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.
International Liberty 
[…] What does trigger disagreement, however, is figuring out the shape of the curve, especially the growth-maximizing size of government (or, in the case of the Laffer Curve, the revenue-maximizing tax rate). […]
[…] What does trigger disagreement, however, is figuring out the shape of the curve, especially the growth-maximizing size of government (or, in the case of the Laffer Curve, the revenue-maximizing tax rate). […]
[…] For what it’s worth, I only do this to people when pontificating about the Laffer Curve. […]
[…] correct, of course, but it’s almost as important to understand that it’s also a very bad idea to be at the “top of the Laffer Curve.” As noted in a study by economists from the Federal […]
[…] correct, of course, but it’s almost as important to understand that it’s also a very bad idea to be at the “top of the Laffer Curve.” As noted in a study by economists from the […]
[…] Mancur Olson (1932-1998) was a great economist who came up with a very useful analogy to help explain the behavior of many governments. He pointed out that a “roving bandit” has an incentive to maximize short-run plunder by stealing everything from victims (i.e. a 100 percent tax rate), whereas a “stationary bandit” has an incentive to maximize long-run plunder by stealing just a portion of what victims produce every year (i.e., the revenue-maximizing tax rate). […]
[…] Mancur Olson (1932-1998) was a great economist who came up with a very useful analogy to help explain the behavior of many governments. He pointed out that a “roving bandit” has an incentive to maximize short-run plunder by stealing everything from victims (i.e. a 100 percent tax rate), whereas a “stationary bandit” has an incentive to maximize long-run plunder by stealing just a portion of what victims produce every year (i.e., the revenue-maximizing tax rate). […]
[…] Mancur Olson (1932-1998) was a great economist who came up with a very useful analogy to help explain the behavior of many governments. He pointed out that a “roving bandit” has an incentive to maximize short-run plunder by stealing everything from victims (i.e. a 100 percent tax rate), whereas a “stationary bandit” has an incentive to maximize long-run plunder by stealing just a portion of what victims produce every year (i.e., the revenue-maximizing tax rate). […]
[…] Swedish politicians, if nothing else, at least figured out that it’s not a good idea to be on the wrong side of the Laffer Curve (i.e., they figured out the government was getting less revenue because tax rates were […]
[…] Swedish politicians, if nothing else, at least figured out that it’s not a good idea to be on the wrong side of the Laffer Curve (i.e., they figured out the government was getting less revenue because tax rates were […]
[…] Swedish politicians, if nothing else, at least figured out that it’s not a good idea to be on the wrong side of the Laffer Curve (i.e., they figured out the government was getting less revenue because tax rates were […]
[…] But if that was his main goal, surely it was a mistake to push the top tax rate far beyond the revenue-maximizing level. […]
[…] like there’s a point at which higher tax rates lead to less revenue. And the authors recognize this […]
[…] don’t want to maximize revenue for the government. Not from the top 1/10th of 1 percent. Not from the top 1 percent. I don’t want to maximize […]
[…] that people finally understand the Laffer Curve. Though let’s not get too optimistic since this common-sense observation about tax rates, taxable income, and tax revenue has not had any impact on the pro-tax bureaucrats at the Joint Committee on Taxation in Washington. […]
sinners repent……………… the end is near….
Zorba:
Interesting perspective!
There are also many other non-linearities and strong delayed inertial effects that could unfold things fast. If you are a market leader and a 10% extra tax decreases your motivation by a mere 5%, and this five percent makes you less competitive than your next closest competitor by a mere 3% then you don’t simply sell 3% less, or even 10% less. You get seriously overrun by your competitor and enter a decline spiral. And so, how are you going to react to that loss of competitiveness? By vomiting up all the HopNChange that you supported all those years? Of course not. No nation reacts that way, and this is why once a decline spiral starts, it becomes unstoppable.
Of course, proponents of mandatory collectivism believe that a less motivated population with great infrastructure produces more than a highly motivated one with less infrastructure. But compounding growth, or lack thereof, is an indomitable force. Singapore devoting fifteen percent of its GDP to infrastructure builds more absolute infrastructure than Venezuela devoting fifty percent of its GDP. The difference? The all overriding power of motivation, growth differentials and behavioral inertial effects that give delayed rise to an environment of lower motivation and mediocrity.
But a redistribution dollar today is worth five percentage points of growth in the future. Hence the decline trendline of the effort-reward flattening western world is irreversible. Distracting fractal noise in the trendlines aside, this decline will keep accelerating.
[…] […]
There can be no “right” answer, since the Laffer Curve is derived from individual reactions to the marginal tax rate, and those reactions are based on external factors. For example, if Canada were to suddenly enact a flat tax of 15%, the entire US Laffer Curve would shift to the left, as individual attitudes changed towards our rates. In the JFK case in the 60’s, the top rate dropped from 91% to 70%. At that time, the curve was probably well to the right of the current curve, since expectations had been “anchored” by 11 years at the 91% rate. During WWII, the 80% rate might have seemed not only reasonable but necessary.
The brilliance of the Laffer Curve was the absence of references other than 0% and 100%. The purpose of the curve was not to suggest some optimum, but to recognize that beyond the revenue maximizing point is a “forbidden zone” which doesn’t benefit anyone.
We do know that the growth maximizing point is to the left of the revenue maximizing point, since at the revenue maximizing point deterioration of the taxable base occurs faster than rate increases can compensate for.
However, the country’s stage of development is critical in determining what is the growth maximizing point. If the country must deal with preventable disease, non-potable water, and lack of infrastructure; the growth maximizing point will be quite different than a developed country. Also, the efficiency and/or corruption of the bureaucracy must be considered.
Mirlees’ 20% mark matches closely with Hauser’s Law, so it’s probably a good maximum benchmark. However, while many of us believe that to be the case economically, we must recognize that any change must be politically acceptable. For example, if the top 5% earn 32% of the income, but pay 59% of the tax; it is unrealistic to believe that the bottom 95% will vote to pay 27% more of total tax revenues with a true flat tax. Regarding our current dependent society, there must be a transition period to move back to a society where individuals take personal responsibility.
For more on a progressive 25% flat tax that brings us to an effective tax rate below 20% see:
What’s crazy is that that’s *exactly* where I put the tax rate when I talk about the flat tax on my blog and to people in real life. It’s just where I think it’s low enough for conservatives and libertarians to accept it, while also probably the lowest you could go for liberal acceptance as well. Because you can tell the conservatives and libertarians “It’s a 20% tax rate” and then you can tell the liberals “The government will take one-fifth of the income.”
I actually think a 20% tax rate will probably be the sweet spot. If we combine it with a negative income tax system, thus shuttering most of the welfare bureaucracies in the country, and then follow up with entitlement reform and military cuts (I know, I know, not gonna happen…) then it could probably fix our massive debt problem within a few decades.
The real point is that we gotta cut the spending.
Reblogged this on Noise Null and commented:
Breaking Down the Laffer Curve. This video won’t win any entertainment awards, but it’d got my vote on clarifying the tax-driven economics.