Last month, I revealed that even Paul Krugman agreed with the core principle of the Laffer Curve.
Today, we have another unlikely ally. Regular readers know that I’m not a big fan of the Organization for Economic Cooperation and Development. The Paris-based international bureaucracy routinely urges higher tax burdens, both in the United States and elsewhere in the world.
But the professional economists who work for the OECD are much better than the political appointees who push a statist agenda.
So when I saw that three of them (Oguzhan Akgun, David Bartolini, and Boris Cournède) produced a study estimating the relationship between tax rates and tax revenues, I was very curious to see the results.
They start by openly acknowledging that high tax rates can backfire.
This paper investigates the capacity of governments to raise revenue by assessing the ways in which tax receipts respond to rates… Revenue returns
from tax increases can be expected to decrease with the level of tax rates, because higher rates exacerbate disincentives to produce and raise incentives to avoid taxation. These two main channels can therefore imply that tax receipts rise less than proportionately with rates and may peak at a given point.
Given the OECD’s love affair with higher tax burdens, this is a remarkable admission about an important limit on the ability of governments to grab revenue.
Their estimate of the actual revenue-maximizing burden is almost secondary. But nonetheless still noteworthy.
According to the estimated coefficients in model 5 of Table 3, an EMTR of 25% maximises CIT revenue.
Not that different from the estimates produced at the Tax Foundation and American Enterprise Institute.
Here’s a chart showing the revenue-maximizing level of tax, which varies depending on the degree to which a country has close economic ties with the rest of the world.
Interestingly, the study openly admits that tax competition plays a big role.
Trade openness is found to reduce CIT revenue. The latter is consistent with…international tax competition, which is likely to increase the effects of tax rates on the location of firms or more broadly of their profit-generating activities.
Sadly, the political types at the OECD have a “BEPS” scheme that is designed to curtail tax competition.
Which is a very good argument for why tax competition should be allowed to flourish.
But let’s not digress. Here’s another remarkable admission in the study. The OECD economists point out that it is not a good idea for governments to try to maximize revenue.
Estimates of revenue-maximising rates should not be seen as policy objectives or recommendations, as they imply high levels of economic distortions or tax avoidance.
Amen. I cited a study in 2012 showing that a revenue-maximizing tax rate might destroy as much as $20 of private sector output for every $1 collected by government. Only Bernie Sanders would think that’s a good deal.
Last but not least, the study even points out a class-warfare approach is misguided when looking at personal income taxes.
More progressive broadly defined personal income taxes generally yield more revenue, but very strong progressivity is associated with lower revenue.
Another wise observation.
The bottom line is that high tax rates of any kind are not a good idea.
P.S. The International Monetary Fund inadvertently provided very strong evidence about the Laffer Curve and corporate taxes.
P.P.S. An occasional good study doesn’t change my belief that the OECD no longer should be subsidized by American taxpayers.
Actually the argument should be for HOW MUCH OF OUR MONEY the government actually needs. Any amount seems to be not enough to them, they just want more for all their pet projects. So, I’d like to see an article addressing what the government needs if it only supplies the basic services enumerated in the constitution for them to be involved with. It is very few. Roads (infrastructure), perhaps schools in depressed areas- but not where the local citizens can fund it, courts, police, etc. As I said- the amount is not big. I certainly don’t need them taking my tax dollars and funding people who want to harm me. PLEASE address this in a column- its a bit of work, but you’re good at it.
Excellent
although Laffer may have used math correctly with empirical data, it begs the wrong question. The right question is “what tax rate maximizes societal productivity as a whole?” not “what maximizes government revenue”. This is touched upon by questions of government spending distorting the market. A government road may increase net productivity more than other expenditures, but a public school??? Hardly. I suspect the most optimal tax rate to improve productivity is closer to zero than its current value.
Here we go again. In the long term there are three things that determine prosperity: Growth, growth, and growth.
Revenue returns from tax increases ALWAYS decrease with tax rates once a country starts operating past the (early) peak in the Rahn curve. This is because in elementary arithmetic an exponent (however small) always dominates a fixed factor (however large) given enough time.
So, to the extent that most countries operate at taxation levels that are well to the right of the early peak on the Rahn curve, any tax increase (increase in the fixed factor) will have a negative impact on growth (on the exponent). Hence, in the longer term, the detrimental effect of compounding foregone growth (and thus also foregone tax revenue) will trump any tax increase (i.e. any increase in the fixed factor). This is how low tax Singapore and Switzerland have come to collect more per capita tax than France and Italy and, most importantly, now have superior prosperity levels to show for it.
However at the individual electoral level most voter lemmings will surely take one redistribution dollar today instead of five perpetually compounding dollars in the future, and these are the voters who elect the politicians that govern us ==> hence few voter lemming democracies will escape decline ==> hence stay mobile…
…enjoy the tax and cronyism smorgasbord on the deck of the western developed democracy titanic… but be prepared to jump in a secure salvage boat.. …because the ship already starts taking in water while things seem just fine and jolly on the decks.
…sure, a few Titanics will survive. But betting that yours will be one of the few that survives seems foolish. The survival will depend on chaotically serendipitous factors that affect electoral voter-lemming sentiment which are virtually impossible to predict (e.g. scandals, whether a Supreme Court justice candidate hit any other children when he was a kid in daycare etc…). The future of these western voter lemming democracies will be decided on these capriciously serendipitous events, not on the all encompassing fundamental issue of productivity incentives.
Hence, a good preparation and practice on how to jump into and deploy a salvage boat will likely prove the best personal investment for any western world voter-lemming democracy resident.
[…] 5. On his blog, libertarian economist Dan Mitchell sees a speck of honesty from some Euro economists who are mouthing some ideas that are Laffer-ian. From his post: […]
[…] 5. On his blog, libertarian economist Dan Mitchell sees a speck of honesty from some Euro economists who are mouthing some ideas that are Laffer-ian. From his post: […]