous 40% rate. Lo, the total number of millionaire tax filers plunged to 6,000 in 2010-2011, from 16,000 in 2009-2010. The new tax was meant to raise about £2.5 billion more revenue. So much for that. In 2009-2010 British millionaires contributed about £13.4 billion to the public coffers, or just under 9% of the total tax liability of all taxpayers that year. At the 50% rate, the shrunken pool yielded £6.5 billion, or about 4.4%.

In case you think this is just a special case, the United States conducted a similar experiment in the 1980s, except we lowered tax rates instead of raising them. And as you can see in this “lesson” post I wrote for the President, we got the same results as the United Kingdom, except in reverse. More rich people, more taxable income, and more tax revenue.

Here’s a chart showing what happened in the U.K. It shows tax revenue for the 2009-2010 fiscal year, followed by a projection for 2010-2011, and then the real-world numbers.

Now time for some important caveats. There are lots of things that determine taxable income for the rich, so we have no way of precisely knowing the extent to which the higher tax rate caused taxable income – and therefore tax revenue – to fall. The economy’s weak performance may have played a role, though the recession in the U.K. occurred in 2008 and 2009, so you would expect taxable income to climb for the 2010-2011 fiscal year.

It’s also possible that some of the revenue loss was the result of income shifting rather than a genuine decline in the amount of economic activity.

But we do know that the same pattern keeps appearing in nation after nation, whether we’re looking at Italy, France, or Spain. Or states such as Illinois, Oregon, Florida, Maryland, and New York.

You mess with the Laffer Curve and it will get its revenge.

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A Laffer Curve Warning about the Economy and Tax Revenue for President Obama and other Class Warriors

Being a thoughtful and kind person, I offered some advice last year to Barack Obama. I cited some powerful IRS data from the 1980s to demonstrate that there is not a simplistic linear relationship between tax rates and tax revenue.

In other words, just as a restaurant owner knows that a 20-percent increase in prices doesn’t translate into a 20-percent increase in revenue because of lost sales, politicians should understand that higher tax rates don’t mean an automatic and concomitant increase in tax revenue.

This is the infamous Laffer Curve, and it’s simply the common-sense recognition that you should include changes in taxable income in your calculations when trying to measure the impact of higher or lower tax rates on tax revenues.

No, it doesn’t mean lower tax rates “pay for themselves” or that higher tax rates lead to less revenue. That only happens in unusual circumstances. But it does mean that lawmakers should exercise some prudence and judgment when deciding tax policy.

Moreover, even though I’m a strong believer in the importance of good tax policy, it’s also important to understand that taxation is just one of many factors that determine economic performance. So lower tax rates, by themselves, are no guarantee of economic vitality, and higher tax rates don’t necessarily mean the world is coming to an end.

With those caveats in mind, take a look at this table from the Congressional Budget Office’s most recent Budget and Economic Outlook. Taken from page 109, it shows what will happen if the economy grows just a tiny bit less than the baseline projection. Not a recession, by any means, just a drop in the projected growth rate of just 1/10th of 1 percent.

As you can see, the 10-year impact is $314 billion, mostly due to lower tax receipts, though there is some impact on outlays because of  higher interest costs and a bit of additional entitlement spending.

So why am I sharing these numbers? Because let’s now think about President Obama’s proposed class-warfare tax hike. He wants higher tax rates on investors, entrepreneurs, small business owners and other “rich” taxpayers. And he wants more double taxation of dividends and capital gains. And a higher death tax rate, even higher than the ones imposed by France and Venezuela.

I think some opponents are exaggerating when they claim that this tax hike will cause a recession and cripple the economy. But I do think that it’s reasonable to contemplate the degree to which the Obama tax hikes will slow growth. More than 1/10th of 1 percent? Less than that? Would the damage occur in the first few years? Would it be spread out over time?

Those questions are hard to answer. Ask five economists and you’ll get nine answers, but there is compelling evidence that higher tax rates do have a negative impact.

But some people assume that taxes don’t matter at all. Using models that, for all intents and purposes, naively assume a simplistic linear relationship between tax rates and tax revenue, the number-crunching bureaucrats in Washington estimate that Obama’s proposed tax hikes will generate about $800 billion over 10 years.

I’m not going to pretend I know the economic impact of those higher tax rates, but for the sake of argument, let’s assume that the impact is minor. Indeed, let’s assume that it’s only 1/10th of 1 percent. Based on the CBO sensitivity analysis above, that means that about 40 percent of the projected deficit reduction will fail to materialize.

And that’s not even considering the fact that politicians will probably increase the burden of government spending because of the expectation of additional tax revenue.

Just something to keep in mind as this debate unfolds.

P.S. I actually shared this exact same data when testifying to the Senate Budget Committee earlier this year. Needless to say,  in some cases I think my testimony went in one ear and out the other.

P.P.S. The revenue-maximizing tax rate is not the ideal point on the Laffer Curve.

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Richard Epstein Discusses the Flat Tax

In addition to being my former debating partner, Richard Epstein is one of America’s premiere public intellectuals.

You can watch him make mincemeat out of George Soros in this video, for instance, and you can listen to his astute observations about his former law school colleague Barack Obama in this video.

Renaissance man of liberty

Given his stature, I’m glad that he agrees that the flat tax is the ideal way of reforming the corrupt internal revenue code. Here’s some of what he wrote about the topic for the Hoover Institution, beginning with an outline of the fundamental issues at stake.

The central challenge for government is to incur minimum political distortions while allowing taxes to raise the revenues needed to discharge essential government functions. …Without question, the form of taxation that best meets these dual requirements is a flat tax on consumption—a position which enjoys virtually no visible political support today. …Unless something is done to alter the direction of political discourse in the United States, the next four years will be a replay of the last four years. We will witness a slow decline in the standard of living across all groups within the United States.

For those not familiar with the lingo, a “flat tax on consumption” simply means a tax system with one rate and no double taxation of income that is saved and invested. That can be a national sales tax or value-added tax, but it usually refers to the “Hall-Rabushka” flat tax championed by Dick Armey and Steve Forbes. If you want more information, click here and here.

Epstein then gives some of the economic arguments for tax reform.

A sound tax system has as few moving parts as possible. We should scrap the current system in favor of a flat tax on consumption. Radically simplifying the tax system to a flat tax on consumption would facilitate two desirable economic changes. First, it reduces taxes to zero when capital is redeployed from one venture to another, which in turn would induce better investor monitoring of current firms. The ability of investors to sell out without adverse tax consequences thus provides an added incentive for efficient market behavior. Second, it eliminates the need to draw any distinction between ordinary income and capital gains, which is one of the weak points of the current system.

And he gives some reasons why the current system is unpalatable.

Current tax policy puts items like income and deductions into political play, generating deleterious short-term consequences. Evidence of this can be seen in the rapid response of investors, who are anticipating the future tax hikes and scaling back on their investments. The adverse responses are not confined to large firms but also extend to wealthy individuals who will bear the brunt of any tax increase. The proposed increase in the estate and gift taxes, targeted exclusively at high-income taxpayers, has set off an immediate flurry of tax planning efforts by well-to-do individuals to minimize the bite of these unknown and unwelcome tax changes. Typical of the common hijinks are the estate planning tactics recently reported in the Wall Street Journal by Annamaria Andriotis, which should belie the naïve belief that high-income taxpayers don’t respond to incentives. It is not just that people go to extra lengths to alter their patterns of giving in order to take full advantage of the life-time exemption from the gift and estate taxes and annual exclusions (now $13,000 per each donor/donee pair); it is that they engage in the conscious destruction of wealth in order to minimize the impact of taxes.

He also provides the Laffer-Curve argument for better tax policy.

The President thinks that revenue growth from taxes can be reduced to a simple task of addition and multiplication. Start with the current tax base, and multiply it by the increased tax rates in order to determine the added tax revenues. …Since the advent of the income tax in 1913, tax rates have gyrated from high to low and back again. …the typical response to these tax reductions is a spur in economic activity that results in the collection of larger amounts of capital gains taxes from wealthy individuals, who also prosper under the regime by their higher after-tax earnings. …If we sock it to the rich, we run the risk of impoverishing the nation.

Esptein concludes by explaining the world is not a zero-sum exercise. Good tax policy can make everybody better off.

Too many people agree with the implicit supposition of the President that taxation is a zero-sum game, whereby the rest of the population can gain amounts that are taken from the rich through taxation. Not so. The explicit tax increases on the rich will be passed on in a variety of ways to the population as a whole so that everyone is made worse off in the name of income equality.

I certainly agree. Statists assert that people like me and Espstein believe in trickle-down economics. That’s obviously a pejorative term, but we do believe in a system where more entrepreneurship and capital formation leads to higher living standards.

How can anybody look at this chart and think otherwise?

If you want more information, here’s my video on the flat tax.

This system is working in about 30 nations around the world. Isn’t it time America had a tax system that made sense?

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The Joint Committee on Taxation’s Head-in-the-Sand Approach to the Laffer Curve

I’m a big believer in the Laffer Curve, which is the common-sense proposition that changes in tax rates don’t automatically mean proportional changes in tax revenue. This is because you also have to think about what happens to taxable income, which can move up or down in response to changes in tax policy.

The key thing to understand is that incentives matter. If you raise tax rates and therefore increase the cost the engaging in productive behavior, people will be less likely to work, save, invest, and be entrepreneurial. And they’ll figure out ways to engage in tax avoidance and tax evasion to protect the interests of their families. In other words, taxable income will be lower because of higher tax rates.

Likewise, people will be more willing to earn – and report – taxable income if tax rates are reduced.

If you don’t believe me, look at this incredible data showing how the rich paid for more money after Reagan slashed their tax rates.

This doesn’t mean that “tax cuts pay for themselves.” That may happen in rare circumstances, but the real issue is the degree of “revenue feedback.”

For some types of tax changes, such as lowering tax rates on the “rich,” the revenue feedback may be very large because they have considerable control over the timing, level, and composition of their income.

In other cases, such as providing a child tax credit, the feedback may be very small because there’s not much of an impact on incentives to engage in productive behavior.

This doesn’t necessarily mean one type of tax cut is good and the other bad. It just means that some changes in tax policy produce revenue feedback and others don’t.

Even leftists recognize there is a Laffer Curve. They may argue that the “revenue-maximizing rate” is very high, with some claiming the government can impose tax rates of more than 70 percent and still collect additional revenue. But they all recognize that there’s a point where revenue-feedback effects are so strong that higher rates will lose revenue.

Actually, let me rephrase that assertion. There is a small group of people in the nation who claim that there’s no Laffer Curve. But that’s no surprise, the world is filled with weird people. Some genuinely think the world is flat. Some think the moon landings were faked. You can probably find some people who actually think the sun is a giant candle in the sky.

But what is surprising is that this small cadre of anti-Laffer Curve fanatics are at the Joint Committee on Taxation, which is the group on Capitol Hill in charge of providing revenue estimates on tax legislation.

They aren’t completely oblivious to the real world. They do acknowledge some “micro” effects of changes in tax rates, such as people shifting between taxable and non-taxable forms of compensation. But they completely reject “macro” changes such as changes in economic growth and employment.

So if we replaced the nightmarish income tax with a simple and fair flat tax, the JCT would assume no impact of GDP or jobs. If we went the other direction and doubled all tax rates, the JCT would blithely assume no change to the economy.

To give you an idea of why this is an extreme view, I want to share some polling data. Last week, I spoke at the national conference of the American Institute of Certified Public Accountants.  As you can imagine, this is a crowd that is very familiar with the internal revenue code. They know the nooks and crannies of the tax code and they have a good sense of how clients respond when tax policy changes.

Prior to my remarks, the audience was polled on certain tax issues.

Some of the answers disappointed me. By a narrow margin, the crowd thought it would be a good idea if the overall tax burden increased. But here’s the response that fascinated me the most. The audience was asked what could be described as a Laffer Curve question. Specifically, they were asked, “Do you believe the growth potential of marginal tax rate cuts could lead to some degree of revenue feedback, even if not enough to be self-financing?”

They had four possible responses. Here’s the breakdown of their answers.

These are remarkable results. A plurality (more than 36 percent) think the Laffer Curve is so strong that lower tax rates are self-financing. Even I don’t think that’s the case. Another 23.5 percent of respondents think there are very significant feedback effects, meaning that lower tax rates don’t lose much money.

There were also 18.6 percent who thought there were some Laffer Curve effects, though they thought the revenue feedback wasn’t very significant.

Less than 15 percent of the crowd, however, agreed with the Joint Committee on Taxation and said that lower tax rates have no measurable revenue feedback.

Why am I sharing this information? Well, we’re going to have a big debate in the next month or two about President Obama’s proposed class-warfare tax hike on investors, entrepreneurs, small business owners, and other rich people.

Supporters of that approach will cite Joint Committee on Taxation numbers to claim that the tax hike will generate a big pile of money.

That number will be based on nonsensical and biased methodology. In an ideal world, opponents will mock that number and expose the JCT’s primitive approach.

For additional information, here’s Part III of my video series on the Laffer Curve, exposing the role of the Joint Committee on Taxation.

If you want to see Parts I and II, click here.

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Dissecting Obama’s Record on Tax Policy

The folks at the Center for Freedom and Prosperity have been on a roll in the past few months, putting out an excellent series of videos on Obama’s economic policies.

• A look at the President’s failure to control government spending.
• A review of the Obama’s dismal track record on jobs and growth.
• A video showing how the auto bailout has been a costly mistake.

Now we have a new addition to the list. Here’s Mattie Duppler of Americans for Tax Reform, narrating a video that eviscerates the President’s tax agenda.

I like the entire video, as you can imagine, but certain insights and observations are particularly appealing.

1. The rich already pay a disproportionate share of the total tax burden – The video explains that the top-20 percent of income earners pay more than 67 percent of all federal taxes even though they earn only about 50 percent of total income. And, as I’ve explained, it would be very difficult to squeeze that much more money from them.

2. There aren’t enough rich people to fund big government – The video explains that stealing every penny from every millionaire would run the federal government for only three months. And it also makes the very wise observation that this would be a one-time bit of pillaging since rich people would quickly learn not to earn and report so much income. We learned in the 1980s that the best way to soak the rich is by putting a stop to confiscatory tax rates.

3. The high cost of the death tax – I don’t like double taxation, but the death tax is usually triple taxation and that makes a bad tax even worse. Especially since the tax causes the liquidation of private capital, thus putting downward pressure on wages. And even though the tax doesn’t collect much revenue, it probably does result in some upward pressure on government spending, thus augmenting the damage.

4. High taxes on the rich are a precursor to higher taxes on everyone else – This is a point I have made on several occasions, including just yesterday. I’m particularly concerned that the politicians in Washington will boost income tax rates for everybody, then decide that even more money is needed and impose a value-added tax.

The video also makes good points about double taxation, class warfare, and the Laffer Curve.

Please share widely.

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Evidence from England Shows that If You Want to “Soak the Rich,” Keep Tax Rates Low

I’ve pulled evidence from IRS publications to show that rich people paid a lot more to Uncle Sam after Reagan reduced the top tax rate from 70 percent to 28 percent.

The good ol’ days

But the Gipper wasn’t the only one to unleash the Laffer Curve. The United Kingdom saw similar dramatic results when Margaret Thatcher lowered the top tax rate from 83 percent to 40 percent. Allister Heath explains.

During the 1970s, when the tax system specialised in inflicting pain, the top one per cent of earners contributed 11pc of income tax. By 1986-87, with the top rate down to 60pc, that had increased to 14pc. After the top rate fell to 40pc in 1988, the top 1pc’s share jumped, reaching 21.3pc by 1999-2000, 24.4pc in 2007-08 and 26.5pc in 2009-10. Lower taxes fuelled a hard-work culture and an entrepreneurial revolution. Combined with globalisation and the much greater rewards available for skilled workers, Britain’s most successful individuals earned a lot and paid a lot in tax.

In other words, Margaret Thatcher’s supply-side tax rate reductions paid big dividends, both for the economy and for the Treasury.

Unfortunately, just as American politicians have forgotten (or decided to ignore) the lessons of the Reagan era, British politicians also have gravitated to a class-warfare approach. Allister points out that this is having a negative impact.

Yet times are changing, and not just because of the recession. HMRC recently slashed its forecasts for revenues from the top 1pc. It now believes the number of people expected to report £500,000 or more in earnings will fall by a tenth this year; those on £2m are set to drop by a third.

Why have the numbers headed in the wrong direction? There are almost certainly lots of factors, but tax policy has moved in the wrong direction and presumably deserves part of the blame. The top income tax rate is now 45 percent. The value-added tax has jumped to 20 percent. Allister provides more details.

Capital gains tax is too high. Luxury homes transactions are falling because of higher stamp duty. Britain is now a high tax economy; this is distorting work and investment decisions, gradually shifting talent and capital overseas. The overwhelming majority of high earners are already contributing disproportionately to the exchequer; tightening the screws further will be disastrously counter-productive. The lesson of the past 30 years is clear: the best way to entice the rich to pay even more tax is to keep rates low and allow them to get even richer.

I have to admit that I don’t want anyone to pay more tax, but I’m even less happy about punitively high tax rates. So I’m reluctantly willing to let the clowns in government have more money in exchange for a tax system that is more conducive to economic growth.

Here’s my Laffer Curve video, which explains more about the relationship of tax rates, taxable income, and tax revenue.

The ultimate goal, of course, is to shrink the central government so that the legitimate functions of the state can be financed at very low tax rates. Heck, if the United States and the United Kingdom had the kind of limited governments that existed 100 years ago, neither nation would even need a flat tax. A few user fees and excise taxes would suffice. Now that’s hope and change.

P.S. I periodically share two great Reagan videos, which can be seen here and here, but I also have a couple of inspiring videos of Thatcher in action, which can be viewed here and here.

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Tax Rates Impact Economic Performance, but other Policies also Matter

I’m a big fan of fundamental tax reform, in part because I believe in fairness and want to reduce corruption.

But I also think the flat tax will boost the economy’s performance, largely because lower tax rates are the key to good tax policy.

There are four basic reasons that I cite when explaining why lower rates improve growth.

1. They lower the price of work and production compared to leisure.
2. They lower the price of saving and investment relative to consumption.
3. They increase the incentive to use resources efficiently rather than seek out loopholes.
4. They attract jobs and investment from other nations.

As you can see, there’s nothing surprising or unusual on my list. Just basic microeconomic analysis.

Yet some people argue that lower tax rates don’t make a difference. And if lower tax rates don’t help an economy, then presumably there is no downside if Obama’s class-warfare tax policy is implemented.

Many of these people are citing David Leonhardt’s column in Saturday’s New York Times. The basic argument is that Bush cut tax rates, but the economy stunk, while Clinton increased tax rates and the economy did well.

The defining economic policy of the last decade, of course, was the Bush tax cuts. President George W. Bush and Congress, including Mr. Ryan, passed a large tax cut in 2001, sped up its implementation in 2003 and predicted that prosperity would follow. The economic growth that actually followed — indeed, the whole history of the last 20 years — offers one of the most serious challenges to modern conservatism. Bill Clinton and the elder George Bush both raised taxes in the early 1990s, and conservatives predicted disaster. Instead, the economy boomed, and incomes grew at their fastest pace since the 1960s. Then came the younger Mr. Bush, the tax cuts, the disappointing expansion and the worst downturn since the Depression. Today, Mitt Romney and Mr. Ryan are promising another cut in tax rates and again predicting that good times will follow. …Mr. Romney and Mr. Ryan would do voters a service by explaining why a cut in tax rates would work better this time than last time.

While I’ll explain below why I think he’s wrong, Leonhardt’s column is reasonably fair. He gives some space to both Glenn Hubbard and Phil Swagel, both of whom make good points.

“To me, the Bush tax cuts get too much attention,” said R. Glenn Hubbard, who helped design them as the chairman of Mr. Bush’s Council of Economic Advisers and is now a Romney adviser. “The pro-growth elements of the tax cuts were fairly modest in size,” he added, because they also included politically minded cuts like the child tax credit. Phillip L. Swagel, another former Bush aide, said that even a tax cut as large as Mr. Bush’s “doesn’t translate quickly into higher growth.” Why not? The main economic argument for tax cuts is simple enough. In the short term, they put money in people’s pockets. Longer term, people will presumably work harder if they keep more of the next dollar they earn. They will work more hours or expand their small business. This argument dominates the political debate.

I hope, by the way, that neither Hubbard nor Swagel made the Keynesian argument that tax cuts are pro-growth because “they put money in people’s pockets.” Leonhardt doesn’t directly attribute that argument to either of them, so I hope they’re only guilty of proximity to flawed thinking.

But that’s besides the point. Several people have asked my reaction to the column, so it’s time to recycle something I wrote back in February. It was about whether a nation should reform its tax system, but the arguments are the same if we replace “a flat tax” with “lower tax rates.”

…even though I’m a big advocate for better tax policy, the lesson from the Economic Freedom of the World Index…is that adopting a flat tax won’t solve a nation’s economic problems if politicians are doing the wrong thing in other areas.

There are five major policy areas, each of which counts for 20 percent of a nation’s grade.

1. Size of government
2. Regulation
3. Monetary Policy
4. Trade
5. Rule of Law/Property Rights

Now let’s pick Ukraine as an example. As a proponent of tax reform, I like that lawmakers have implemented a 15 percent flat tax.

But that doesn’t mean Ukraine is a role model. When looking at the mix of all policies, the country gets a very poor score from Economic Freedom of the World Index, ranking 125 out of 141 nations.

Conversely, Denmark has a very bad tax system, but it has very free market policies in other areas, so it ranks 15 out of 141 countries.

In other words, tax policy isn’t some sort of magical elixir. The “size of government” variable accounts for just one-fifth on a country’s grade, and keep in mind that this also includes key sub-variables such as the burden of government spending.

Yes, lower tax rates are better for economic performance, just as wheels matter for a car’s performance. But if a car doesn’t have an engine, transmission, steering wheel, and brakes, it’s not going to matter how nice the wheels are.

Not let’s shift from theory to reality. Here’s the historical data for the United States from Economic Freedom of the World. As you can see, overall economic policy moved in the right direction during the Clinton years and in the wrong direction during the Bush-Obama years.

To be more specific, the bad policy of higher tax rates in the 1990s was more than offset by good reforms such as lower trade barriers, a lower burden of government spending, and less regulation.

Similarly, the good policy of lower tax rates last decade was more than offset by bad developments such as a doubling of the federal budget, imposition of costly regulations, and adoption of two new health entitlements.

This is why I have repeatedly challenged leftists by stating that I would be willing to go back to Bill Clinton’s tax rates if it meant I could also go back to the much lower levels of spending and regulation that existed when he left office.

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Spending Cuts and Tax Cuts Should Be an All-of-the-Above Option, Not an Either-Or Choice

I’m in Slovenia where I just finished indoctrinating educating a bunch of students on the importance of Mitchell’s Golden Rule as a means of restraining the burden of government spending.

And I emphasized that the fiscal problem in Europe is the size of government, not the fact that nations are having a hard time borrowing money. As explained in this video, spending is the disease and deficits are one of the symptoms.

This is also an issue in the United States, and Steve Moore of the Wall Street Journal is worried that the GOP ticket is debt-obsessed and doesn’t have sufficient enthusiasm for lower tax rates and tax reform.

Stylistically, Paul Ryan’s Republican convention speech last night was a grand slam. …But was it the growth message that supply-siders wanted to hear, or debt-clock obsession? There were clearly apocalyptic claims. “Before the math and the momentum overwhelm us all, we are going to solve this nation’s economic problems,” said Mr. Ryan in reference to the federal rea ink. “I’m going to level with you; we don’t have that much time.” …In fact, he talked about turning around the economy with “tax fairness.” Ugh, that’s an Obama term. …Larry Kudlow of CNBC and a former Reagan economist tells me, “Paul’s speech just didn’t have the growth, tax-cutting message. We didn’t even get the words tax reform. I don’t know what happened, but it worries me.” It’s a question of priorities. Are Mitt Romney and Paul Ryan signaling that they will put spending cuts ahead of pro-growth tax-rate cuts?

I share Steve’s concern, but with a twist.

I’m not worried that the Republicans will put spending cuts ahead of tax cuts. I’m worried that they won’t do spending cuts at all (even using the dishonest DC definition) and therefore wind up getting seduced into some sort of tax-increase deal that facilitates bigger government.

As a general rule, it is always good to do spending cuts (however defined). And it is always good to lower tax rates. And if you can do both at the same time, even better.

But since I have low expectations, I’ll be delighted if we “merely” manage to get entitlement reform during a Romney-Ryan Administration. That would mean some progress on the spending side and presumably reduce the risk of bad things (like a VAT!) on the revenue side.

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The Laffer Curve Wreaks Havoc in the United Kingdom

Back in 2010, I excoriated the new Prime Minister of the United Kingdom, noting that David Cameron was increasing tax rates and expanding the burden of government spending (including an increase in the capital gains tax!).

I also criticized Cameron for leaving in place the 50 percent income tax rate imposed by his feckless predecessor, and was not surprised when experts began to warn that this class-warfare tax hike might actually result in less revenue because the reduction in taxable income could be more significant than the increase in the tax rate.

In other words, bad policy might lead to a turbo-charged version of the Laffer Curve.

Allow me to elaborate. In most cases, punitive tax hikes do raise revenue, but not as much as politicians predict. As explained in this three-part video series, this is because it takes a very significant reduction in taxable income to offset the revenue-generating impact of the higher tax rate.

But if a tax increase imposes a lot of damage and taxpayers have enough flexibility in their financial affairs, then it’s possible that a tax hike can lose revenue (or, as we saw with Reagan’s “tax cuts for the rich,” a well-designed reduction in tax rates can actually generate higher revenue).

With that background knowledge, let’s now take a closer look at David Cameron’s tax increases. They’ve been in place for a while, so we can look at some real-world data. Allister Heath of City AM has the details.

Something very worrying is happening to the UK’s public finances. Income tax and capital gains tax receipts fell by 7.3 per cent in May compared with a year ago, according to official figures. Over the first two months of the fiscal year, they are down by 0.5 per cent. This is merely the confirmation of a hugely important but largely overlooked trend: income and capital gains tax (CGT) receipts were stagnant in 2011-12, edging up by just £414m to £151.7bn, from £151.3bn, a rise of under 0.3 per cent. By contrast, overall tax receipts rose 3.9 per cent.

Is this because the United Kingdom is cutting tax rates? Nope. As we mentioned in the introduction, Cameron is doing just the opposite.

…overall taxes on labour and capital have been hiked: the 50p tax was introduced from April 2010 (and will fall to a still high 45p in April 2013), those earning above £150,000 have lost their personal allowance, CGT has risen to 28 per cent, many workers have been dragged into higher tax thresholds, and so on. In theory, if one were to believe the traditional static model of tax, beloved of establishment economists, this should have meant higher receipts, not lower revenues.

So what’s the problem? Well, it seems that there’s thing called the Laffer Curve.

…there is a revenue-maximising rate of tax – and that if you set rates too high, you raise less because people work less, find ways of avoiding tax or quit the country. The world isn’t static, it is dynamic; people respond to tax rates, just as they respond to other prices. Laffer told a gathering at the Institute of Economic Affairs that this is definitely true in the UK today – and the struggling tax take revealed in the official numbers suggest that he is right. Tax rates and levels are so high as to be counterproductive: slashing capital gains tax would undoubtedly increase its yield, for example. Many self-employed workers are delaying incomes as much as possible until the new, lower top rate of tax kicks in.

Allister’s column also makes the critical point that not all taxes are created equal.

…higher VAT is also damaging growth, though it is still yielding more. Some taxes can still raise more – but try doing that with income tax, CGT or corporation tax and the result is now clearly counter-productive. These taxes are maxed out; they have been pushed beyond their ability to raise revenues.

Last but not least, he makes an essential point about the role of bad spending policy.

The problem is that spending is too high – central government current expenditure is up by 3.7 per cent year on year in April-May – not that taxes are too low. The result is that the April-May budget deficit reached £30.7bn, some £6.2bn higher than a year ago.

By the way, you won’t be surprised to learn that Paul Krugman has been whining about “spending cuts” in the United Kingdom, even though the burden of the public sector has been climbing. But given his outlandish errors about Estonia, we shouldn’t be surprised.

But that’s not the point of this post. The relevant question is why do politicians pursue bad policy and why do some economists aid and abet bad policy?

For politicians, I think the answer is easy. They simply care about getting elected and holding power. So if they think class-warfare tax policy is the way of achieving those narcissistic goals, they’ll push higher tax rates. Even if it means lower revenue, notwithstanding their usual desire to have more money so they can buy more votes.

I’m more mystified by the behavior of economists. Let’s look at a couple of examples. Justin Wolfers and Mark Thoma recently cited some survey data to claim that the Laffer Curve was universally rejected by the profession.

But as James Pethokoukis of the American Enterprise Institute explained, the survey actually showed just the opposite, with economists by a margin of nearly 5-1 agreeing that lower tax rates could boost GDP (and therefore taxable income).

Those economists did say that a reduction in tax rates, based on current levels, would not cause taxable income to jump by a large enough amount to fully offset the revenue-losing impact of the lower tax rate. But the Laffer Curve says that only happens in extreme circumstances, so there’s zero contradiction.

So why did Wolfers and Thoma create a straw man in an attempt to discredit the Laffer Curve?

I have no idea, but Republican politicians probably deserve some of the blame. Too many of them make silly claims that “all tax cuts pay for themselves,” even when talking about new credits and deductions that have no positive impact on economic performance.

To the extent that Wolfers, Thoma, and others think that’s what the Laffer Curve is all about, then their skepticism is warranted.

But if that’s the case, they should read what Art Laffer actually wrote so they can be more accurate in the future. Or they can watch these three videos.

Part I describes the theory.

Part II describes the evidence.

And Part III explains the sloppy and inaccurate revenue-estimating methodology of the Joint Committee on Taxation.

But if they think I’m too biased or that Art is similarly misguided, then they should look at some of the evidence produced by other economists.

• Such as this study by economists from the University of Chicago and Federal Reserve.
• Or this study by the IMF, which not only acknowledges the Laffer Curve, but even suggests that the turbo-charged version exists.
• Or this European Central Bank study showing substantial Laffer-Curve effects.
• Or this research from the American Enterprise Institute about the Laffer Curve for the corporate income tax.

The sooner they get up to speed on these issues, the sooner they can help give politicians good advice so that the Laffer Curve doesn’t cause more unpleasant surprises.

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Welcome Instapundit readers. Y’all may also want to read (here and here) about the Laffer Curve disrupting the plans of French politicians. Heck, even Snooki has teamed up with the Laffer Curve to deny our greedy overlords in Washington.

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If You Want To Understand Why Obama’s Tax Agenda Is Bad for Workers, this Picture Says a Thousand Words

A good tax system (like the flat tax) does not impose extra layers of tax on income that is saved and invested.

I’ve tried to emphasize this point with a flowchart, and I’ve defended so-called trickle-down economics, which is nothing more than the common-sense notion that investment boosts wages for workers by making them more productive.

But if you doubt this relationship, just take a look at this chart posted by Steve Landsburg.

(H/T: Cafe Hayek)

That’s an amazingly powerful relationship. Wages for workers are very much tied to the amount of capital that’s invested. In other words, capitalists are the best friends of workers.

Something to think about with the President proposing big increases in the double taxation of capital gains. And something to consider since he wants America to have the highest level of dividend double taxation in the industrialized world.

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The Laffer Curve Shows that Tax Increases Are a Very Bad Idea – even if They Generate More Tax Revenue

The Laffer Curve is a graphical representation of the relationship between tax rates, tax revenue, and taxable income. It is frequently cited by people who want to explain the common-sense notion that punitive tax rates may not generate much additional revenue if people respond in ways that result in less taxable income.

Unfortunately, some people misinterpret the insights of the Laffer Curve. Politicians, for instance, tend to either pretend it doesn’t exist, or they embrace it with excessive zeal and assume all tax cuts “pay for themselves.”

Another problem is that people assume that tax rates should be set at the revenue-maximizing level. I explained back in 2010 that this was wrong. Policy makers should strive to set tax rates at the growth-maximizing level. But since a growth-generating tax is about as common as a unicorn, what this really means is that tax rates should be set to produce enough revenue to finance the growth-maximizing level of government – as illustrated by the Rahn Curve.

That’s the theory of the Laffer Curve. What about the evidence? Where are the revenue-maximizing and growth-maximizing points on the Laffer Curve?

Well, ask five economists and you’ll get nine answers. In part, this is because the answers vary depending on the type of tax, the country, and the time frame. In other words, there is more than one Laffer Curve.

With those caveats in mind, we have some very interesting research produced by two economists, one from the Federal Reserve and the other from the University of Chicago. They have authored a new study that attempts to measure the revenue-maximizing point on the Laffer Curve for the United States and several European nations. Here’s an excerpt from their research.

Figure 6 shows the comparison for the US and EU-14. …Interestingly, the capital tax Laffer curve is affected only very little across countries when human capital is introduced. By contrast, the introduction of human capital has important effects for the labor income tax Laffer curve. Several countries are pushed on the slippery slope sides of their labor tax Laffer curves. …human capital turns labor into a stock variable rather than a flow variable as in the baseline model. Higher labor taxes induce households to work less and to acquire less human capital which in turn leads to lower labor income. Consequently, the labor tax base shrinks much more quickly when labor taxes are raised.

There’s a bit of jargon in this passage, so here are the charts from Figure 6. They look complex, but here are the basic facts to make them easy to understand.

The top chart shows the Laffer Curve for labor taxation, and the bottom chart shows the Laffer Curve for capital taxation. And both charts show different curves for the United States and an average of 14 European nations. Last but not least, the charts show how the Laffer Curves change is you add some real-world assumptions about the role of human capital.

Some people will look at these charts and conclude that there should be higher tax rates. After all, neither the U.S. or E.U. nations are at the revenue-maximizing  point (though the paper explains that some European nations actually are on the downward-sloping portion of the curve for capital taxes).

But let’s think about what higher tax rates imply, and we’ll focus on the United States. According to the first chart, labor taxes could be approximately doubled before getting to the downward-sloping portion of the curve. But notice that this means that tax revenues only increase by about 10 percent.

This implies that taxable income would be significantly smaller, presumably because of lower output, but also perhaps due to some combination of tax avoidance and tax evasion.

The key factoid (assuming my late-at-night, back-of-the-envelope calculations are right) is that this study implies that the government would reduce private-sector taxable income by about $20 for every $1 of new tax revenue.

Does that seem like good public policy? Ask yourself what sort of politicians are willing to destroy so much private sector output to get their greedy paws on a bit more revenue.

What about capital taxation? According to the second chart, the government could increase the tax rate from about 40 percent to 70 percent before getting to the revenue-maximizing point.

But that 75 percent increase in the tax rate wouldn’t generate much tax revenue, not even a 10 percent increase. So the question then becomes whether it’s good public policy to destroy a large amount of private output in exchange for a small increase in tax revenue.

Once again, the loss of taxable income to the private sector would dwarf the new revenue for the political class. And the question from above bears repeating. What should we think about politicians willing to make that trade?

And that’s the real lesson of the Laffer Curve. Yes, the politicians usually can collect more revenue, but the concomitant damage to the private sector is very large and people have lower living standards. So that leaves us with one final question. Do we think government spending has a sufficiently high rate-of-return to justify that kind of burden? This Rahn Curve video provides the answer.

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What’s the Difference between a Libertarian, a Supply-Sider, a Keynesian, and an IMF Bureaucrat?

I realize the title of this post sounds like the beginning of a joke, along the lines of “A priest, a minister, and a rabbi walk into a bar…”, but this is a serious topic.

A big problem in fiscal debates is that people can’t even agree on what they mean by certain words. For instance, what’s the definition of austerity? Is it budget cuts, higher taxes, or both? Why are people saying the United Kingdom is practicing austerity, when the burden of government spending is going up?

Or how do we define responsible fiscal policy? Should politicians try to balance budgets, or should they shrink the burden of government? Is it reasonable for some people to call Obama a conservative because he wants higher taxes and claims the money would be used to reduce red ink?

I grapple with some of these questions in this appearance on Fox Business News.

But I’m not happy with my performance, largely because there needs to be a simple way of categorizing the various approaches to fiscal policy. So that’s what I’ve done in this Table. This is a first draft, so I welcome suggestions.

I’m serious about looking for input, For instance, I would like to come up with some way to describe Bushonomics without sullying the name of supply-side economics.

But perhaps I am just sensitive to that issue because supply-side economists tend to be serious and sober people who favor smaller government, but some of the politicians associated with supply-side economics – such as Jack Kemp – have been unapologetic big spenders.

I’m also unhappy with the division between IMFers and Keynesians, which is strange because it seems like half of my time is devoted to battling statists who argue for more government spending and the other half is consumed by fights against proponents of higher taxes.

What makes this so frustrating, though, is that Keynesians and IMFers are usually the same people, even though the philosophies are supposedly inconsistent.

I suspect that all they really want is bigger government, and they use any sign of weakness to argue for more spending, and then they quickly pivot and ask for higher taxes because of red ink. The biased analysis of the Congressional Budget Office is a good example.

The right approach, needless to say, is libertarianism. Small government and low tax rates are the pro-growth, pro-freedom recipe. That’s the one part of the Table that’s right on the mark.

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Even Officials from the Clinton Administration Agree that the United States Should Have a Lower Corporate Tax Rate

Since the Clinton Administration turned out to be much more market-oriented than either his GOP predecessor or successor, this isn’t quite a man-bites-dog story.

Nonetheless, it is still noteworthy that Elaine Kamarck, a high-level official from the Clinton White House, has a column on a left-of-center website arguing in favor of a pro-growth, supply-side corporate tax reform.

Here’s some of what she wrote.

Not only have the OECD countries reduced their corporate tax rates over the years to an average of 25 percent — members of the OECD are starting in on yet another round of cuts. Canada and Great Britain, two of our closest trading partners, are moving in this direction. America has the second highest corporate tax rate of any of the developed nations. We can’t sit by while our competition is changing. A 2008 report by economists at the OECD found that the corporate income tax is the most harmful tax for long-term economic growth. A 2010 World Bank study demonstrated that corporate tax rates have a “large and significant adverse” effect on investment. And investment and economic growth equals jobs. Wage data from 65 countries over 25 years shows that every one percent increase in corporate tax rates leads to a 0.5 to 0.6 percent decrease in wages.

There are things in the rest of the article that rub me the wrong way, but I agree with everything in the above passage, as I explain in this video.

The thing that’s most striking about Ms. Kamarck’s article is that she acknowledges the link between corporate tax rates and workers’ wages, thus agreeing with me – at least implicitly – about “trickle-down economics” and the deleterious impact of double taxation.

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Alan Blinder’s Accidental Case for the Flat Tax

Alan Blinder has a distinguished resume. He’s a professor at Princeton and he served as Vice Chairman of the Federal Reserve.

So I was interested to see he authored an attack on the flat tax – and I was happy after I read his column. Why? Well, because his arguments are rather weak. So anemic that it makes me think there’s actually a chance to get rid of America’s corrupt internal revenue code.

There are two glaring flaws in his argument. First, he demonstrates a complete lack of familiarity with the flat tax and seemingly assumes that tax reform simply means imposing one rate on the current system.

Here’s some of what he wrote in a Wall Street Journal column.

Many useful steps could be taken to simplify the personal income tax. But, contrary to much misleading rhetoric, flattening the rate structure isn’t one of them. The truth is that 100% of the complexity inheres in the definition of taxable income, which takes up millions of words in the tax laws. None inheres in the progressive rate structure. If you don’t believe that, consider the fact that the corporate income tax is virtually flat once a corporation passes a paltry $75,000 in taxable income. Is it simple? Back to the personal tax. Figuring out your taxable income can be quite an effort. But once that is done, most taxpayers just look up their tax bill on an IRS-provided table. Those with incomes above $100,000 must perform a simple calculation that involves multiplying two numbers together and adding a third. A flat tax with an exemption would require precisely the same sort of calculation. The net reduction in complexity? Zero.

I can understand how an average person might think the flat tax is nothing more than applying a single tax rate to the current system, but any public finance economist must know that the plan devised by Professors Hall and Rabushka completely rips up the current tax system and implements a new system based on one tax rate with no double taxation and no loopholes.

Heck, the Hall/Rabushka book is online and free of charge. But Blinder obviously could not be bothered to understand the proposal before launching his attack.

What about his second mistake? This one’s a doozy. He actually assumes that taxable income is fixed, which is a remarkable error for anyone who supposedly understands economics.

…flattening the rate structure won’t make the tax code any simpler. It would, however, make the tax system far less progressive. Do the math. …Someone with $20 million in taxable income pays nearly $7 million in taxes under the current rate structure, with its 35% top rate. Replace that with a 23% flat tax, and the bill drops to just under $4.6 million.

In other words, he assumes that people won’t change their behavior even though incentives to engage in productive behavior are significantly altered.

In a previous post, I showed how rich people dramatically increased the amount of income they were willing to earn and report after Reagan lowered the top tax rate from 70 percent to 28 percent.

To Blinder, this real-world evidence doesn’t matter – even though the rich paid much more tax to the IRS after Reagan slashed tax rates.

For more information, here’s my flat tax video.

And here’s the video on the global flat tax revolution. Interestingly, there are now about five more flat tax jurisdictions since this video was made – though Iceland abandoned its flat tax, so there are some steps in the wrong direction.

Makes you wonder. If the flat tax is such a bad idea, why are so many nations doing so well using this simple and fair approach?

But be careful, as this cartoon demonstrates, simplicity can mean bad things if the wrong people are in charge.

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A Lesson on the Laffer Curve for Barack Obama

One of my frustrating missions in life is to educate policy makers on the Laffer Curve.

This means teaching folks on the left that tax policy affects incentives to earn and report taxable income. As such, I try to explain, this means it is wrong to assume a simplistic linear relationship between tax rates and tax revenue. If you double tax rates, for instance, you won’t double tax revenue.

But it also means teaching folks on the right that it is wildly wrong to claim that “all tax cuts pay for themselves” or that “tax increases always mean less revenue.” Those results occur in rare circumstances, but the real lesson of the Laffer Curve is that some types of tax policy changes will result in changes to taxable income, and those shifts in taxable income will partially offset the impact of changes in tax rates.

However, even though both sides may need some education, it seems that the folks on the left are harder to teach – probably because the Laffer Curve is more of a threat to their core beliefs.

If you explain to a conservative politician that a goofy tax cut (such as a new loophole to help housing) won’t boost the economy and that the static revenue estimate from the bureaucrats at the Joint Committee on Taxation is probably right, they usually understand.

But liberal politicians get very agitated if you tell them that higher marginal tax rates on investors, entrepreneurs, and small business owners probably won’t generate much tax revenue because of incentives (and ability) to reduce taxable income.

To be fair, though, some folks on the left are open to real-world evidence. And this IRS data from the 1980s is particularly effective at helping them understand the high cost of class-warfare taxation.

There’s lots of data here, but pay close attention to the columns on the right and see how much income tax was collected from the rich in 1980, when the top tax rate was 70 percent, and how much was collected from the rich in 1988, when the top tax rate was 28 percent.

The key takeaway is that the IRS collected fives times as much income tax from the rich when the tax rate was far lower. This isn’t just an example of the Laffer Curve. It’s the Laffer Curve on steroids and it’s one of those rare examples of a tax cut paying for itself.

Folks on the right, however, should be careful about over-interpreting this data. There were lots of factors that presumably helped generate these results, including inflation, population growth, and some of Reagan’s other policies. So we don’t know whether the lower tax rates on the rich caused revenues to double, triple, or quadruple. Ask five economists and you’ll get nine answers.

But we do know that the rich paid much more when the tax rate was much lower.

This is an important lesson because Obama wants to run this experiment in reverse. He hasn’t proposed to push the top tax rate up to 70 percent, thank goodness, but the combined effect of his class-warfare policies would mean a substantial increase in marginal tax rates.

We don’t know the revenue-maximizing point of the Laffer Curve, but Obama seems determined to push tax rates so high that the government collects less revenue. Not that we should be surprised. During the 2008 campaign, he actually said he would like higher tax rates even if the government collected less revenue.

That’s class warfare on steroids, and it definitely belong on the list of the worst things Obama has ever said.

But I don’t care about the revenue-maximizing point of the Laffer Curve. Policy makers should set tax rates so we’re at the growth-maximizing level instead.

To broaden the understanding of the Laffer Curve, share these three videos with your friends and colleagues.

This first video explains the theory of the Laffer Curve.

This second video reviews some of the real-world evidence.

And this video exposes the biased an inaccurate “static scoring” of the Joint Committee on Taxation.

And once we educate everybody about the Laffer Curve, we can then concentrate on teaching them about the equivalent relationship on the spending side of the fiscal ledger, the Rahn Curve.

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A Victory for the Laffer Curve, a Defeat for England’s Economy

A new study from the Adam Smith Institute in the United Kingdom provides overwhelming evidence that class-warfare tax policy is grossly misguided and self-destructive. The authors examine the likely impact of the 10-percentage point increase in the top income tax rate, which was imposed as an election-year stunt by former  Gordon Brown and then kept in place by his feckless successor, David Cameron.

They find that boosting the top tax rate to 50 percent will slow economic performance. And because of both macroeconomic and microeconomic responses, tax revenues over the next 10 years are likely to drop by the equivalent of more than $550 billion. Here’s a key paragraph from the executive summary of the new study.

The country is suffering from a 50%-­plus marginal tax rate which even its architect admits was imposed without economic purpose. Now our analysis shows that the policy is set for failure: at best leading to flat growth for a decade and £350bn of lost revenue. The Chancellor should seize the occasion of the 2011 budget to reverse this disaster promptly, for the benefit of public revenues, economic growth, the government’s standing with domestic wealth-creators, and the UK’s reputation with world business.

The authors urge Prime Minister Cameron to reverse this disastrous policy, but the odds of that happening are very slight. I hope I’m wrong, but I have repeatedly noted on this blog that Cameron almost always makes the wrong choice when deciding between liberty and statism.

President Obama wants to impose similar policies in the United States and there is every reason to expect similarly poor results. I’ve already posted evidence from IRS data showing that the rich paid much more tax following the Reagan tax cuts, so it shouldn’t shock anybody when the reverse happens if Obama is successful in moving America back toward a 1970s-style tax system.

To emphasize these critical points, let’s close with two videos. This first video explains the Laffer Curve and why politicians are foolish if they assume that there is a fixed linear relationship between tax rates and tax revenue.

This second video debunks the notion of class-warfare tax policy.

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Suddenly, I Like Soccer (at least When It Confirms Supply-Side Economics, Tax Competition, and the Laffer Curve)

I don’t particularly like soccer and I’m not normally a fan of the research of Professor Emannuel Saez, so it is rather surprising that I like Professor Saez’s new research on taxes and soccer.

While Saez may have a reputation for doing work that often is used by advocates of class warfare, his latest research is classic, supply-side economics. He and his co-authors studied soccer players and found that they are very sensitive to marginal tax rates.

They even confirmed that the Laffer Curve is sometimes so strong that governments can collect more revenue by reducing tax rates on the rich. Krugman won’t be happy about this.

Here are some segments from a story about the research in the Christian Science Monitor.

…on one subject, Europe’s soccer stars have an important message for Americans: Tax rates. It turns out that highly paid soccer players are sensitive to taxes. They tend to move to those nations that give them a break. Why is Spain’s top league a sudden soccer powerhouse? One reason is tax policy. Why are Denmark and Belgium’s leagues stronger than in other similar countries? Ditto. In perhaps the first study to provide compelling evidence of a link between tax rates and worker migration, three economists look at this highly paid, highly mobile workforce and make several surprising conclusions: 1) Top marginal tax rates matter to big earners. 2) If you’re going to cut taxes to lure such highly skilled workers, make it a big tax cut. Otherwise, it won’t have much effect. …Professor Saez and his colleagues found something striking: The leagues in low-tax nations attracted better players and had better teams. The effect was also pronounced in individual nations that reformed their taxes. For example, Spain in 2004 introduced a new flat rate of 24 percent for foreign soccer players, nearly half the top marginal rate it charged its residents. After that law – called the “Beckham law” because British star David Beckham took advantage of it – Spain saw its share of foreign players increase while the foreign talent in nearby Italy shrank. Tax cuts for foreign players in Denmark and Belgium had similar effects.

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A Laffer Curve Tutorial

Greetings from frigid Minnesota. I’m in this misplaced part of the North Pole to testify before both the Senate and House Tax Committees today on issues related to the Laffer Curve.

In other words, I will be discussing how governments should measure the revenue impact of changes in tax policy – what is sometimes known as the dynamic scoring vs static scoring debate.

Most governments, including the folks in Washington, assume that tax policy has no impact on the economy. As such, it is relatively easy to measure how much revenue will rise or fall when tax policy is altered. After all, there are only two moving parts – tax rates and tax revenue.

So if tax rates double, revenues climb by 100 percent. If tax rates are reduced by 50 percent, tax revenues drop by one-half.

This is a slight over-simplification, but it does capture the basics of conventional revenue estimating. And it also shows why “static scoring” is deeply flawed. In the real world, people respond to incentives. When tax rates rise and fall, people change their behavior.

When tax rates are punitive, for instance, people earn and/or declare less income to the government. And when tax rates are reasonable, by contrast, people earn and/or declare more income to the government. In other words, there are actually three moving parts – tax rates, tax revenue, and taxable income.

Figuring out the relationship of these three variables is known as “dynamic scoring” and it is much more challenging that static scoring, but it is much more likely to give lawmakers correct information.

It does not mean, by the way, that “tax cuts pay for themselves” or that “tax increases lose revenue,” as GOPers sometimes claim. That only happens in rare circumstances.

If you want to understand this issue and be more knowledgeable than 99 percent of the people in government (not very difficult, so don’t let it go to your head), watch this three-part series on the Laffer Curve.

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The Super Bowl of Taxation

The Wall Street Journal uses the clash between the Steelers and Packers as an opportunity to make a much-need point about taxes. Because of Pennsylvania’s flat tax, Ben Roethlisberger keeps a greater percentage of his salary than Aaron Rodgers, who gets raped by Wisconsin’s “progressive” tax system. Packers fans shouldn’t worry about this, though, since even I’m not willing to claim that the negative impact of high tax rates on incentives will have any effect on the outcome of the game.

We won’t predict the winner of this Sunday’s Super Bowl between the Pittsburgh Steelers and Green Bay Packers. But we can report this much: The Steelers will get to keep a lot more of their season earnings, though both team’s players would be a lot richer if they played all of their home games in Dallas. Take the Packers’ fleet-footed quarterback Aaron Rodgers. He made $8.6 million in 2009, according to USA Today’s database of player salaries. Of that, we calculate he paid roughly $680,000 in state and $3.1 million in federal income and payroll taxes. Steeler quarterback Ben Roethlisberger didn’t earn as much, but he got to keep a relatively larger chunk of his haul—$4.6 million of his $7.7 million salary. (This excludes taxes paid to states that tax players visiting on away games.) Unlike Wisconsin, which has a graduated income tax that charges top earners 7.75% on earnings over $220,000, Pennsylvania has a 3% flat rate. Even football players can behold the merit of a flat tax. Of course, both players would keep a lot more of their earnings if like quarterback Tony Romo (salary: $625,000) they played for the Cowboys since Texas levies no state income tax. On the other hand, Packer and Steeler fans will pay if they travel to Texas for the game since Texas’s beer tax is more than twice as high as their home state’s.

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A Debate Between John F. Kennedy and Barack Obama

Here’s a clever video produced by the Winston Group, comparing the tax policies of two Democratic Presidents. Having previously highlighted Kennedy’s tax-cutting approach, it is painful for me to observe the class warfare approach of the Obama Administration.
 

What’s especially fascinating is that JFK intuitively understood the Laffer Curve, particularly the insight that deficits usually are the result of slow growth, not the cause of slow growth.

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Obama’s Class-Warfare Tax Policy Will Hit Small Business

Kevin Hassett and Alan VIard of the American Enterprise Institute have a column in the Wall Street Journal showing how Obama’s proposed tax hikes will impose significant harm on small business owners and other entrepreneurs. Higher tax rates are damaging for the obvious reason that business cash flow gets diverted to the IRS, but also because they alter the price (or tradeoff) between work and leisure and between consumption and investment. This means less productive activity, which is just another way of saying reduced national income. 

Vice President Joe Biden harshly rejected House Minority Leader John Boehner’s assertion that the hikes would harm small businesses, saying that “he has created this myth that a tax cut for millionaires is actually a tax cut for small business. There aren’t 3% of small businesses in America that would qualify for that tax cut.” House Speaker Nancy Pelosi flipped the number around, saying that the planned tax increases would exempt “98% of American families and about 97% of small businesses.” …The 3% figure, which is computed from IRS data, is based on simply counting the number of returns with any pass-through business income. So, if somebody makes a little money selling products on eBay and reports that income on Schedule C of their tax return, they are counted as a small business. The fact that there are millions of people in the lower tax brackets with small amounts of business income may be interesting for some purposes, but it is irrelevant for the assessment of the economic impact of the tax hikes. The numbers are clear. According to IRS data, fully 48% of the net income of sole proprietorships, partnerships, and S corporations reported on tax returns went to households with incomes above $200,000 in 2007. That’s the number to look at, not the 3%. …A pair of papers by economists Robert Carroll, Douglas Holtz-Eakin, Harvey Rosen and Mark Rider that were published in 1998 and 2000 by the National Bureau of Economic Research analyzed tax return data and uncovered high responsiveness of sole proprietors’ business activity to tax rates. Their estimates imply that increasing the top rate to 40.8% from 35% (an official rate of 39.6% plus another 1.2 percentage points from the restoration of a stealth provision that phases out deductions), as in Mr. Obama’s plan, would reduce gross receipts by more than 7% for sole proprietors subject to the higher rate. These results imply a similar effect on proprietors’ investment expenditures. A paper published by R. Glenn Hubbard of Columbia University and William M. Gentry of Williams College in the American Economic Review in 2000 also found that increasing progressivity of the tax code discourages entrepreneurs from starting new businesses.

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The Laffer Curve Strikes Again

In the private sector, no business owner would be dumb enough to assume that higher prices automatically translate into proportionately higher revenues. If McDonald’s boosted hamburger prices by 30 percent, for instance, the experts at the company would fully expect that sales would decline. Depending on the magnitude of the drop, total revenue might still climb, but by far less than 30 percent. And it’s quite possible that the company would lose revenue. In the public sector, however, there is very little understanding of how the real world works. Here’s a Reuters story I saw on Tim Worstall’s blog, which reveals that Bulgaria and Romania both are losing revenue after increasing tobacco taxes.

Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead. Criminal gangs and impoverished Roma communities near borders with countries where prices are lower — Serbia, Macedonia, Moldova and Ukraine — have taken to smuggling which has wiped out gains from higher excise duties. Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third. …Overall losses from smuggling will probably outweigh tax gains as Bulgaria struggle to fight the growing black market, which has risen to over 30 percent of all cigarette sales and could cost 500 million levs in lost revenues this year, said Bezlov at the Center for the Study of Democracy. While the government expected higher income from taxes in 2010 it has already revised that to the same level as last year. “However, this (too) looks unlikely at present,” Bezlov added. Romania, desperately trying to keep a 20 billion-euro International Monetary Fund-led bailout deal on track, has a similar problem after nearly doubling cigarette prices in 2009 then hiking value added tax. Romania’s top three cigarette makers — units of British American Tobacco, Japan Tobacco International and Philip Morris — contributed roughly 2 billion euros to the budget in taxes in 2009, or just under 2 percent of GDP. They estimate about a third of cigarettes in Romania are smuggled and say this could cost the state over 1 billion euros.

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Higher Tax Rates on the Rich Will Backfire

I know I’ve beaten this drum several times before, but the Wall Street Journal today has a very good explanation of why class-warfare tax policy will backfire. The Journal’s editorial focuses on what happened after the 2003 tax rate reductions. And below the excerpt, you’ll find a table I prepared showing what happened with tax revenues from the rich following the Reagan tax cuts. The simple message is that lower tax rates are the best way to soak the rich.

Congress’s Joint Committee on Taxation recently dropped a study claiming that millionaires will pay $31 billion of the $36 billion in revenue that it expects will be raised next year if tax rates rise as scheduled on January 1. …If you believe that, you probably also believed Joint Tax when it predicted that the rich would gain a huge tax windfall when tax rates were cut in 2003. Let’s go to the videotape. According to the most recent IRS data on actual tax payments, total revenues collected over the period 2003-07 were about $350 billion higher than Joint Tax and the Congressional Budget Office predicted when the 2003 tax cuts were enacted. Moreover, the wealthiest taxpayers paid a larger share of all income taxes from the beginning to the end of this period. The IRS data show that in 2003 those with incomes above $200,000 paid $313 billion in income tax. By 2007 they paid $610 billion. …Guess what income group paid the most in higher taxes after tax rates were cut? Millionaires. From 2003 to 2008, millionaires increased their tax payments to $249 billion from $132 billion. One reason for the big increase in payments: the number of returns declaring $1 million or more in income increased 76% to 319,000 from 181,000 as the economy expanded. The IRS data are a useful reminder of how dependent Uncle Sam is on the rich to pay the government’s bills. …We’re not saying that tax cuts “pay for themselves.” What we are saying is that the 2003 tax cuts proved again, as we should have learned in the 1960s and 1980s, that rich people are the most responsive to changes in tax rates. When tax rates are high, the wealthy invest less, hire accountants to protect more of their income from the IRS, and park more of their money in tax shelters, such as municipal bonds. …That’s why it’s a fantasy to think that raising income and capital gains and dividend tax rates on the rich is going to pry $31 billion out of millionaire households. History teaches that the best way to soak the rich and reduce the deficit is to promote rapid economic growth. But that’s less likely to happen in 2011 if the economy is rear-ended with the biggest tax increase in at least 16 years.

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I Support the Democratic President’s Tax Policy

Unfortunately, I’m not talking about President Obama, though the current occupant of the White House could learn a lot from a previous Democratic President.

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