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Archive for the ‘Laffer Curve’ Category

Since I’m a fiscal wonk, it’s sometimes tempting to overstate the importance of good tax policy. So I’m always reminding myself that all sorts of other factors matter for a jurisdiction’s competitiveness and success, including regulation and government effectiveness (and, for national governments, policies such as trade and monetary policy).

That being said, taxes are very important. In some cases, you could almost say tax policy is suicidally important.

Here’s some of what the Wall Street Journal reported earlier this week.

Hartford, Connecticut…is edging closer to joining a small club of American municipalities: those that have sought bankruptcy protection. …The city must pay nearly $180 million on debt service, health care, pensions and other fixed costs in the coming fiscal year beginning July 1. That is more than half of the city’s budget, excluding education.

This sounds like a run-of-the-mill story about a city (like Detroit) that has spent itself into fiscal trouble, mostly because of a bloated and over-compensated bureaucracy.

But tax policy is the story behind the story. Here’s the headline that caught my attention.

As I’ve written before, this is the “Fox Butterfield” version of financial reporting (he’s the New York Times reporter who was widely mocked for repeatedly expressing puzzlement that crime rates fell when crooks were locked up).

Simply stated, it would be more accurate to state (just as it was in Detroit) that the city is in trouble “because of” high property taxes, not “despite” those onerous levies.

Imagine being a homeowner or business with this type of burden.

Since 2000, Hartford has increased its property-tax, or millage, rate seven times. The rate is now more than 50% higher than it was in 1998. At the current level, a Hartford resident who owns a home with an assessed value of $300,000 currently pays an annual tax bill of $22,287, at rate of 7.43%. A West Hartford homeowner with a similar house pays $11,853 at a rate of 3.95%.

Wow, you get to pay twice as much tax on your home simply for the “privilege” of subsidizing an inefficient and incompetent city bureaucracy (not to mention the problem of excessive state taxes).

No wonder some major taxpayers are escaping, leaving the city (and state) even more vulnerable.

…the impending departure of one of its biggest employers, Aetna Inc. …Aetna and the other four biggest taxpayers in the city contribute nearly one-fifth of the city’s $280 million of property-tax revenue. Property-tax receipts make up nearly half of the city’s general-fund revenues.

To make matters worse, the city exempts a lot of property owners, which is one of the reasons for higher tax burdens on those that don’t get favored treatment.

Half of the city’s properties are excluded from paying taxes because they are government entities, hospitals and universities. …In Baltimore, about 32% of the property is tax exempt, and in Philadelphia it’s 27%.

Excuse me if I don’t shed a tear of sympathy for Hartford’s politicians. The city is in dire straits because of a perverse combination of excessive taxation and special tax favors. Combined, of course, with lavish remuneration for a gilded bureaucracy.

That’s the worst of all worlds. It’s Detroit all over again. Or you could call it the local-government version of Illinois.

Needless to say, I don’t want my tax dollars involved in any sort of bailout.

P.S. Though it would be amusing if Hartford politicians thought this bailout application form was real rather than satire.

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As far as I’m concerned, no sentient human being could look at what happened in the United States in the 1980s and not agree that high tax rates on upper-income taxpayers are foolish and self-destructive.

Not only did the economy grow faster after Reagan lowered rates, but the IRS even collected more revenue (a lot more revenue) because rich people earned and reported so much additional income.

That should be a win-win for all sides, though there are some leftists who hate the rich more than they like additional revenue.

Anyhow, I raise this example because there are politicians today who think it’s a good idea to go back to the punitive tax policy that existed in the 1970s.

Hillary Clinton proposed big tax hikes in last year’s campaign. And now, as reported by the U.K.-based Times, the Labour Party across the ocean is openly embracing a soak-the-rich agenda.

Labour’s tax raid on the country’s 1.3 million highest earners could raise less than half the £4.5 billion claimed by the party, experts said last night. The policy was announced by Jeremy Corbyn as part of plans to raise £48 billion through tax increases. …At the manifesto’s heart are plans to lower the threshold for the 45p tax rate from £150,000 to £80,000 and introduce a 50p tax band for those earning more than £123,000 a year. …Labour said that the increases could raise as much as £6.4 billion to help to fund giveaways such as the scrapping of tuition fees and more cash for the NHS, schools and childcare.

Here’s a chart from the article, showing who gets directly hurt by Corbyn’s class-warfare scheme.

But here’s the amazing part of the article.

The Labour Party, which has become radically left wing under Corbyn, openly acknowledges that the Laffer Curve is real and that there will be negative revenue feedback.

Under Labour’s calculation, if no one changed their behaviour as a result of the tax changes, a future government would raise an extra £6.4 billion a year. In its spending commitments the party is assuming that the new measures would bring in about £4.5 billion.

This is remarkable. The hard-left Labour Party admits that about 30 percent of the tax increase will disappear because taxpayers will respond by earning and/or reporting less taxable income.

That’s a huge concession to the real world, which is more than Barack Obama or Hillary Clinton ever did. Welcome to the supply side, Jeremy Corbyn!

Moreover, establishment organizations such as the Institute for Fiscal Studies also incorporate the Laffer Curve in their analysis. But even more so.

They say Labour’s class-warfare tax hike would – at best – raise less than half as much as the static revenue estimate.

The IFS said that even this reduced figure looked optimistic and the changes were more likely to raise £2 billion to £3 billion — about half the amount claimed. “The amount of extra revenue these higher tax rates would raise is very uncertain,” Paul Johnson, director of the IFS, said. “What we do know is that raising tax levels on those people earning over £150,000 does not bring in additional revenues because the kind of people on these kinds of incomes are significantly more able to work around the tax system.

Now let’s compared the enlightened approach in the United Kingdom to the more primitive approach in the United States.

The official revenue-estimating body on Capitol Hill, the Joint Committee on Taxation, has only taken baby steps in the direction of dynamic scoring (which is an improvement over their old approach of static scoring, but they still have a long way to go).

Fortunately, there are some private groups who do revenue estimates, similar to the IFS in the UK.

The Committee for a Responsible Federal Budget put together this very useful table comparing how the Tax Foundation and the Tax Policy Center “scored” the Better Way Plan.

The key numbers are in the dark blue rows. As you can see, the Tax Foundation assumes about 90 percent revenue feedback while the left-leaning Tax Policy Center only projects about 22 percent revenue feedback.

Since not all tax cuts/tax increases are created equal, the 22-percent revenue feedback calculation by the Tax Policy Center does not put them to the left of the Labour Party, which assumed 30-percent revenue feedback.

Indeed, the Labour Party’s tax hike is focused on upper-income taxpayers, who do have more ability to respond when there are changes in tax policy, so a high number is appropriate. However, there are some very pro-growth provisions in the Better Way Plan, such as a lower corporate tax rate, expensing, death tax repeal, etc, so I definitely think the Tax Foundation’s projections are closer to the truth.

For policy wonks, Alan Cole of the Tax Foundation explained why their numbers tend to differ.

The bottom line is that we are slowly but surely making progress on dynamic scoring. Even folks on the left openly acknowledge that higher tax rates impose at least some damage. You know what they say about a journey of a thousand miles.

P.S. None of this changes the fact that I still don’t like the BAT, but I freely admit that the economy would grow much faster if the overall Better Way Plan was enacted.

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Seven years ago, I wrote about the “Butterfield Effect,” which is a term used to mock clueless journalists.

A former reporter for the New York Times, Fox Butterfield, became a bit of a laughingstock in the 1990s for publishing a series of articles addressing the supposed quandary of how crime rates could be falling during periods when prison populations were expanding. A number of critics sarcastically explained that crimes rates were falling because bad guys were behind bars and invented the term “Butterfield Effect” to describe the failure of leftists to put 2 + 2 together.

Journalists are especially susceptible to silly statements when writing about the real-world impact of tax policy.

They don’t realize (or prefer not to acknowledge) that changes in tax rates alter incentives to engage in productive behavior, and this leads to changes in taxable income. Which leads to changes in tax revenue, a relationship known as the Laffer Curve.

Here are some remarkable examples of the Butterfield Effect.

  • A newspaper article that was so blind to the Laffer Curve that it actually included a passage saying, “receipts are falling dramatically short of targets, even though taxes have increased.”
  • Another article was entitled, “Few Places to Hide as Taxes Trend Higher Worldwide,” because the reporter apparently was clueless that tax havens were attacked precisely so governments could raise tax burdens.
  • In another example of laughable Laffer Curve ignorance, the Washington Post had a story about tax revenues dropping in Detroit “despite some of the highest tax rates in the state.”
  • Likewise, another news report had a surprised tone when reporting on the fully predictable news that rich people reported more taxable income when their tax rates were lower.

And now we can add to the collection.

Here are some excerpts from a report by a Connecticut TV station.

Connecticut’s state budget woes are compounding with collections from the state income tax collapsing, despite two high-end tax hikes in the past six years. …wealthy residents are leaving, and the ones that are staying are making less, or are not taking their profits from the stock market until they see what happens in Washington. …It now looks like expected revenue from the final Income filing will be a whopping $450 million less than had been expected.

Reviewing the first sentence, it would be more accurate to replace “despite” with “because.”

Indeed, the story basically admits that the tax increases have backfired because some rich people are fleeing the state, while others have simply decided to earn and/or report less income.

The question is whether politicians are willing to learn any lessons so they can reverse the state’s disastrous economic decline.

But don’t hold your breath. We have an overseas example of the Laffer Curve, and one of the main lessons is that politicians are willing to sacrifice just about everything in the pursuit of power.

Here are some passages from a story in the U.K.-based Times.

The SNP is expected to fight next month’s general election on a commitment to reintroduce a 50p top rate of tax… The rate at present is 45p on any earnings over £150,000. …civil service analysis suggested that introducing a 50p top rate of tax in Scotland could cost the government up to £30 million a year, as the biggest earners could seek to avoid paying the levy by moving their money south of the border.

If you read the full report, you’ll notice that the head of the Scottish National Party previously had decided not to impose the higher tax rate because revenues would fall (just as receipts dropped in the U.K. when the 50 percent rate was imposed).

But now that there’s an election, she’s decided to resurrect that awful policy, presumably because a sufficient number of Scottish voters are motivated by hate and envy.

This kind of self-destructive behavior (by both politicians and voters) is one of the reasons why I’m not overly optimistic about the future of Scotland if it becomes an independent nation.

P.S. I’m not quite as pessimistic about the future of tax policy in the United States. The success of the Reagan tax cuts is a very powerful example and American voters still have a bit of a libertarian streak. I’m not expecting big tax cuts, to be sure, but at least we’re fighting in the United States over how to cut taxes rather than how to raise them.

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I shared yesterday an example of how a big tax increase on expensive homes led to fewer sales. Indeed, the drop was so pronounced that the government didn’t just collect less money than projected, which is a very common consequence when fiscal burdens increase, but it actually collected less money than before the tax hike was enacted.

That’s the Laffer Curve on steroids.

The purpose of that column was to share with my leftist friends an example of a tax increase that achieved something they desired (i.e., putting a damper on sales of expensive houses) in hopes of getting them to understand that higher taxes on other types of economic activity also will have similar effects.

And some of those “other types of economic activity” will be things that they presumably like, such as job creation, entrepreneurship, and upward mobility.

I now have another example to share. The New York Times is reporting that a Mexican tax on soda is causing a big drop in soda consumption.

In the first year of a big soda tax in Mexico, sales of sugary drinks fell. In the second year, they fell again, according to new research. The finding represents the best evidence to date of how sizable taxes on sugary drinks, increasingly favored by large American cities, may influence consumer behavior.

This is an amazing admission. Those first three sentences of the article are an acknowledgement of the central premise of supply-side economics: The more you tax of something, the less you get of it.

In other words, taxes do alter behavior. In the wonky world of economics, this is simply the common-sense observation that demand curves are downward-sloping. When the price of something goes up (in this case, because of taxes), the quantity that is demanded falls and there is less output.

And here’s another remarkable admission in the story. The effect of taxes on behavior can be so significant that revenues are impacted.

The results…matter for policy makers who hope to use the money raised by such taxes to fund other projects. …some public officials may be dismayed… Philadelphia passed a large soda tax last year and earmarked most of its proceeds to pay for a major expansion to prekindergarten. City budget officials had assumed that the tax would provide a stable source of revenue for education. If results there mirror those of Mexico, city councilors may eventually have to find the education money elsewhere.

Wow, not just an admission of supply-side economics, but also an acknowledgement of the Laffer Curve.

Now if we can get the New York Times to admit that these principle also apply to taxes on work, saving, investment, and entrepreneurship, that will be a remarkable achievement.

P.S. Leftists are capable of amazing hypocrisy, so I won’t be holding my breath awaiting the consistent application of the NYT‘s newfound knowledge.

P.P.S. Just because some folks on the left are correct about the economic impact of soda taxes, that doesn’t mean they are right on policy. As a libertarian, I don’t think it’s the government’s job to dictate (or even influence) what we eat and drink.

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In my never-ending strategy to educate policy makers about the Laffer Curve, I generally rely on both microeconomic theory (i.e., people respond to incentives) and real-world examples.

And my favorite real-world example is what happened in the 1980s when Reagan cut the top tax rate from 70 percent to 28 percent. Critics said Reagan’s reforms would deprive the Treasury of revenue and result in rich people paying a lot less tax. So I share IRS data on annual tax revenues from those making more than $200,000 per year to show that there was actually a big increase in revenue from upper-income taxpayers.

It has slowly dawned on me, though, that this may not be the best example to share if I’m trying to convince skeptical statists. After all, they presumably don’t like Reagan and they may viscerally reject my underlying point about the Laffer Curve since I’m linking it to the success of Reaganomics.

So I have a new strategy for getting my leftist friends to accept the Laffer Curve. I’m instead going to link the Laffer Curve to “successful” examples of left-wing policy. To be more specific, statists like to use the power of government to control our behavior, often by imposing mandates and regulations. But sometimes they impose taxes on things they don’t like.

And if I can use those example to teach them the basic lesson of supply-side economics (if you tax something, you get less of it), hopefully they’ll apply that lesson when contemplating higher taxes on thing they presumably do like (such as jobs, growth, competitiveness, etc).

Here’s a list of “successful” leftist tax hikes that have come to my attention.

Now I’m going to augment this list with an example from the United Kingdom.

By way of background, there’s been a heated housing market in England, with strong demand leading to higher prices. The pro-market response is to allow more home-building, but the anti-developer crowd doesn’t like that approach, so instead a big tax on high-value homes was imposed.

And as the Daily Mail reports, this statist approach has been so “successful” that the tax hike has resulted in lower tax revenues.

George Osborne’s controversial tax raid on Britain’s most expensive homes has triggered a dramatic slump in stamp duty revenues. Sales of properties worth more than £1.5million fell by almost 40 per cent last year, according to analysis of Land Registry figures… This has caused the total amount of stamp duty collected by the Treasury to fall by around £440million, from £1.079billion to a possible £635.7million. The figures cover the period between April and November last year compared to the same period in 2015.

Our leftist friends, who sometimes openly admit that they want higher taxes on the rich even if the government doesn’t actually collect any extra revenue, should be especially happy because the tax has made life more difficult for people with more wealth and higher incomes.

Those buying a £1.5 million house faced an extra £18,750 in stamp duty. …Tory MP Jacob Rees-Mogg…described Mr Osborne’s ‘punitive’ stamp duty hikes as the ‘politics of envy’, adding that they have also failed because they have raised less money for the Treasury.

By the way, the fact that the rich paid less tax last year isn’t really the point. Instead, the lesson to be learned is that a tax increase caused there to be less economic activity.

So I won’t care if the tax on expensive homes brings in more money next year, but I will look to see if fewer homes are being sold compared to when this tax didn’t exist.

And if my leftist friends say they don’t care if fewer expensive homes are being sold, I’ll accept they have achieved some sort of victory. But I’ll ask them to be intellectually consistent and admit that they are implementing a version of supply-side economics and that they are embracing the notion that tax rates change behavior.

Once that happens, it’s hopefully just a matter of time before they recognize that it’s not a good idea to impose high tax rates on things that are unambiguously good for an economy, such as work, saving, investment, and entrepreneurship.

Yes, hope springs eternal.

P.S. In addition to theory and real-world examples, my other favorite way of convincing people about the Laffer Curve is to share the poll showing that only 15 percent of certified public accountants agree with the leftist view that taxes have no impact have taxable income. I figure that CPAs are a very credible source since they actually do tax returns and have an inside view of how behavior changes in response to tax policy.

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For more than 30 years, I’ve been trying to educate my leftist friends about supply-side economics and the Laffer Curve.

Why is it so hard for them to recognize, I endlessly wonder, that when you tax something, you get less of it? And why don’t they realize that when you tax something at high rates, the effect is even larger?

And if the tax is high and the affected economic activity is sufficiently discouraged, why won’t they admit that this will have an impact on tax revenue?

Don’t they understand the basic economics of supply and demand?

But I’m not giving up, which means I’m either a fool or an optimist.

In this Skype interview with the Blaze’s Dana Loesch, I pontificate about the economy and tax policy.

I made my standard points about the benefits a lower corporate rate and “expensing,” while also warning about the dangers of the the “border adjustable tax” being pushed by some House Republicans.

But for today, I want to focus on the part of the interview where I suggested that a lower corporate tax rate might generate more revenue in the long run.

That wasn’t a throwaway line or an empty assertion. America’s 35 percent corporate tax rate (39 percent if you include the average of state corporate taxes) is destructively high compared to business tax systems in other nations.

Last decade, the experts at the American Enterprise Institute calculated that the revenue-maximizing corporate tax rate is about 25 percent.

More recently, the number crunchers at the Tax Foundation estimated the long-run revenue-maximizing rate is even lower, at about 15 percent.

You can (and should) read their studies, but all you really need to understand is that companies will have a greater incentive to both earn and report more income when the rate is reasonable.

But since the U.S. rate is very high (and we also have very punitive rules), companies are discouraged from investing and producing in America. Firms also have an incentive to seek out deductions, credits, exemptions, and other preferences when rates are high. And multinational companies understandably will seek to minimize the amount of income they report in the United States.

In other words, a big reduction in the corporate rate would be unambiguously positive for the American economy. And because there will be more investment and job creation, there also will be more taxable income. In other words, a bigger “tax base.”

Though I confess that I’m not overly fixated on whether that leads to more revenue. Remember, the goal of tax policy should be to finance the legitimate functions of government in the least-destructive manner possible, not to maximize revenue for politicians.

P.S. Economists at the Australian Treasury calculated the effect of a lower corporate rate and found both substantial revenue feedback and significant benefits for workers. The same thing would happen in the United States.

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Yesterday was “Australia Day,” which I gather for Aussies is sort of like the 4th of July for Americans.

To belatedly celebrate for our friends Down Under, I suppose we could sing Waltzing Matilda.

But since I’m a policy wonk with a special fondness for the nation, let’s instead acknowledge Australia Day by citing some very interesting research

Economists at the Australian Treasury crunched the numbers and estimated the economic effects of a lower corporate tax rate. They had several levers in their model for how this change could be financed, including increases in other taxes.

Corporate income taxes are one of the most destructive ways for a government to generate revenue, so it’s not surprising that the study concluded that a lower rate would be desirable under just about any circumstance.

But what caught my attention was the section that looked at the economic impact of a lower corporate tax rate that is offset by a reduction in the burden of government spending. The consequences are very positive.

This subsection reports the findings from the model simulation of a company income tax rate cut from 30 to 25 per cent, leaving all other tax rates unchanged and assuming any shortfall in revenue across all jurisdictions is financed by a cut in government spending. …Under this scenario, GNI is expected to rise by 0.7 per cent in the long run (see Chart 9). …the improvement in real GNI is largely due to the gain in labour income. Underlying the gain in COE is an estimated rise in before-tax real wages of around 1.1 per cent and a rise in employment of 0.1 per cent.

For readers unfamiliar with economic jargon, GNI is gross national income and COE is compensation of employees.

And here’s the chart that was referenced. Note that workers (labour income) actually get more benefit from the lower corporate rate than investors (capital income).

So the bottom line is that a lower corporate tax rate leads to more economic output, with workers enjoying higher incomes.

And higher output and increased income also means more taxable income. And this larger “tax base” means that there is a Laffer Curve impact on tax revenues.

No, the lower corporate tax rate isn’t self financing. That only happens in rare circumstances.

But the study notes that about half of the revenue lost because of the lower corporate rate is recovered thanks to additional economic activity.

…After second-round effects, it is estimated that government spending must be cut by 51 cents for every dollar of direct net company tax cut. It is also estimated that 13 cents of every dollar cut is recovered through higher personal income tax receipts in the long run, while 14 cents is recovered thorough higher company income tax receipts. In the long run, the total revenue dividend from the company tax cut is estimated to be around 49 cents per dollar lost through the company tax cut

Here’s the relevant chart showing these results.

And the study specifically notes that the economic benefits of a lower corporate rate are largest when it is accompanied by less government spending.

A decrease in the company income tax rate financed by lower government spending implies a significantly higher overall welfare gain when compared with the previous scenarios of around 0.7 percentage points… As anticipated in the theoretical discussion, when viewed from the standpoint of the notional owners of the factors of production, the welfare gain is largely due to a significant improvement in labour income due to higher after-tax real wages.

By the way, the paper does speculate whether the benefits (of a lower corporate rate financed in part by less government spending) are overstated because they don’t capture benefits that might theoretically be generated by government spending. That’s a possibility, to be sure.

But it’s far more likely that the benefits are understated because government spending generates negative macroeconomic and microeconomic effects.

In the conclusion, the report sensibly points out that higher productivity is the way to increase higher living standards. And if that’s the goal, a lower corporate tax rate is a very good recipe.

Australia’s terms of trade, labour force participation and population growth are expected to be flat or declining in the foreseeable future which implies any improvement in Australia’s living standards must be driven by a higher level of labour productivity. This paper shows that a company income tax cut can do that, even after allowing for increases in other taxes or cutting government spending to recover lost revenue, by lowering the before tax cost of capital. This encourages investment, which in turn increases the capital stock and labour productivity.

This is spot on. A punitive corporate income tax is a very destructive way of generating revenue for government.

Which is why I hope American policy makers pay attention to this research. We already have the highest corporate tax rate in the developed world (arguably the entire world depending on how some severance taxes in poor nations are counted), and we magnify the damage with onerous rules that further undermine competitiveness.

P.S. By world standards, Australia has a lot of economic freedom. But that’s in part a sad indictment on the global paucity of market-oriented nations. There are some very good policies Down Under, but the fiscal burden of government is far too large. The current government is taking some small steps in the right direction (lower corporate rate, decentralization), but much more is needed.

P.P.S. In the interest of being a good neighbor, the Australian government should immediately put an end to its crazy effort to force Vanuatu to adopt an income tax.

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