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Posts Tagged ‘Laffer Curve’

Based on what she’s been saying during the campaign, Hillary Clinton is a big fan of class warfare. She has put forth a series of “soak-the-rich” tax hikes designed to finance bigger government.

Her official plan includes provisions such as an increase (“surcharge”) in the top tax rate, the imposition of the so-called Buffett Rule, an increase in the tax burden on capital gains (including carried interest), and a more onerous death tax.

The Tax Foundation explains that this plan won’t be good for the economy or the budget.

Hillary Clinton’s tax plan would reduce the economy’s size by 1 percent in the long run. The plan would lead to 0.8 percent lower wages, a 2.8 percent smaller capital stock, and 311,000 fewer full-time equivalent jobs. …If we account for the economic impact of the plan, it would end up raising $191 billion over the next decade.

Here’s a table showing the static revenue impact for the various provisions, followed by the estimated economic impact, which then allows the Tax Foundation to calculate the real-world, dynamic revenue impact.

So what does all this mean?

Well, the Congressional Budget Office estimates that tax revenue over the next 10 years will be $41,658 billion based on current law. Hillary’s plan will add $191 billion to that total, an increase of 0.46 percent.

Which means that she’s willing to lower our incomes by 0.80 percent to increase the government’s take by 0.46 percent. A good deal for her and her cronies, but bad for America.

But it gets worse. Hillary’s official tax plan doesn’t include her biggest proposed tax hike. As I’ve warned before, and as Andrew Biggs of the American Enterprise explains in a new article, she has explicitly stated her support for huge tax hikes to bail out Social Security.

…she has endorsed both of the main tax increases included in Sanders’ Social Security plan: imposing the Social Security tax on earnings above the current $118,500 cap and applying Social Security taxes to investment income in addition to wages.

Andrew warns that busting the wage-base cap may boost payroll tax receipts, but such a policy will lead to lower revenues from other sources.

Eliminating the payroll tax ceiling would require workers and employers to each pay an additional 6.2% tax on all earnings above the ceiling, currently $118,500. Both the SSA actuaries and the Congressional Budget Office assume that when employers are hit with an additional payroll tax they will over time reduce employees’ wages to cover the increased cost, consistent with economists’ view that employees ultimately “pay” for employer-provided benefits through lower wages. Those lost wages would then no longer be subject to federal income taxes, Medicare payroll taxes or state government income taxes. If the average marginal tax rate on earnings above the current payroll tax ceiling is 48% – say, the top earned income tax rate of 39.6%, plus the 3.8% top Medicare payroll tax rate, plus a roughly 5% state income tax – then federal and state tax revenues would fall by 26 cents for each additional dollar of Social Security taxes collected.

And this estimate is based solely on the reduction in taxable income that occurs as businesses give their employees less take-home buy because of the higher payroll tax.

To be accurate, you also have to consider how workers will react (and rest assured that upper-income taxpayers have plenty of ability to alter the timing, level, and composition of their income). Andrew looks at the potential impact.

…revenue losses occur even if individual earners themselves make no adjustments to their earnings in response to higher tax rates. They’re purely a function of employers adjusting wages to compensate for their payroll tax bills. But if affected earners react to higher tax rates by reducing their earnings, either though less work or by tax avoidance strategies, then net revenue losses would be even higher. A 2010 literature survey by economists Emmanuel Saez, Joel Slemrod, and Seth Giertz found that high earners reduce their earnings by between 0.12% and 0.40% for each 1% increase in their taxes. These estimates imply that total revenues gained by eliminating the Social Security tax max would fall one-third to one-half below the static assumptions that Social Security reforms rely upon. Other credible academic studies find even higher sensitivities of taxable income to tax rates.

For more information, here’s a video I narrated on the issue for the Center for Freedom and Prosperity.

Let’s close on a grim note. If Hillary Clinton goes forward with her plan to bust the wage base cap and change Social Security from an actuarially bankrupt social insurance program into a conventional tax-and-spend redistribution program, she won’t collect very much tax revenue because of the way workers and employers will react.

But from Hillary’s perspective, she won’t care. Under the budget rules governing Washington, she’ll still be able to increase spending (i.e., buy votes) based on how much revenue the Joint Committee on Taxation inaccurately predicts will materialize based on primitive “static scoring” estimates.

In other words, the Laffer Curve will prevail, but – other than the ability to say “I told you so” – proponents of good policy won’t have any reason to be happy.

And when, in the real world, the long-run fiscal and economic outlook weakens because of her misguided policies, Mrs. Clinton will just propose additional tax hikes to deal with the “unexpected” shortfalls. Lather, rinse, repeat, until we become Greece.

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Our statist friends like high taxes for many reasons. They want to finance bigger government, and they also seem to resent successful people, so high tax rates are a win-win policy from their perspective.

They also like high tax rates to micromanage people’s behavior. They urge higher taxes on tobacco because they don’t like smoking. They want higher taxes on sugary products because they don’t like overweight people. They impose higher taxes on “adult entertainment” because…umm…let’s simply say they don’t like capitalist acts between consenting adults. And they impose higher taxes on tanning beds because…well, I’m not sure. Maybe they don’t like artificial sun.

Give their compulsion to control other people’s behavior, these leftists are very happy about what’s happened in Berkeley, California. According to a study published in the American Journal of Public Health, a new tax on sugary beverages has led to a significant reduction in consumption.

Here are some excerpts from a release issued by the press shop at the University of California Berkeley.

…a new UC Berkeley study shows a 21 percent drop in the drinking of soda and other sugary beverages in Berkeley’s low-income neighborhoods after the city levied a penny-per-ounce tax on sugar-sweetened beverages. …The “Berkeley vs. Big Soda” campaign, also known as Measure D, won in 2014 by a landslide 76 percent, and was implemented in March 2015. …The excise tax is paid by distributors of sugary beverages and is reflected in shelf prices, as a previous UC Berkeley study showed, which can influence consumers’ decisions. …Berkeley’s 21 percent decrease in sugary beverage consumption compares favorably to that of Mexico, which saw a 17 percent decline among low-income households after the first year of its one-peso-per-liter soda tax that its congress passed in 2013.

I’m a wee bit suspicious that we’re only getting data on consumption by poor people.

Why aren’t we seeing data on overall soda purchases?

And isn’t it a bit odd that leftists are happy that poor people are bearing a heavy burden?

I’m also amused by the following passage. The politicians want to discourage people from consuming sugary beverages. But if they are too successful, then they won’t collect all the money they want to finance bigger government.

In Berkeley, the tax is intended to support municipal health and nutrition programs. To that end, the city has created a panel of experts in child nutrition, health care and education to make recommendations to the City Council about funding programs that improve children’s health across Berkeley.

In other words, one of the lessons of the Berkeley sugar tax and the 21-percent drop in consumption is that the Laffer Curve applies to so-called sin taxes just like it applies to income taxes.

But the biggest lesson to learn from this episode is that it confirms the essential insight of supply-side economics. Simply stated, when you tax something, you get less of it.

Which is something that statists seem to understand when they urge higher “sin taxes,” but they deny when the debate shifts to taxes on work, saving, entrepreneurship, and investment.

I’m not joking. I debate leftists all the time and they will unabashedly argue that it’s okay to have higher tax rates on labor income and more double taxation on capital income because taxpayers supposedly don’t care about taxes.

Oh, and the same statists who say that high tax burdens don’t matter because people don’t change their behavior get all upset about “tax havens” and “tax competition” because…well, because people will change their behavior by shifting their economic activity where tax rates are lower.

It must be nice not to be burdened by a need for intellectual consistency.

Speaking of which, Mark Perry used the Berkeley soda tax as an excuse to add to his great collection of Venn Diagrams.

P.S. On the issue of sin taxes, a brothel in Austria came up with an amusing form of tax avoidance. The folks in Nevada, by contrast, believe in sin loopholes. And the Germans have displayed Teutonic ingenuity and efficiency.

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Over the years, I’ve run into oddball stories about what happens when politicians and bureaucrats get involved with matters relating to sex.

And here are two more examples. Government isn’t involved yet, but will be if statists get their way.

  • Leftists concocted a crazy theory that tax havens promote sex slavery.
  • And other leftists hypothesized that climate change promotes prostitution and AIDS.

Let’s add to our collection. We now have new evidence in favor of the Laffer Curve, thanks to Illinois politicians levying a tax on strip clubs.

Here are some excerpts from a story in the St. Louis Post-Dispatch.

…she and others…were expecting at least $1 million to be raised…the Live Adult Entertainment Facility Surcharge tax…went into effect Jan. 1, 2013, with the first monies collected in fiscal year 2014. For that fiscal year, the State Department of Revenue reported $405,996.62 in revenue; over the next two fiscal years, the amounts collected were a bit more — $501,334.85 for fiscal year 2015 and $532,271.46 for fiscal year 2016. The state’s newest ‘sin tax,’ which poses a tax on facilities that serve alcohol and that have live adult entertainment, includes topless, nude dancing and stripping. “They were expecting it to raise quite a bit of revenue,” McClanahan said of the tax on strip-club type facilities… “We anticipated it would be a greater number of clubs that would be paying and we would have anticipated about a million in revenue,” Poskin said. “So I don’t know if that if the tax that they’re paying is accurate and consistent with their gross receipts.”

The bottom line (no pun intended) is that politicians collected about half as much money as originally projected.

It’s unclear, to be sure, why the revenues didn’t materialize.

The clubs are probably engaging in a bit of avoidance and evasion, which is quite common in all areas of the economy when tax burdens increase.

And the clubs presumably are suffering from a loss of business because of the tax, which also is a common effect of higher tax burdens in all sectors of the economy.

Which gives me an excuse to make a broader point about the economy-wide implication of higher tax burdens.

Scott Sumner compares output in the U.S. and the four biggest European nations (Germany, U.K., France, and Italy), observes that per-capita tax collections in the U.S. are almost as high as they are in these other countries with far higher tax burdens, and has some must-read analysis about the very high economic cost of getting additional tax revenue.

…tax rates in the US are about 31% lower than in Europe, so there is a lot of scope for tax increases in the US. But how much revenue would those higher taxes actually collect—in the long run? This data suggests not very much. …we are in a region where disincentive effects are kicking in. GDP per person in these four countries is about 25.5% lower than in the US (PPP), so they only raise about 7.5% more revenue that we do, despite far higher tax rates. …The mistake that progressives make is to see the huge US GDP as a sort of piggy bank from which money can be raised for any policy objectives, without killing the goose that lays the golden eggs. …it’s clear that progressivism can never succeed in America. The only question is how badly it will fail.

Looking at all this data, the one important question that must be asked is how anyone could possibly think that it’s a good idea to sacrifice 25.5 percent of our income in order to give politicians 7.5 percent more tax revenue.

By the way, for those who think Scott’s conclusions are somehow illegitimate because they’re based on back-of-the-envelope calculations, check out the very detailed and rigorous analysis from the European Central Bank that found an even larger negative relationship between tax revenue and foregone economic output.

In other words, there is a Laffer Curve. When tax burdens climb, taxable income falls. Which is just another way of stating that the cost of higher taxes isn’t just that politicians take our money. They also impose lots of damage on the economy, which means we suffer from lower earnings.

So it’s a double-whammy. They tax more, we earn less.

P.S. While I don’t want politicians involved with sex, I must confess that there’s also some compelling evidence that people don’t want economists involved with sex.

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Hillary Clinton and Bernie Sanders are basically two peas in a pod on economic policy. The only difference is that Sanders wants America to become Greece at a faster rate.

Folks on the left may get excited by whether we travel 60 mph in the wrong direction or 90 mph in the wrong direction, but this seems like a Hobson’s choice for those of us who would prefer that America become more like Hong Kong or Singapore.

Consider the issue of taxation. Clinton and Sanders both agree that they want to raise tax rates on investors, entrepreneurs, small business owners, and other “rich” taxpayers. The only difference is how high and how quickly.

Scott Winship of the Manhattan Institute has a must-read column on this topic in today’s Wall Street Journal.

He starts by speculating whether there’s a rate high enough to satisfy the greed of these two politicians.

Here is a question to ask Hillary Clinton and Bernie Sanders: What is the best tax rate to impose on high-income earners…? Perhaps they think it is 83%, a rate that economists Thomas Piketty and Emmanuel Saez hypothesized in 2014… Or maybe it is 90%, which Sen. Sanders told CNBC last May was not out of the question.

He then points out that there were very high tax rates in America between World War II and the Reagan era.

…the U.S. had such rates in the past. From 1936 to 1980, the highest federal income-tax rate was never below 70%, and the top rate exceeded 90% from 1951 to 1963. …The discussion of these rates can easily create the impression that the federal government collected far more money from “the rich” before the Reagan administration.

But rich people aren’t fatted calves awaiting slaughter. They generally are smart enough to figure out ways to avoid high tax rates. And if they’re not smart enough, they know to hire bright lawyers, lobbyists, and accountants who figure out ways to protect their income.

Which is exactly what happened.

The effective tax rates actually paid by the highest income earners during the 1950s and early ’60s were far lower than the highest marginal rates. …In the 1960s, for example, the average rate paid by the top 0.1% of tax filers—the top 10th of the top 1%—ranged from 26.5% to 29.5%, according to a 2007 study by Messrs. Piketty and Saez. Even during the 20 years after the Reagan tax cuts, the top 10th of the top 1% paid an average rate of 23.7% to 33%—essentially the same as in the 1960s.

Gee, sounds like Hauser’s Law – a limit on how much governments can tax – is true, at least for upper-income taxpayers.

And Winship provides some data showing that high tax rate are not the way to collect more revenue.

When average tax rates went up from 27.6% in 1965 to 34% in 1975, revenues went down, from 0.6% to 0.5% of the sum of GDP plus capital gains. When average tax rates declined to 23.7% over the second half of the 1970s and the ’80s, tax revenues from the top went up, reaching 0.8% of GDP plus capital gains in 1990. …in the early 1990s, Presidents George H.W. Bush and Bill Clinton raised average tax rates at the top, and revenue from the top 0.1% eventually skyrocketed. But the flood of revenue overwhelmingly reflected not the increase in rates but the stock market’s takeoff… Consider: If the higher top tax rates had caused the growth in revenue, then revenues should have fallen when Mr. Clinton cut the top tax rate on capital gains to 20% from 28% in 1997. But revenues from the top 0.1% kept pouring in.

And if you want more detail, check out the IRS data from the 1980s, which shows that rich taxpayers paid a lot more tax when the top rate was dropped from 70 percent to 28 percent.

That was a case of the Laffer Curve on steroids!

No wonder some leftists admit that spite is their real reason for supporting confiscatory tax rates on the rich, not revenue.

But what if the high tax rates are imposed on a much bigger share of the population, not just the traditional target of the “top 1 percent”?

Well, even hardcore statists who favor punitive tax policy admit that this would be a recipe for economic calamity.

Mr. Piketty said, “I firmly believe, that imposing a 70% or 80% marginal rate on large segments of the population (say, 25% of the population, or even 10%, or even a few percentage points) would lead to an economic disaster.” In other words, sayonara increased tax revenue.

Heck, even the European governments with the biggest welfare states rarely impose tax rates at those levels.

And when they do (as in the case of Hollande’s 75 percent tax rate in France), they suffer severe consequences.

Which is why the real difference in taxation between the United States and Europe isn’t the way the rich are taxed. Government is bigger in Europe because of higher tax burdens on the poor and middle class, specifically onerous value-added taxes and top income tax rates that take effect at relatively modest levels of income.

In other words, the rich already pay the lion’s share of tax in the United States. But not because we have 1970s-style tax rates, but because the tax burden is relatively modest for lower- and middle-income people.

Which brings us to Winship’s final point.

Proposals to soak the rich by raising their tax rates are unlikely to yield the revenue windfall that Mr. Sanders or Mrs. Clinton are dangling before voters. Leveling with the American people means…admitting that they will have to raise the money from tax hikes on middle-class voters.

Though he “buried the lede,” as they say in the journalism business. The most important takeaway from his column is that the redistribution agenda being advanced by Clinton and Sanders necessarily will require big tax hikes on the middle class.

Indeed, the “tax-the-rich” rhetoric they employ is simply a smokescreen to mask their real goals.

Which is why I included that argument in my video that provided five reasons why class-warfare taxation is a bad idea.

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About one year ago, Scott Hodge authored a report explaining the mechanics and utility of the Tax Foundation’s Taxes and Growth Dynamic Model. He made a very persuasive argument about the need to modernize and improve the Joint Committee on Taxation’s antiquated revenue-estimating process by estimating the degree to which changes in tax policy impact economic performance. The use of “dynamic scoring,” Scott explained, would produce more accurate data than “static scoring,” which is based on rather bizarre and untenable assumption that the economy’s output is unaffected by taxation.

Conventional scoring treats this process as an exercise in arithmetic, whereas dynamic scoring makes the process an exercise in economics.

Since I’m a proponent of the Laffer Curve, I obviously applaud the Tax Foundation’s superb work on this issue.

And for those who doubt the value of dynamic scoring, I challenge them to come up with an alternative explanation for why rich people paid five times as much tax after Reagan lowered the top tax rate from 70 percent to 28 percent in the 1980s.

But the Laffer Curve isn’t the focus of today’s column. Instead, I want to address the argument that supply-side tax policy (i.e., lower marginal tax rates, less tax bias against saving and investment) is no longer important or desirable.

Writing for Slate, Reihan Salam argues that Donald Trump’s success is a sign that the traditional tax-cutting agenda no longer is relevant.

Why can’t his GOP opponents convince Republican voters that they would do a far better job than Trump of defending middle-class economic interests? …Trump has demonstrated its weakness and the failure of its stale policy agenda to resonate with voters. …The GOP can no longer survive as the party of tax cuts for the rich. …If Republicans are to win the trust of working- and middle-class voters who’ve grown deeply skeptical of their economic nostrums, they will have to do something dramatic: It’s time for the GOP to abandon its near-obsessive devotion to tax cuts that disproportionately benefit upper-income households. …The GOP elite has also yet to grasp that most voters simply don’t care as much about taxes as they did in the Reagan era. …the share of voters who consider their federal tax burden their top priority is a mere 1 percent. To break out of their tax trap, Republicans…should continue to back tax cuts for the middle class, and in particular for middle-class parents. But until the country sees large and sustained budget surpluses, there should be no tax cuts for households earning $250,000 or more.

I’m not an expert on politics, so I won’t pretend to have any insight on whether tax policy motivates voters. But from an economic perspective, assuming the goal is a faster-growing economy that creates broadly shared prosperity, it would be very unfortunate if Republicans abandoned supply-side tax policy.

In the Tax Foundation study, Scott succinctly summarized the issue.

The primary goal of comprehensive tax reform is economic growth. …It is critically important that lawmakers make the right choices that lift everyone’s standards of living.

And here’s what I recently wrote, specifically addressing the assertion that proponents of good policy simply want to help the “rich.”

…It’s not that we lose any sleep about the average tax rate of successful people. We just don’t want to discourage highly productive investors, entrepreneurs, and small business owners from doing things that result in more growth and prosperity for the rest of us.

But what are those “right choices” that “result in more growth and prosperity for the rest of us”?

The Tax Foundation points us in the right direction. Let’s look at some charts (updated versions of the ones in Scott’s report), starting with this estimate of how various tax cuts affect overall economic output.

As you can see, expanded child credits don’t have any positive impact on growth for the simple reason that they don’t alter incentives to work, save, or invest (they may be desirable for other reasons, however). Lower marginal tax rates lead to some added growth, particularly if the top rate is reduced since upper-income taxpayers have far greater control of the timing, level, and composition of their income. But the biggest growth effects come from lowering the corporate tax rate and reducing the tax code’s bias against new investment.

Now let’s take the next step.

If changes in tax policy lead to increases in economic output, that also means a greater amount of taxable income.

So the Tax Foundation also can tell us the degree to which the aforementioned tax cuts will change revenue after 10 years. As you can see, most tax cuts result in less revenue, but in some cases there’s a considerable amount of revenue feedback. And if policy makers shift toward expensing, the long-run effect is more tax revenue.

Now let’s look from the other perspective.

What happens to the economy if various tax hikes are imposed?

As you can see, some tax increases have relatively modest effects on economic output while others significantly discourage productive behavior.

And when you feed the growth effects back into the model, you then can see the likely real-world effect of those tax increases on tax revenue.

So if policy makers impose a relatively benign tax hike, such as scaling back the state and local tax deduction, they will collect a considerable amount of revenue. But if they increase top tax rates on personal income or corporate income, a lot of the projected revenue evaporates. And if they exacerbate the tax bias against new investment, the net effect is less revenue.

By the way, these charts show why the class-warfare tax policies of Hillary Clinton and Bernie Sanders are so misguided. The amount of economic damage per dollar collected would be ridiculous.

Such tax increases wouldn’t be good for rich people, of course, but the real lesson is that the rest of us will be adversely affected because of a slower-growing economy.

The bottom line is that poor people and middle-class people have much more opportunity and prosperity with a Hong Kong-style tax system instead of a punitive French-style tax system.

To conclude, let’s now consider a few caveats.

If you examine the broad measures of what causes prosperity, tax policy is just one piece of the puzzle. The burden of government spending also is important, as is trade policy, regulatory policy, monetary policy, property rights, and the rule of law.

So it’s possible for a nation to be relatively prosperous with bad tax policy so long as it has free-market policies in other areas. It’s also possible for a nation with a good tax system to be poor and stagnant if other economic policies are statist and interventionist.

But if the goal is faster growth and more broadly shared prosperity, why not seek good policy in all areas?

The bottom line is that supply-side tax policies can contribute to better economic performance. In an ideal world, those policies also are politically popular. But even if they aren’t, the policy-making community should strive to educate the populace on what works, not abandon good policy for the sake of short-term political expediency.

P.S. Even international bureaucracies acknowledge the Laffer Curve, which means they understand that changes in tax policy can lead to changes in taxable income.

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Greece is special, though not in a good way.

The nation has such a pro-welfare mentality that pedophiles get disability benefits. And the regulatory mindset is so nutty that you need to submit a stool sample if you want to create an online company.

2300-greece0708-a1While those are bizarre examples of foolish government, Greece is probably best known for bailouts. Lots of them.

The politicians spent too much money and drove the economy into a ditch. And ever since, they’ve been trying to tax their way back to solvency, apparently oblivious to the fact that the private sector can’t rescue the economy if it’s being taxed into oblivion.

And that’s not idle rhetoric. A new report from The Economist gives us a very good warning of what happens when politicians get too greedy.

The story starts with an anecdote about a Greek entrepreneur who failed. But he didn’t fail because of a bad idea or a poor work ethic. Instead, the government got too greedy and taxed him into exile.

Panagiotis Korfoksyliotis set up a business in Athens in 2011, ferrying tourists around by car…he paid his staff a decent wage and declared all his earnings. Unfortunately, the taxman did not repay the kindness. Sharp increases in business taxes have prompted Mr Korfoksyliotis to pack his bags and move his company and his life to Bulgaria. Now he employs drivers to take foreign visitors around that country’s tourist spots instead.

And it turns out that Mr. Korfoksyliotis has lots of company.

He is part of a growing trend. …Greek governments desperate for cash have sought to squeeze it from companies, despite evidence that this is driving them away to places like Bulgaria, Cyprus and Albania. …by some estimates more than 200,000 businesses have closed or in some cases left Greece since then. ……accountants, lawyers and businesspeople reckon that perhaps as many as 10,000 Greek-owned firms have moved abroad. In a recent survey of 300 firms, Endeavor Greece, a non-profit organisation that helps entrepreneurs, found that more than a third had either left or were thinking about going.

And guess what? When a whole bunch of entrepreneurs and businesses decide that it’s no fun to work hard when the government is the main beneficiary, they leave. And all of sudden the politicians no longer have as much income to tax.

Between 2009 and 2014 the taxable profits declared by the country’s businesses fell by more than €5 billion ($5.6 billion) to €10 billion.

Wow, that’s a big Laffer Curve effect, even when including all the other factors that would have caused taxable income to decline over the past few years.

We also see the impact of tax competition in this story. The nations that are being sensible are attracting jobs and investment. Greece, of course, isn’t in that category.

Other euro-crisis countries, such as Portugal and Ireland, cut business taxes or kept them low, to encourage investment and growth. …But Greece has raised its corporation-tax rate from 20% in 2012 to 29% in 2015… Greece’s tax rise makes Bulgaria’s rate of just 10% even more alluring; likewise Cyprus’s 12.5% rate and Albania’s 15%.

But what’s really amazing is that Greece will probably go from bad to worse.

…the left-wing ruling coalition is not listening. It is now proposing a 20% rise in a levy on companies’ profits that goes toward pensions. Carry on in this vein, and there will not be many businesses, or much profit, left to tax.

Let that final sentence sink in. Our friends at The Economist are very much part of the left-leaning establishment. Yet they ended the story with about as powerful of an endorsement of the Laffer Curve as one could imagine.

In the meantime, I’ll end my column with an utterly depressing assessment of Greece’s future.

The country is basically doomed. In part, this is because government is too big. But it’s even more because the social capital of the Greek people has been eroded by decades of handouts and subsidies.

Social-Collapse-TheoremAnd when people think that it’s morally acceptable to use the coercive power of government to take money from their neighbors, it’s just a matter of time before than society collapses.

Why? Because people like Mr. Korfoksyliotis eventually decide that it’s no fun being enslaved by a bunch of looters and moochers.

The Economist slowly but surely seems to be waking up to this reality.

But I have very little hope for Bernie Sanders. Like the Syriza government, he would double down on higher taxes even as more and more taxpayers decided to “go Galt.” And just like Greece, there will be no turning back when we reach that dependency tipping point.

P.S. While part of me wants Greece to suffer because of bad politicians and scrounging voters, even I don’t want to subject the Greeks to this much torture.

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Based on my writings, some people may think I’m 100 percent against higher taxes.

But that’s not exactly true. In some cases, I like punitive taxation. Or, to be more precise, I sometimes take pleasure when punitive tax policy backfires on bad people.

Here’s an example. An interesting article in Slate, authored by Adam Chodorow of Arizona State University Law School, looks at how a terrorist group’s attempt to form a government is being stymied by an inability to collect taxes.

Revolution is easy. Governing is hard. And there are few things more difficult than taxes. Operating a country requires money, and that typically requires taxes. … The population in this area is estimated to be between 7 million and 8 million, about the same as the population of Washington state. While ISIS currently collects about $1 billion annually, countries of similar size collect about $16 billion, suggesting that ISIS has a long way to go if it wants to operate like a real state.

But the comparatively low levels of tax are not because of a Hong Kong-type commitment to limited government.

Instead, the terror group is discovering that people don’t like giving their money to politicians and bureaucrats, even ones motivated by Islamic fundamentalism.

…taxes aren’t a great way to ingratiate oneself with the governed. …More than one government has fallen because of its tax policy. ISIS must face these challenges just as any emerging polity does… ISIS may have displayed prowess on the battlefield, but it has revealed that it is as stymied and constrained by the complexities of taxation as the rest of us. …ISIS’s taxes appear to be…no more popular in the territory it controls than they would be here in the U.S. As the Times reported, ISIS’s taxes are now so onerous that large numbers of people, who were apparently willing to tolerate ISIS’s religious authoritarianism, are fleeing Syria and Iraq to escape them. At some point people will either rise up or leave, threatening ISIS’s internal revenue source.

So taxes are becoming so onerous that taxpayers (and taxable income) are escaping.

Hmmm…, excessive taxation leading to less taxable economic activity. That seems like a familiar concept.

Something I’ve written about one or two times. Or maybe 50 or 100 times.

Ah, yes, our old friend, the Laffer Curve!

ISIS is…constrained by a lack of administrative resources and the simple reality once sketched on the back of a cocktail napkin by the economist Arthur Laffer: that tax rates can only get so high before they actually drive down government revenues. Given current conditions, ISIS may be near or at the limits of its ability to tax, even if it can recruit jihadi tax accountants to its cause. Thus, …it’s not clear how much room the group has to grow internal revenues. More important, its efforts to do so may do more to damage its prospects than outside forces can accomplish.

This sounds like the tax equivalent of War of the Worlds, the H.G. Wells’ classic in which alien invaders wreak havoc on earth until they are felled by bacteria.

Tom Cruise was the star of a 2005 movie adaptation of this story, but I’m thinking I could rekindle my acting career and star in a movie of how the Laffer Curve thwarts ISIS!

But to have a happy ending, ISIS has to be defeated. And Professor Chodorow closes his article with a very helpful suggestion.

Rather than send in ground troops, …view our tax code as a weapon of mass destruction… We could make full use of it in the war on ISIS, perhaps by translating it into Arabic in the hopes that the group adopts it.

Sounds like the advice I gave about threatening Assad with Obamacare.

P.S. If they do decide to make a movie about the Laffer Curve and ISIS, maybe Obama could star as tax adviser for ISIS. At least if he’s not too busy in some of the other movie roles people have envisioned.

P.P.S. I like excessive taxes when they lead to the downfall of terrorist thugs. But I also take perverse pleasure when class-warfare tax hikes backfire in places such as France and the United Kingdom. I feel sorry for the taxpayers of those nations, to be sure, but it sometimes helps to have examples of what not to do.

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If you owned a restaurant and wanted to generate more income and boost your bottom line, would you double your prices thinking that this would double your revenue?

Of course not. You would understand that a lot of your patrons would simply dine elsewhere. And if they didn’t have other restaurants available, many of them would simply eat at home.

But now imagine you’re a politicians and you want more tax revenue so you can try to buy more votes and redistribute more money to the special interests that fund your campaign.

Would you assume that doubling a tax rate would lead to twice as much revenue?

Based on the shoddy methodology of the Joint Committee on Taxation (JCT), which is in charge of the revenue-estimating process on Capitol Hill, the answer is yes.

To be fair, the bureaucrats at the JCT probably wouldn’t say that tax revenue would double, but their model basically assumes that tax policy doesn’t affect the economy’s overall performance. So even if there’s a huge increase in the tax burden, they assume overall economic output won’t be affected.

This obviously is an absurd assumption. You don’t have to be a rocket scientist to realize that taxes impact economic performance. Low-tax economies like Hong Kong and Singapore, for instance, routinely outperform medium-tax economies like the United States. Similarly, differences in tax policy are one of the reasons why the United States generally grows faster than (or doesn’t grow as slowly as) Europe’s high-tax welfare states.

The lesson that should be learned is that the JCT should not estimate the revenue impact of a change in tax policy simply by looking at the change in the tax rate and the current trendline for taxable income. To get a more accurate answer, the bureaucrats also should try to estimate the degree to which taxable income will change.

This is the essential insight of the Laffer Curve. You can’t calculate changes in tax revenue simply by looking at changes in tax rates. You also have to consider the resulting changes in taxable income.

So it’s an empirical question whether a shift in a tax rate will cause revenues to change a little or a lot, just as it’s an empirical issue whether revenues will go up or down.

It depends on how sensitive taxpayers are to changes in tax rates. Some types of taxpayers are very responsive, while other aren’t.

Now let’s consider two implications.

First, you presumably shouldn’t want to be at the revenue-maximizing point of the Laffer Curve. Unless, of course, you think giving politicians an extra $1 to spend is worth destroying $5 or $10 of income for households.

Second, you definitely don’t want to be on the revenue-losing side of the Laffer Curve. That means households are losing so much income that politicians actually have less money to spend, a lose-lose scenario.

Politicians, though, often can’t resist the temptation to raise tax burdens all the way to the short-run revenue-maximizing point.

Many of them simply don’t care if the private economy suffers several dollars of lost output per dollar of additional tax revenue. All that matters is that they have the ability to buy more votes with other people’s money.

But what’s really amazing is that some of them are so short-sighted and greedy that they raise the tax burden by so much that revenues actually fall.

And that’s what is happening in New York, where the tax burden on cigarettes has become so high that tax revenues are falling. Here are some excerpts from a story in the Syracuse newspaper.

The number of state-taxed cigarette packs sold in New York has plummeted by 54 percent in the past decade. …more smokers are buying cigarettes in ways that avoid New York’s $4.35 per pack tax, the highest in the nation. They cross state lines, shop from black market vendors and travel to Native American outlets to save $6 per pack or more, experts say. New York is losing big. In the past five years, the state’s cigarette tax collections have dropped by about $400 million…off-the-tax-grid shopping options add up to as much as $1.3 billion in uncollected state cigarette taxes each year, according to a study by the National Academies of Sciences, Engineering, and Medicine.

It’s not just happening in New York.

I’ve already written about massive Laffer Curve effects from excessive tobacco taxation in Michigan, Ireland, Bulgaria, and Quebec, and Washington.

And the article notes that Oklahoma’s non-compliance rate is even higher.

About 35 percent of smokers in Oklahoma buy cigarettes in ways that avoid state taxes, compared with about one-third of smokers in New York who do the same, experts said.

Needless to say, politicians hate it when the sheep don’t willingly line up to be fleeced. So they’re trying to change policy in ways that divert more money into their greedy hands.

That’s the bad news. The good news is that they’re not very successful.

a federal court in 2011 ruled in the state’s favor and paved the way for Gov. Andrew Cuomo to try to collect the state tax from Native American nations by making their wholesalers pick up the cost. Instead, many nations abandoned the wholesale route and stopped selling name-brand cigarettes. They began stocking their stores with significantly cheaper ones made by Indian-owned manufacturers, experts said, like Seneca-brand cigarettes.

And even when policy changes are “successful,” that doesn’t necessarily translate into more loot that politicians can use to buy votes.

When taxes become extortion, people will evade when they can’t avoid.

…the illegal trade of cigarettes has grown, especially in New York City where smokers are supposed to pay an extra $1.50 per pack on top of the state tax. A recent study by New York University estimated as many as 15 percent of New York City cigarettes sales avoided the state tax.

The Germans call it Schadenfreude when you take pleasure from another person’s misfortune. Normally, I would think people who feel this way have a character flaw.

But not in this case. I confess that get a certain joy from this story because politicians are being punished for their greed. I like the fact that they have less money to waste.

We can call it the revenge of the Laffer Curve!

P.S. Years ago, the JCT actually estimated that a 100 percent tax rate would generate more tax revenue. I realize it’s only a small sign of progress, but I don’t think the bureaucrats would make that assertion today.

P.P.S. Here’s my as-yet-unheeded Laffer Curve lesson for President Obama, based on the fact that rich taxpayers paid five times as much tax after Reagan reduced the top tax rate from 70 percent to 28 percent.

P.P.P.S. And here’s something that’s downright depressing. Some leftists are so resentful of successful people that they want higher tax rates even if the result is less revenue. And you’ll notice at the 4:20 mark of this video that President Obama is one of those people.

P.P.P.P.S. Speaking of leftists, here’s my response when one of them argued against the Laffer Curve.

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Since I’m a big fan of the Laffer Curve, I’m always interested in real-world examples showing good results when governments reduce marginal tax rates on productive activity.

Heck, I’m equally interested in real-world results when governments do the wrong thing and increase tax burdens on work, saving, investment, and entrepreneurship (and, sadly, these examples are more common).

My goal, to be sure, isn’t to maximize revenue for politicians. Instead, I prefer the growth-maximizing point on the Laffer Curve.

In any event, my modest hope is that politicians will learn that higher tax rates lead to less taxable income. Whether taxable income falls by a lot or a little obviously depends on the specific circumstance. But in either case, I want policy makers to understand that there are negative economic effects.

Writing for Forbes, Jeremy Scott of Tax Notes analyzes the supply-side policies of Israel’s Benjamin Netanyahu.

Netanyahu…argued that the Laffer curve worked, and that his 2003 tax cuts had transformed Israel into a market economy and an engine of growth. …He pushed through controversial reforms… The top individual tax rate was cut from 64 percent to 44 percent, while corporate taxes were slashed from 36 percent to 18 percent. …Netanyahu credits these reforms for making Israel’s high-tech boom of the last few years possible. …tax receipts did rise after Netanyahu’s tax cuts. In fact, they were sharply higher in 2007 than in 2003, before falling for several years because of the global recession. …His tax cuts did pay for themselves. And he has transformed Israel into more of a market economy…In fact, the prime minister recently announced plans for more cuts to taxes, this time to the VAT and corporate levies.

Pretty impressive.

Though I have to say that rising revenues doesn’t necessarily mean that the tax cuts were completely self-financing. To answer that question, you have to know what would have happened in the absence of the tax cut. And since that information never will be available, all we can do is speculate.

That being said, I have no doubt there was a strong Laffer Curve response in Israel. Simply stated, dropping the top tax rate on personal income by 20 percentage points creates a much more conducive environment for investment and entrepreneurship.

And cutting the corporate tax rate in half is also a sure-fire recipe for improved investment and job creation.

I’m also impressed that there’s been some progress on the spending side of the fiscal ledger.

Netanyahu explained that the public sector had become a fat man resting on a thin man’s back. If Israel were to be successful, it would have to reverse the roles. The private sector would need to become the fat man, something that would be possible only with tax cuts and a trimming of public spending. …Government spending was capped for three years.

The article doesn’t specify the years during which spending was capped, but the IMF data shows a de facto spending freeze between 2002 and 2005. And the same data, along with OECD data, shows that the burden of government spending has dropped by about 10 percentage points of GDP since that period of spending restraint early last decade.

Here’s the big picture from the Fraser Institute’s Economic Freedom of the World. As you can see from the data on Israel, the nation moved dramatically in the right direction after 1980. And there’s also been an upward bump in recent years.

Since I’m not an expert on Israeli economic policy, I don’t know the degree to which Netanyahu deserves a lot of credit or a little credit, but it’s good to see a country actually moving in the right direction.

Let’s close by touching on two other points. First, there was one passage in the Forbes column that rubbed me the wrong way. Mr. Scott claimed that Netanyahu’s tax cuts worked and Reagan’s didn’t.

Netanyahu might have succeeded where President Reagan failed.

I think this is completely wrong. While it’s possible that the tax cuts in Israel has a bigger Laffer-Curve effect than the tax cuts in the United States, the IRS data clearly shows that Reagan’s lower tax rates led to more revenue from the rich.

Second, the U.S. phased out economic aid to Israel last decade. I suspect that step helped encourage better economic policy since Israeli policy makers knew that American taxpayers no longer would subsidize statism. Maybe, just maybe, there’s a lesson there for other nations?

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During last night’s Democratic debate, Senator Bernie Sanders said he would not raise tax rates as high as they were in the 1950s. And if Twitter data is accurate, his comment about being “not that much of a socialist compared to [President] Eisenhower” was one of the evening’s most memorable moments.

But a clever line is not the same as smart policy. Promising not to raise top tax rates to 90 percent or above is hardly a sign of moderation from the Vermont politician.

Fortunately, not all Democrats are infatuated with punitive tax rates.

Or at least they didn’t used to be. When President John F. Kennedy took office, he understood that the Eisenhower tax rates (in fairness to Ike, he’s merely guilty of not trying to reduce confiscatory tax rates imposed by FDR) were harming the economy and JFK argued for across-the-board tax rate reductions.

…an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profits. Surely the lesson of the last decade is that budget deficits are not caused by wild-eyed spenders but by slow economic growth and periodic recessions and any new recession would break all deficit records. In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.

Here’s a video featuring some of President Kennedy’s wisdom on lower tax rates.

If that wasn’t enough, here’s another video featuring JFK’s wisdom on taxation.

By the way, if Senator Sanders really wants the rich to pay more, one of the lessons reasonable people learned from the Kennedy tax cuts is that upper-income taxpayers respond to lower tax rates by earning and reporting more income. Here’s a chart from a study I wrote almost 20 years ago.

Last but not least, let’s preemptively address a likely argument from Senator Sanders. He might be tempted to say that he doesn’t want the 90-percent tax rate of the Eisenhower years, but that he’s perfectly content with the 70-percent top tax rate that existed after the Kennedy tax cuts.

But if that’s the case, instead of teaching Sanders a lesson from JFK, then he needs to learn a lesson from Ronald Reagan.

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More than two years ago, I cited some solid research from the Tax Foundation to debunk some misguided analysis from the New York Times about the taxation of multinational companies.

Well, it’s déjà vu all over again, as the late Yogi Berra might say. That’s because we once again find something in the New York Times that cries out for correction.

Here’s some of what Patricia Cohen recently wrote about ostensibly generating lots of tax revenue by pillaging America’s top-1 percent taxpayers.

…what could a tax-the-rich plan actually achieve? As it turns out, quite a lot…the government could raise large amounts of revenue exclusively from this small group, while still allowing them to take home a majority of their income.

Oh, how generous of her for deciding that the awful, evil rich people can keep perhaps keep 50.1 percent of what they earn. Sounds like she should join the other cranks advising Jeremy Corbyn in the United Kingdom.

But I’m getting distracted. Let’s focus on the more important topic, which is her claim that it’s easy to generate a lot of tax revenue by soaking the rich.

The top 1 percent on average already pay roughly a third of their incomes to the federal government, according to a Treasury Department analysishow much more revenue could be generated by asking the rich to pay a larger share of their income in taxes?

Interestingly, Ms. Cohen shares some data showing that the rich already are paying far higher tax rates than the rest of us. Here’s the table that accompanied her article.

Normal people would look at those numbers, or at similar data produced by the IRS, and conclude that we’re already selectively over-penalizing upper-income taxpayers.

But statists see income in the private sector as belonging to the state, so there’s no such thing as too much money for government.

And Ms. Cohen seems to have this attitude. She engages in some simplistic calculations to estimate how much loot could be seized.

Raising their total tax burden to, say, 40 percent would generate about $157 billion in revenue the first year. Increasing it to 45 percent brings in a whopping $276 billion. Move a rung down the ladder and expand the contribution of those in the 95th to 99th percentile — who earn on average $405,000. Raising their total tax rate to 30 percent from a quarter of their total yearly income would generate an additional $86 billion. …A 35 percent share produces $176 billion.

Gee, how easy, at least on paper. If the politicians can figure out how to raise average tax rates to 45 percent for the rich (and 35 percent for the upper-middle class), then they get about $450 billion of additional tax revenue every year.

And you can buy a lot of votes with that much of other people’s money.

But sometimes things that are simple on paper are not so simple in reality.

It turns out that raising someone’s average tax rate (total tax payments/total income) requires some very big (and very bad) decisions on marginal tax rates (tax paid on the last dollar of income/last dollar of income).

Scott Greenberg of the Tax Foundation does that heavy lifting and his analysis makes mincemeat out of Ms. Cohen’s argument.

…how exactly would Congress go about raising the effective tax rate of the 1% from 33.4 percent to 45 percent? The article is not specific about this point. In fact, the article acknowledges that it is “sidestepping… the messy question of just which taxes would be increased.” This is irresponsible policy analysis… When one examines exactly which taxes would have to be increased to raise the effective tax rate of the 1% from 33.4 percent to 45 percent, the endeavor begins to appear much more difficult than the New York Times portrays.

For instance.

…the top tax bracket on ordinary income is 39.6%. How high would Congress have to raise this rate, in order to raise the effective tax rate of the 1% to 45 percent? According to our estimates, Congress would have to raise the top rate on ordinary income to 74 percent, in order to raise the effective rate of the 1% from 33.4 percent to 45 percent.What if Congress decided to increase, not only the top rate on ordinary income, but also the top rate on capital gains and dividends? …According to our estimates, Congress would have to raise the top rate on ordinary income, capital gains, and dividends to 56 percent, in order to increase the effective rate of the 1% to 45 percent.

In other words, if you target the rich with higher income tax rates, you’d have to have a rate higher than the confiscatory structure that existed before any of the Reagan tax cuts.

Or you could boost the top rate “only” to 56 percent, but only by also dramatically increasing the double taxation of dividends and capital gains.

And that might not be very smart, at least if you care about economic performance. Scott explains.

The high rates that would need to be in place to tax the 1% at a 45 percent effective rate would almost certainly have negative economic consequences. According to our Taxes and Growth model, raising the top rate on ordinary income to 74 percent would shrink the size of the U.S. economy by 3.5 percent in the long run, by discouraging labor and pass-through business. While this tax increase would raise $3.49 trillion over 10 years under conventional scoring, after taking its economic effects into account, it would only raise $2.37 trillion. This is a significantly smaller figure than that cited by the New York Times. Furthermore, raising the top rate on ordinary income, capital gains, and dividends to 56 percent would lead to an even larger decline in GDP, of 4.9 percent. This is because taxes on investment income are especially harmful to long-term economic growth. After taking economic effects into account, this proposal would only raise $1.96 trillion over 10 years.

So the politicians would still have some extra revenue, but they would destroy several dollars of private economic activity for every one dollar of revenue they would collect.

In what world would that be a good trade?

Oh, and by the way, those revenue estimates overstate how much money the politicians would collect. In the real world, higher tax rates also would increase tax avoidance and tax evasion.

…none of these figures take into account the effects of increased tax evasion and profit shifting by wealthy Americans that would surely occur in response to such high rates. After all, when taxes rise, taxpayers have more incentives to avoid them. And it is well-documented that, when rates on capital gains rise, shareholders simply defer their realizations, making it difficult to raise much revenue from tax increases on capital gains income.

So here’s the bottom line.

…the New York Times claims that the federal government could raise large amounts of revenue by taxing the rich just a little bit more. In fact, taxes on the rich would have to go up enormously in order to bring in the sorts of revenue figures cited by the article. The negative economic effects of these tax increases would then reduce these revenues considerably.

I’d like to think Scott’s analysis will change minds and cause statists to reassess their desire to impose high tax rates.

But I’m not overly hopeful. Let’s not forget that some of these people aren’t particularly interested in generating more revenue for politicians. Their real motive is hate and envy.

P.S. Let’s hope American statists never learn about Francois Hollande’s flat tax.

P.P.S. Speaking of which, here are some amusing cartoons about class-warfare tax policy.

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I have a very mixed view of the Committee for a Responsible Federal Budget, which is an organization representing self-styled deficit hawks in Washington.

They do careful work and I always feel confident about citing their numbers.

Yet I frequently get frustrated because they seem to think that tax increases have to be part of any budget deal, regardless of the evidence that such an approach will backfire.

So when CRFB published a “Fiscal FactChecker” to debunk 16 supposed budget myths that they expect during this campaign season, I knew I’d find lots of stuff I would like…and lots of stuff I wouldn’t like.

Let’s look at what they said were myths, along with my two cents on CRFB’s analysis.

Myth #1: We Can Continue Borrowing without Consequences

Reality check: CRFB’s view is largely correct. If we leave policy on autopilot, demographic changes and poorly structured entitlement programs  will lead to an ever-rising burden of government spending, which almost surely will mean ever-rising levels of government debt (as well as ever-rising tax burdens). At some point, this will lead to serious consequences, presumably bad monetary policy (i.e., printing money to finance the budget) and/or Greek-style crisis (investors no longer buying bonds because they don’t trust the government will pay them back).

The only reason I don’t fully agree with CRFB is that we could permanently borrow without consequence if the debt grew 1 percent per year while the economy grew 3 percent per year. Unfortunately, given the “new normal” of weak growth, that’s not a realistic scenario.

Myth #2: With Deficits Falling, Our Debt Problems are Behind Us

Reality check: The folks at CRFB are right. Annual deficits have dropped to about $500 billion after peaking above $1 trillion during Obama’s first term, but that’s just the calm before the storm. As already noted, demographics and entitlements are a baked-into-the-cake recipe for a bigger burden of government and more red ink.

That being said, I think that CRFB’s focus is misplaced. They fixate on debt, which is the symptom, when they should be more concerned with reducing excessive government, which is the underlying disease.

Myth #3: There is No Harm in Waiting to Solve Our Debt Problems

Reality check: We have a spending problem. Deficits and debt are merely symptoms of that problem. But other than this chronic mistake, CRFB is right that it is far better to address our fiscal challenges sooner rather than later.

CRFB offers some good analysis of why it’s easier to solve the problem by acting quickly, but this isn’t just about math. Welfare State Wagon CartoonsIt’s also important to impose some sort of spending restraint before a majority of the voting-age population has been lured into some form of government dependency. Once you get to the point when more people are riding in the wagon than pulling the wagon (think Greece), reform becomes almost impossible.

Myth #4: Deficit Reduction is Code for Austerity, Which Will Harm the Economy

Reality check: The folks at CRFB list this as a myth, but they actually agree with the assertion, stating that deficit reduction policies “have damaged economic performance and increased unemployment.” They even seem sympathetic to “modest increases to near-term deficits by replacing short-term ‘sequester’ cuts”, which would gut this century’s biggest victory for good fiscal policy!

There are two reasons for CRFB’s confusion. First, they seem to accept the Keynesian argument about bigger government and red ink boosting growth, notwithstanding all the evidence to the contrary. Second, they fail to distinguish between good austerity and bad austerity. If austerity means higher taxes, as has been the case so often in Europe, then it is unambiguously bad for growth. But if it means spending restraint (or even actual spending cuts), then it is clearly good for growth. There may be some short-term disruption since resources don’t instantaneously get reallocated, but the long-term benefits are enormous because labor and capital are used more productively in the private economy.

Myth #5: Tax Cuts Pay For Themselves

Reality check: I agree with the folks at CRFB. As a general rule, tax cuts will reduce government revenue, even after measuring possible pro-growth effects that lead to higher levels of taxable income.

But it’s also important to recognize that not all tax cuts are created equal. Some tax cuts have very large “supply-side” effects, particularly once the economy has a chance to adjust in response to better policy. So a lower capital gains tax or a repeal of the death tax, to cite a couple of examples, might increase revenue in the long run. And we definitely saw a huge response when Reagan lowered top tax rates in the 1980s. But other tax cuts, such as expanded child credits, presumably generate almost no pro-growth effects because there’s no change in the relative price of productive behavior.

Myth #6: We Can Fix the Debt Solely by Taxing the Top 1%

Reality check: The CRFB report correctly points out that confiscatory tax rates on upper-income taxpayers would backfire for the simple reason that rich people would simply choose to earn and report less income. And they didn’t even include the indirect economic damage (and reductions in taxable income) caused by less saving, investment, and entrepreneurship.

Ironically, the CRFB folks seem to recognize that tax rates beyond a certain level would result in less revenue for government. Which implies, of course, that it is possible (notwithstanding what they said in Myth #5) for some tax cuts to pay for themselves.

Myth #7: We Can Lower Tax Rates by Closing a Few Egregious Loopholes

Reality check: It depends on the definition of “egregious.” In the CRFB report, they equate “egregious” with “unpopular” in order to justify their argument.

But if we define “egregious” to mean “economically foolish and misguided,” then there are lots of preferences in the tax code that could – and should – be abolished in order to finance much lower tax rates. Including the healthcare exclusion, the mortgage interest deduction, the charitable giving deduction, and (especially) the deduction for state and local taxes.

Myth #8: Any Tax Increases Will Cripple Economic Growth

Reality check: The CRFB folks are right. A small tax increase obviously won’t “cripple” economic growth. Indeed, it’s even possible that a tax increase might lead to more growth if it was combined with pro-growth policies in other areas. Heck, that’s exactly what happened during the Clinton years. But now let’s inject some reality into the conversation. Any non-trivial tax increase on productive behavior will have some negative impact on economic performance and competitiveness. The evidence is overwhelming that higher tax rates hurt growth and the evidence is also overwhelming that more double taxation will harm the economy.

The CRFB report suggests that the harm of tax hikes could be offset by the supposed pro-growth impact of a lower budget deficit, but the evidence for that proposition if very shaky. Moreover, there’s a substantial amount of real-world data showing that tax increases worsen fiscal balance. Simply stated, tax hikes don’t augment spending restraint, they undermine spending restraint. Which may be why the only “bipartisan” budget deal that actually led to a balanced budget was the one that lowered taxes instead of raising them.

Myth #9: Medicare and Social Security Are Earned Benefits and Should Not Be Touched

Reality check: CRFB is completely correct on this one. The theory of age-related “social insurance” programs such as Medicare and Social Security is that people pay into the programs while young and then get benefits when they are old. This is why they are called “earned benefits.”

The problem is that politicians don’t like asking people to pay and they do like giving people benefits, so the programs are poorly designed. The average Medicare recipient, for instance, costs taxpayers $3 for every $1 that recipient paid into the program. Social Security isn’t that lopsided, but the program desperately needs reform because of demographic change. But the reforms shouldn’t be driven solely by budget considerations, which could lead to trapping people in poorly designed entitlement schemes. We need genuine structural reform.

Myth #10: Repealing “Obamacare” Will Fix the Debt

Reality check: Obamacare is a very costly piece of legislation that increased the burden of government spending and made the tax system more onerous. Repealing the law would dramatically improve fiscal policy.

But CRFB, because of the aforementioned misplaced fixation on red ink, doesn’t have a big problem with Obamacare because the increase in taxes and the increase in spending are roughly equivalent. So the organization is technically correct that repealing the law won’t “fix the debt.” But it would help address America’s real fiscal problem, which is a bloated and costly public sector.

Myth #11: The Health Care Cost Problem is Solved

Reality check: CRFB’s analysis is correct, though it would have been nice to see some discussion of how third-party payer is the problem.

Myth #12: Social Security’s Shortfall Can be Closed Simply by Raising Taxes on or Means-Testing Benefits for the Wealthy

Reality check: To their credit, CRFB is basically arguing against President Obama’s scheme to impose Social Security payroll taxes on all labor income, which would turn the program from a social-insurance system into a pure income-redistribution scheme.

On paper, such a system actually could eliminate the vast majority of Social Security’s giant unfunded liability. In reality, this would mean a huge increase in marginal tax rates on investors, entrepreneurs, and small business owners, which would have a serious adverse economic impact.

Myth #13: We Can Solve Our Debt Situation by Cutting Waste, Fraud, Abuse, Earmarks, and/or Foreign Aid

Reality check: Earmarks (which have been substantially curtailed already) and foreign aid are a relatively small share of the budget, so CRFB is right that getting rid of that spending won’t have a big impact. But what about the larger question. Could our fiscal mess (which is a spending problem, not a “debt situation”) be fixed by eliminating waste, fraud, and abuse?

It depends on how one defines “waste, fraud, and abuse.” If one uses a very narrow definition, such as technical malfeasance, then waste, fraud, and abuse might “only” amount to a couple of hundred billions dollars per year. But from an economic perspective (i.e., grossly inefficient misallocation of resources), then entire federal departments such as HUD, Education, Transportation, Agriculture, etc, should be classified as waste, fraud, and abuse.

Myth #14: We Can Grow Our Way Out of Debt

Reality check: CRFB is correct that faster growth won’t solve all of our fiscal problems. Unless one makes an untenable assumption that economic growth will be faster than the projected growth of entitlement spending. And even that kind of heroic assumption would be untenable since faster growth generally obligates the government to pay higher benefits in the future.

Myth #15: A Balanced Budget Amendment is All We Need to Fix the Debt

Reality check: CRFB accurately explains that a BBA is simply an obstacle to additional debt. Politicians still would be obliged to change laws to fulfill that requirement. But that analysis misses the point. A BBA focuses on red ink, whereas the real problem is that government is too big and growing too fast. State balanced-budget requirement haven’t stopped states like California and Illinois from serious fiscal imbalances and eroding competitiveness. The so-called Maastricht anti-deficit and anti-debt rules in the European Union haven’t stopped nations such as France and Greece from fiscal chaos.

This is why the real solution is to have some sort of enforceable cap on government spending. That approach has worked well in jurisdictions such as Switzerland, Hong Kong, and Colorado. And even research from the IMF (a bureaucracy that shares CRFB’s misplaced fixation on debt) has concluded that expenditure limits are the only effective fiscal rules.

Myth #16: We Can Fix the Debt Solely by Cutting Welfare Spending

Reality check: The federal government is spending about $1 trillion this year on means-tested (i.e., anti-poverty) programs, which is about one-fourth of total outlays, so getting Washington out of the business of income redistribution would substantially lower the burden of federal spending (somewhat offset, to be sure, by increases in state and local spending). And for those who fixate on red ink, that would turn today’s $500 billion deficit into a $500 billion surplus.

That being said, there would still be a big long-run problem caused by other federal programs, most notably Social Security and Medicare. So CRFB is correct in that dealing with welfare-related spending doesn’t fully solve the long-run problem, regardless of whether you focus on the problem of spending or the symptom of borrowing.

This has been a lengthy post, so let’s have a very simple summary.

We know that modest spending restraint can quickly balance the budget.

We also know lots of nations that have made rapid progress with modest amounts of spending restraint.

And we know that the tax-hike option simply leads to more spending.

So the only question to answer is why the CRFB crowd can’t put two and two together and get four?

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Every so often, I’ll assert that some statists are so consumed by envy and spite that they favor high tax rates on the “rich” even if the net effect (because of diminished economic output) is less revenue for government.

In other words, they deliberately and openly want to be on the right side (which is definitely the wrong side) of the Laffer Curve.

Critics sometimes accuse me of misrepresenting the left’s ideology, to which I respond by pointing to a poll of left-wing voters who strongly favored soak-the-rich tax hikes even if there was no extra tax collected.

But now I have an even better example.

Writing for Vox, Matthew Yglesias openly argues that we should be on the downward-sloping portion of the Laffer Curve. Just in case you think I’m exaggerating, “the case for confiscatory taxation” is part of the title for his article.

Here’s some of what he wrote.

Maybe at least some taxes should be really high. Maybe even really really high. So high as to useless for revenue-raising purposes — but powerful for achieving other ends. We already accept this principle for tobacco taxes. If all we wanted to do was raise revenue, we might want to slightly cut cigarette taxes. …But we don’t do that because we care about public health. We tax tobacco not to make money but to discourage smoking.

The tobacco tax analogy is very appropriate.

Indeed, one of my favorite arguments is to point out that we have high taxes on cigarettes precisely because politicians want to discourage smoking.

As a good libertarian, I then point out that government shouldn’t be trying to control our private lives, but my bigger point is that the economic arguments about taxes and smoking are the same as those involving taxes on work, saving, investment.

Needless to say, I want people to understand that high tax rates are a penalty, and it’s particularly foolish to impose penalties on productive behavior.

But not according to Matt. He specifically argues for ultra-high tax rates as a “deterrence” to high levels of income.

If we take seriously the idea that endlessly growing inequality can have a cancerous effect on our democracy, we should consider it for top incomes as well. …apply the same principle of taxation-as-deterrence to very high levels of income. …Imagine a world in which we…imposed a 90 percent marginal tax rate on salaries above $10 million. This seems unlikely to raise substantial amounts of revenue.

I suppose we should give him credit for admitting that high tax rates won’t generate revenue. Which means he’s more honest than some of his fellow statists who want us to believe confiscatory tax rates will produce more money.

But honesty isn’t the same as wisdom.

Let’s look at the economic consequences. Yglesias does admit that there might be some behavioral effects because upper-income taxpayers will be discouraged from earning and reporting income.

Maybe…we really would see a reduction of effort, or at least a relaxation of the intensity with which the performers pursue money. But would that be so bad? Imagine the very best hedge fund managers and law firm partners became inclined to quit the field a bit sooner and devote their time to hobbies. What would we lose, as a society? …some would presumably just move to Switzerland or the Cayman Islands to avoid taxes. That would be a real hit to local economies, but hardly a disaster. …Very high taxation of labor income would mean fewer huge compensation packages, not more revenue. Precisely as Laffer pointed out decades ago, imposing a 90 percent tax rate on something is not really a way to tax it at all — it’s a way to make sure it doesn’t happen.

While I suppose it’s good that Yglesias admits that high tax rates have behavioral effects, he clearly underestimates the damaging impact of such a policy.

He presumably doesn’t understand that rich people earn very large shares of their income from business and investment sources. As such, they have considerable ability to alter the timing, level, and composition of their earnings.

But my biggest problem with Yglesias’ proposals is that he seems to believe in the fixed-pie fallacy that public policy doesn’t have any meaningful impact of economic performance. This leads him to conclude that it’s okay to rape and pillage the “rich” since that will simply mean more income and wealth is available for the rest of us.

That’s utter nonsense. The economy is not a fixed pie and there is overwhelming evidence that nations with better policy grow faster and create more prosperity.

In other words, confiscatory taxation will have a negative effect on everyone, not just upper-income taxpayers.

There will be less saving and investment, which translates into lower wages and salaries for ordinary workers.

And as we saw in France, high tax rates drive out highly productive people, and we have good evidence that “super-entrepreneurs” and inventors are quite sensitive to tax policy.

To be fair, I imagine that Yglesias would try to argue that these negative effects are somehow offset by benefits that somehow materialize when there’s more equality of income.

But the only study I’ve seen that tries to make a connection between growth and equality was from the OECD and that report was justly ridiculed for horrible methodology (not to mention that it’s hard to take serious a study that lists France, Spain, and Ireland as success stories).

P.S. This is my favorite bit of real-world evidence showing why there should be low tax rates on the rich (in addition, of course, to low tax rates on the rest of us).

P.P.S. And don’t forget that leftists generally view higher taxes on the rich as a precursor to higher taxes on the rest of the population.

P.P.P.S. In the interests of full disclosure, Yglesias says I’m insane and irrational.

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What’s the Laffer Curve?

It’s the simple, common-sense observation that there’s not a linear relationship between tax rates and tax revenue.

Folks in the private sector understand this principle. No restaurant owner, for instance, would double meal prices and assume that revenues would climb by 100 percent.

Yet that’s basically the methodology used by the Joint Committee on Taxation when estimating the revenue impact of changes in tax rates.

Which helps to explain why Washington is so often wrong about revenue implications of personal tax rates and corporate tax rates.

The Laffer Curve also applies to tobacco taxation.

Patrick Gleason of Americans for Tax Reform points out in the Wall Street Journal that greedy politicians in New York have pushed cigarette taxes so high that the main beneficiaries are smugglers.

Rampant cigarette smuggling isn’t the problem in New York. It’s a symptom of the problem: sky high tobacco taxes. …New York state levies the highest cigarette tax in the nation, $4.35 per pack, and New York City tacks on an additional $1.50 local tax. All told, the cost of one pack there can run to $12 or more. …The result? Most of the cigarettes smoked in New York, 58%, are smuggled in from out of state… The higher that revenue-hungry politicians raise tobacco taxes, the more profit smugglers can make.

Which means, of course, that the higher tax rates don’t lead to more tax revenue.

…revenue from increases in cigarette taxes often falls short of expectations. Washington, D.C., experienced this firsthand after cigarette taxes were raised by 25%, to $2.50 per pack from $2, in October 2009. City leaders claimed the hike would generate a windfall of additional revenue. By February of 2010, D.C.’s chief financial officer reported that projections were off by $15 million. Revenue from the cigarette tax actually fell by $7 million after the hike. New Jersey should have learned the same lesson. In 2007 the Garden State raised cigarette taxes to $2.575, from $2.40. The new tax generated $52 million less than expected, and revenue from cigarette taxes fell by $22 million. But in 2009 New Jersey raised the tax by another 17.5 cents.

By the way, don’t believe the fall-back excuse that politicians don’t care about revenue because they’re motivated by public health concerns.

Lawmakers can claim they’re raising taxes on cigarettes to reduce smoking and improve public health. That talking point is belied by the recent imposition of taxes on electronic cigarettes, which are saving lives by delivering nicotine in puffs of water vapor instead of chemical-filled smoke. There are more than 15 tax bills pending across the country for currently untaxed e-cigarettes. Hawaii is proposing a tax of 80%, New York of 75%, Oregon of 65% and Ohio of 60%. For politicians, cigarette taxes are—and have always been—about one thing: money.

One last thing. Gleason reports that New York is suing UPS because the company ships cigarettes to New York customers.

New York state and New York City in February announced a $180 million lawsuit against the shipping company UPS over what officials allege was unlawful delivery of nearly 700,000 cartons of cigarettes from 2010-14. …New York state officials claim that the cigarette smuggling via UPS cost the treasury $29.7 million in lost tax revenue. That’s less than 0.03% of the state budget. The $4.7 million allegedly lost by New York City represents less than 0.006% of its budget. For a mere rounding error, state and city officials want to grab $180 million from UPS. That’s $180 million UPS could use to hire new workers, give employees raises, or invest back into its business. The leaders of New York and New York City should drop this silly lawsuit and find a more productive use of their time.

They shouldn’t merely drop the lawsuit. They should be condemned for engaging in a thuggish shakedown.

Returning to the main topic, here’s a video from the Center for Freedom and Prosperity that reviews real-world examples of the Laffer Curve.

P.S. If local officials are greedy, state officials are ever greedier, and federal officials are greediest, then you can imagine how awful it would be to let international officials impose tobacco taxes.

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With tax day looming, let’s wallow in misery by contemplating the burden on America’s taxpayers.

But we’ll ignore the angst caused be dealing with an indecipherable tax code and an oppressive IRS and simply focus on the amount of money that gets extracted from our income each year.

The bad news is that the federal government is collecting a record amount of money, even after adjusting for inflation. Here’s a chart, based on the latest numbers from the Office of Management and Budget.

But there is some good news. This isn’t a record tax burden when measured as a share of economic output.

Federal taxes are projected to consume 17.7 percent of GDP this year. That’s higher than the post-WWII average of 17.2 percent of GDP, but there have been several years in which the federal tax burden has been higher than 17.7 percent, most recently in 2007, when it reached 17.9 percent of economic output.

So while it’s bad news that the IRS is collecting a record amount of revenue in inflation-adjusted dollars, I guess we should consider ourselves lucky that it’s not a record share of GDP.

I discuss the growing federal tax burden in this CNBC debate with Jared Bernstein.

A few points are worth emphasizing from the interview, two of which deal with corporate taxation.

First, it’s silly to talk to compare “taxes by individuals” to “taxes paid by corporations.” That’s because all taxes on business ultimately are paid by individuals, whether as workers, consumers, or shareholders. To be blunt, corporations may collect taxes, but the burden inevitably falls on people.

Second, the fact that corporate tax receipts are lagging is a sign that tax rates are too high rather than too low. In other words, there’s a Laffer Curve effect, and there’s lots of evidence that a lower corporate rate will generate more revenue. Which is precisely what happened when personal tax rates were reduced on the “rich” in the 1980s.

Third, if we want a balanced budget, the only responsible approach is spending restraint. As I’ve noted before, our long-run fiscal challenge is because of a rising burden of spending. Indeed, spending is more than 100 percent of the long-run problem.

By the way, let’s not forget about the role of state and local governments. WalletHub just released a report on state and local tax burdens.

Here are the 10 best states.

I’m mystified to see California in the top 10.

Though maybe this is a Laffer Curve-based result. In other words, perhaps taxes are so high that people are paying less?

Moreover, the Golden State drops to 30 if you adjust for the cost of living (see column on far right).

Now here are the 10 worst states.

I’m not surprised to see Illinois in last place, but who knew that Nebraska was a hotbed of taxaholism?

And if you look at the right-most column, you’ll see that New York and Connecticut could be considered the worst states. Both jurisdictions are richly deserving of that designation.

P.S. Don’t forget that Puerto Rico is a secret tax haven for American citizens, particularly when considering federal taxes, so it deserves honorary first place recognition.

P.P.S. The best (i.e., least worst or least destructive) approach to taxation is the flat tax.

P.P.P.S. Though the ideal scenario is to have a very small federal government so that there’s no need for any broad-based tax whatsoever. Our nation enjoyed strong growth before that dark day in 1913 when the income tax was imposed.

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A few days ago, I cited some research by an economics professor at the University of Georgia (Go Dawgs!), who calculated that we would have a big budget surplus today if Washington lawmakers had simply maintained Bill Clinton’s final budget, adjusting it only for inflation plus population growth.

My purpose was to show that some sort of long-run spending cap (such as limiting outlays so they can’t grow faster than population plus inflation) is the best way of achieving good fiscal outcomes.

And I cited similar hypothetical examples when writing about fiscal policy in Canada and also when sharing some good analysis from Investor’s Business Daily.

I think these examples are persuasive, but some people aren’t overly impressed by arguments that aren’t based on real-world evidence. So I also make sure to show how good things happen in those rare instances that politicians can be convinced to restrain spending.

A review of data for 16 nations reveals that multi-year periods of spending restraint lead to lower fiscal burdens and less red ink.

Between 2009 and 2014, a de facto spending freeze at the federal level dramatically reduced burden of spending in the United States.

Thanks to a constitutional spending cap, Switzerland has shrunk the public sector, balanced its budget and reduced government debt.

Now we have another real-world example to add to our list.

Check out these excerpts from a New York Times story.

A year after Colorado became the first state to allow recreational marijuana sales, millions of tax dollars are rolling in… But a legal snarl may force the state to hand that money back to marijuana consumers, growers and the public — and lawmakers do not want to.

Hmmm…I can understand lawmakers wanting to hold on to other people’s money, but what is meant by “legal snarl”?

Well, it turns out that this is just a way of describing Colorado’s Taxpayer Bill of Rights (TABOR), which imposes caps on how fast the state’s fiscal burden can increase. The reporter from the New York Times writes that this is a “problem,” but taxpayers obviously have a different perspective.

The problem is a strict anti-spending provision in the state Constitution… Technical tripwires in that voter-approved provision, known as the Taxpayer’s Bill of Rights, may require Colorado to refund nearly $60 million…because it collected more than it had anticipated in taxes last year across the board — including construction, oil and gas and other sections of the state’s booming economy. …The complex measure, first approved by voters in 1992, essentially requires that when Colorado collects more money than it had anticipated, it has to give some back to taxpayers.

In other words, the state is collecting plenty of money in taxes, but the politicians are irked they can’t raise spending beyond what’s allowed by TABOR.

And that irks the pro-spending crowd.

Blame lies with the Taxpayer’s Bill of Rights, said Tim Hoover, a spokesman for the Colorado Fiscal Institute, which tracks budget issues in the state. …“It has its own malevolent programming that is really hard to override,” he said.

I obviously don’t agree with Mr. Hoover’s philosophy, but his quote is very powerful evidence that a well-designed spending cap can be effective.

Which is why I cited Colorado’s TABOR back in 2013 as being the best role model in the United States for those who want to genuinely constrain government.

Heck, even the International Monetary Fund now acknowledges that spending caps are the only effective fiscal policy.

By the way, there’s also a Laffer Curve lesson in this story. Echoing what I wrote earlier this year, marijuana tax revenues have been below estimates because the tax rate is too high.

“It’s not that the pot tax came in too high,” said State Senator Pat Steadman, a Democrat who has been trying to write a law that would provide a solution. “It’s that every other revenue came in high.” …Miguel Lopez, who organizes Denver’s annual 4/20 rally — intended to be a giant feel-good festival — said he was sick of what he called high taxes on recreational marijuana. He said they were hurting small stores and helping to keep the black market alive.

Not that we should be surprised. Politicians routinely over-tax tobacco.

And other so-called sin taxes also get set too high, which is a point I made when commenting about a proposed tax on strip clubs in Florida.

“You get a bigger underground economy with high tax rates, which means less revenue than anticipated, and also openings for organized crime and other bad guys,” he said. “Regarding the proposal, I have to imagine that a $25 cover charge, combined with record-keeping, will kill off most strip clubs, so I don’t think they’ll get much money,” Mitchell said. “Customers, presumably, will gravitate to substitute forms of entertainment.”

In the case of Colorado’s pot tax, the “substitute form of entertainment” is simply buying pot in the underground economy.

So the moral of the story, whether looking at spending caps or tax rates, is that politicians are too greedy for their own good.

P.S. What’s the opposite of a spending cap? There are probably a couple of possible answers, but I would pick Obama’s proposed tax-increase “trigger.” Here’s some of what I wrote about that scheme.

Called a “debt failsafe trigger,” Obama’s scheme would automatically raise taxes if politicians spend too much. …Let’s ponder what this means. If politicians in Washington spend too much and cause more red ink, which happens on a routine basis, Obama wants a provision that automatically would raise taxes on the American people.

Fortunately, this was such an awful idea that even gullible GOPers said no. Now if we can keep Republicans from getting seduced into counterproductive tax-hike budget deals, we may actually make some progress!

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On the issue of so-called progressive taxation, our left-wing friends have conflicting goals. Some of them want to maximize tax revenue in order to finance ever-bigger government.

But others are much more motivated by a desire to punish success. They want high tax rates on the “rich” even if the government collects less revenue.

Some of them simply pretend there isn’t a conflict, as you might imagine. They childishly assert that the Laffer Curve doesn’t exist and that upper-income taxpayers are fiscal pinatas, capable of generating never-ending amounts of tax revenue.

But more rational leftists admit that the Laffer Curve is real. They may argue that the revenue-maximizing rate is up around 70 percent, which is grossly inconsistent with the evidence from the 1980s, but at least they understand that successful taxpayers can and do respond when tax rates increase.

So the question for grown-up leftists is simple: What’s the answer if they have to choose between collecting more revenue and punishing the rich with class-warfare taxation?

And here’s some new research looking at this tradeoff. Authored by economists from the University of Oslo in Norway, École polytechnique de Lausanne in France, and the University of Pennsylvania, they look at “Tax progressivity and the government’s ability to collect additional tax revenue.”

The recent massive expansion of public debt around the world during the Great Recession raises the question how much debt a government can maximally service by raising the level of taxes. Or, to phrase this classic public finance question differently, how much additional tax revenue can the government generate by increasing income taxes?

And since they’re part of the real world (unlike, say, the Joint Committee on Taxation or the Obama Administration), they recognize that higher tax rates impose costs on the economy that lead to feedback effects on tax revenue.

Our research (Holter et al. 2014) investigates how tax progressivity and household heterogeneity impacts the Laffer curve. We argue that a more progressive labour income tax schedule significantly reduces the maximal amount of tax revenues a government can raise…under progressive taxes heterogeneous workers will face different average and marginal tax rates. …the answer to our question is closely connected to the individual (and then properly aggregated) response of labour supply to taxes. The microeconometric literature, as surveyed e.g. by Keane (2011), has found that both the intensive and extensive margins of labour supply (the latter especially for women), life-cycle considerations, and human capital accumulation are important determinants of these individual responses. …households make a consumption–savings choice and decide on whether or not to participate in the labour market (the extensive margin), how many hours to work conditional on participation (the intensive margin), and thus how much labour market experience to accumulate (which in turn partially determines future earnings capacities).

The above passage has a bit of economic jargon, but it’s simply saying that taxpayers respond to incentives.

They also provide estimates of tax progressivity for various developed nations. They’re only looking at the personal income tax, so these numbers don’t include, for instance, the heavy burden of the value-added tax on low-income people in Europe.

The good news (at least relatively speaking) is that the American income tax is not as punitive as it is in many other nations.

But the key thing to consider, at least in the context of this new research, is the degree to which so-called progressivity comes with a high price.

Here is some additional analysis from their research.

Why does the degree of tax progressivity matter for the government’s ability to generate labour income tax revenues…? changes in tax progressivity typically affects hours worked…increasing tax progressivity induces differential income and substitution effects on the workers in different parts of the earnings distribution. …a more progressive tax system may disproportionately reduce labour supply for high earners and lead to a reduction in tax revenue. …more progressive taxes will reduce the incentives for young agents to accumulate labour market experience and become high (and thus more highly taxed) earners.

Now let’s look at some of the results.

Remarkably, they find that the best way of maximizing revenue is to minimize the economic damage of the tax system. And that means…drum roll, please…a flat tax.

For its current choice of progressivity (the green line), the US can sustain a debt burden of about 330% of its benchmark GDP, by increasing the average tax rate to about 42%. Thus, according to our findings the US is currently still nowhere close to its maximally sustainable debt levels…we also observe that larger public debt can be sustained with a less progressive tax system. Converting to a flat tax system (the black line) increases the maximum sustainable debt to more than 350% of benchmark GDP, whereas adopting Danish tax progressivity lowers it to less than 250% of benchmark GDP.

Here are a couple of charts from their study, both of which underscore that punitive tax rates are very counterproductive, assuming the goal is to either maximize revenue or to sustain a larger public sector.

Notice that if you want to punish “the rich” and impose Danish-type levels of progressivity (the dashed line), you’ll get less revenue and won’t be able to sustain as much debt.

Now let’s shift from discussing intellectual quandaries for the left and talk about challenges for believers in limited government.

We like a flat tax because it treats people equally and it raises revenue in a relatively non-destructive manner.

But because it is an “efficient” form of taxation, it’s also an “efficient” way to generate revenues to finance bigger government.

Indeed, this was one of the findings in a 1998 study by Professors Gary Becker and Casey Mulligan.

So does this mean that instead of supporting a flat tax, we should a loophole-riddled system based on high tax rates solely because that system will be so inefficient that it won’t generate revenue?

Of course not. At the risk of stating the obvious, this is why my work on fundamental tax reform is intertwined with my work on constitutional and legal mechanisms to limit the size and scope of government.

And it’s also why Obama’s class-warfare approach is so perversely destructive. If you think I’m exaggerating, watch this video – especially beginning about the 4:30 mark.

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Regular readers know that I don’t approve of drug use, but that I also favor legalization because the Drug War has been a costly and ineffective failure.

(And it’s led to horrible policies such as intrusive money-laundering laws and Orwellian asset-forfeiture laws).

So I was happy when folks in Colorado voted to decriminalize marijuana use, even if part of me didn’t like the idea that politicians would gain a new source of tax revenue.

If nothing else, what’s happening in Colorado (and Washington state) will be an interesting social experiment.

And even though we only have a modest bit of data, I’m going to be bold and assert that we can already learn two lessons from what’s happened.

1. Politicians are so greedy that they set taxes too high.

In the real world, there’s this thing called the Laffer Curve. And what it shows is that excessive tax rates don’t generate big piles of tax revenue because people change their behavior.

I’ve made this point before when dealing with personal income tax rates, corporate tax rates, capital gains taxes, and tobacco taxes.

Simply stated, the political class is so anxious to get more of our money that they impose punitive tax rates that fail to generate the desired amount of revenue.

And it’s also true with taxes on marijuana.

But don’t believe me. Let’s look at some news sources about what’s happened in Colorado.

Here are some excerpts from a Daily Beast report.

According to the Colorado Department of Revenue, the state collected $44 million in taxes from recreational marijuana in 2014, $25 million less than predicted.  …why did recreational marijuana sales in Colorado fall short? …Coloradoans bought less recreational marijuana than they could have… Looking at the taxes on cannabis in the state, it’s not hard to see why. Pot taxes in Colorado are steep. In Denver, for example, an eighth of cannabis can come with four taxes: an excise tax, regular sales tax, special sales tax (for pot retailers), and a special city tax. That equals a markup of roughly 30 percent. …many pot aficionados looked at the numbers and decided to stick with their medical marijuana programs or their other dealers.

Here’s some similar analysis from a New York Times article.

Colorado’s tax results underscore a big conflict facing public officials considering marijuana legalization. Taxes should be kept low if the goal is to eliminate pot’s black market. …Colorado has also shown that pot-smokers don’t necessarily line up to leave the tax-free black market and pay hefty taxes. If medical pot is untaxed, or if pot can be grown at home and given away as in Colorado, the black market persists.

And here are some passages from the Mic’s analysis.

David Huff…from Aurora, told the AP that the state’s taxes on marijuana, which increase the price of pot by 30 percent or more, are too, um, high. “I don’t care if they write me a check, or refund it in my taxes, or just give me a free joint next time I come in. The taxes are too high, and they should give it back,” Huff said. …only 60 percent of Coloradans obtained their marijuana through a legal exchange in 2014. Some buyers are using the state’s legal medical marijuana, which is untaxed, as a source for green, while others take advantage of Amendment 64’s provision allowing the personal use of as many as six marijuana plants. The products of those plants have flooded the black market, depriving Colorado of more taxable pot.

The bottom line is that politicians better figure out how to limit their greed if they truly want the legal market to function properly.

2. A spending cap ensures that new revenue won’t finance bigger government.

I’m a big fan of restraining the growth of government. Needless to say, this means I don’t like giving politicians new sources of revenue.

That’s my view on all of the proposals for new revenue that are percolating in the corridors of power, including energy taxes, financial taxes, value-added taxes, and wealth taxes.

But if there’s actually some sort of binding limit on the growth of government, then politicians can’t use new revenue to finance a more bloated public sector.

And thanks to the nation’s best expenditure limit, that’s the case in Colorado.

Here’s what Mic wrote on the topic.

Colorado’s state constitution limits how much tax money the state treasury can receive before having to return it to taxpayers. The provision, known as the Taxpayer Bill of Rights, or TABOR… Since Colorado’s economy has been growing as a faster rate than expected, the state underestimated its total revenue, which means Centennial State residents may soon get a cut of the estimated $50 million in taxes collected from the sale of recreational marijuana during its first year of legalization. …TABOR, passed in 1992, dictates that Colorado can’t spend revenue made from taxation if those revenues grow faster than the rate of inflation and population growth. That money, known as a TABOR bonus, must be refunded to taxpayers unless voters approve a revenue change. This amendment has netted Colorado taxpayers about $3.3 billion since 1992.

Let’s return to the Daily Beast story.

In a state with one of the strictest tax and expenditure limitations in the country, Colorado operates under a Taxpayer Bill of Rights called TABOR. According to the bill, refunds are to be considered when state tax revenues don’t match up to the state estimates. This year, owing to a slight rise in the economy, the overall revenue was higher.

Though you won’t be surprised to learn that politicians want to figure out a way of spending the money. Check out these passages from the aforementioned piece in the New York Times.

Colorado will likely have to return to voters to ask to keep the pot tax money. That’s because of a 1992 amendment to the state constitution that restricts government spending. The amendment requires new voter-approved taxes, such as the pot taxes, to be refunded if overall state tax collections rise faster than permitted. Lawmakers from both parties are expected to vote this spring on a proposed ballot measure asking Coloradans to let the state keep pot taxes.

So both Republicans and Democrats will join hands in an effort to spend the money.

Gee, knock me over with a feather. What a surprise!

But let’s not focus on whether politicians want more of our money. Let’s learn from TABOR.

What it teaches us is that you get better policy when you limit the growth of government spending. And the closest thing we have to TABOR at the national level is the Swiss Debt Brake.

It’s worked very well in Switzerland because it puts the focus on the underlying problem of too much government. Notwithstanding the name, it limits the annual growth of spending, not the growth of debt.

The moral of the story is that when you address the real problem of too much spending, you automatically address the symptom of red ink.

And politicians presumably won’t have much incentive to impose higher taxes if they can’t use the money to buy votes with bigger government, so it’s a win-win situation!

P.S. Though there are some who favor higher taxes solely for reasons of spite and envy.

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Since I’m a big advocate of the Laffer Curve, that means I favor dynamic scoring. This is the common-sense observation that you can’t figure out the effect of tax changes on revenue without first estimating the impact on taxable income.

And I’ve shared some very persuasive data and analysis in favor of the Laffer Curve and dynamic scoring.

The huge increase in taxes paid by upper-income taxpayers after Reagan slashed the top income tax rate.

The fact that the overwhelming majority of CPAs believe in significant feedback effects.

Even left-wing economists admit that you lose revenue if tax rates get too high.

International bureaucracies even admit that there are “Laffer Curve” limits that make some tax hikes self-defeating.

Notwithstanding all this evidence, we have a system in Washington that is based on static scoring, which simplistically assumes a linear relationship between tax rates and tax revenue.

The Joint Committee on Taxation makes the revenue estimates, and reformers argue the status quo is biased in favor of higher tax and have long urged the system to be modernized to get more accurate numbers.

Needless to say, establishment leftists don’t want to see any changes.

Edward Kleinbard, a former Staff Director for the Joint Committee on Taxation, writes with disapproval in the New York Times that Republicans want to change the existing methodology for estimating the revenue impact of changes in tax policy.

…at the top of their to-do list is changing how the government measures the impact of tax cuts on federal revenue: namely, to switch from so-called static scoring to “dynamic” scoring. While seemingly arcane, the change could have significant…consequences.

Here’s his description of the issue, which is reasonably fair.

…conventional estimates do not…incorporate macroeconomic behavioral changes. Dynamic scoring does. Proponents point out, correctly, that if a tax proposal is large enough, then those sorts of feedback effects can aim the entire economy on a slightly different path. Such proponents argue that conventional projections are skewed against tax cuts, because they do not consider that cutting taxes could lead to higher economic output, which would make up at least some of the lost revenues. They maintain that dynamic scoring will, therefore, be both more neutral and more accurate than current methodologies.

He then gives two reasons why he doesn’t like dynamic scoring.

First, he argues that a modernized system will be imprecise.

Economists disagree on the answers, and different models’ predicted feedback effects vary wildly, depending on the values selected for those uncertain assumptions.  …Consider the nonpartisan scorekeepers’ estimates of the consequences of a tax-reform bill proposed last year by Representative Dave Camp, Republican of Michigan. Using different models and plausible inputs, the scorekeepers estimated that, under the bill, total gross domestic product might rise between 0.1 percent and 1.6 percent over the next decade — a 16-fold spread in projected outcomes. Which result should be the basis of congressional scorekeeping?

He’s certainly right that economic models will generate a range of predictions.

And I’ll be the first to admit that models are woefully inadequate in their attempts to measure millions of people making billions of decisions. Heck, I’ve even pointed out that economists are terrible forecasters.

But Kleinbard is basically arguing that it’s better to be exactly wrong than inexactly right.

Under the current system, for instance, the JCT will simplistically calculate that a doubling of tax rates will lead to a near-doubling of tax revenue.*

That’s very precise, but it’s also very wrong. In reality, a doubling of tax rates would have a very large and very negative impact on economic performance. Shouldn’t lawmakers have a system that at least gives them an estimate, or a range of estimates, to suggest the possible real-world consequences?

This video explains what is wrong with the Joint Committee on Taxation’s methodology.

Kleinbard’s second argument against dynamic scoring is based on his assumption that bigger government is good for the economy since the government spends money wisely.

I’m not joking.

Federal deficits are on an unsustainable path (as it happens, because of undertaxation, not excessive spending). Simply cutting taxes against the headwind of structural deficits leads to lower growth, as government borrowing soaks up an ever-increasing share of savings. …these models are political statements. They show the biggest economic effects by assuming that tax cuts are financed by unspecified future spending cuts. The smaller size of government, not the tax cuts by themselves, largely drives the models’ results. …the models are not a step toward more neutral revenue estimates, because they assume that, while individuals make productive investments, government does not. In reality, government spending contributes significantly to economic output. …When revenues do in fact decline and deficits rise, those same proponents will push for steep cuts in government insurance or investment programs, because they will claim that the models demand it.

Wow. I hardly know where to start. So many wrong assertions in so little space.

I guess I’ll begin by pointing out that it’s absurd to argue America’s fiscal problems are the result of taxes being too low. But if you don’t believe me, just look at the White House’s own numbers.

But the most important point to address is that Kleinbard thinks government spending is more efficient than private spending.

That arguably might be true if government was consuming only 2 percent of GDP and certain core “public goods” weren’t being provided.

But that’s hardly the case today, or at any time in recent history.

The burden of government spending is well beyond the growth-maximizing level in the United States. This video elaborates.

The evidence strongly indicates we need less government rather than more. Unless, of course, you think the United States would grow faster if we were more like France or Greece.

* There are some “micro-economic” feedback effects in the current system, so even the JCT wouldn’t assert that revenues would double if tax rates rose by 100 percent.

P.S. Here’s my debunking of the straw-man debunking of the Laffer Curve and dynamic scoring.

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Barack Obama and the rest of the class-warfare crowd act as if “tax the rich” is an appropriate answer to every question about fiscal policy.

I’m not joking. Here are some of the President’s main tax hikes that have been enacted or proposed.

Obama imposed higher income tax rates on upper-income taxpayers as part of the fiscal cliff deal.

Obama also succeeded in increasing the double-taxation of dividends and capital gains for successful taxpayers.

Obamacare was a budget-busting nightmare with lots of tax increases, but the biggest tax hike targeted rich taxpayers.

Obama’s proposed solution for Social Security’s huge unfunded liability is a large tax increase on taxpayers making more than $100,000 per year.

Obama also has proposed big tax hikes for American companies trying to compete in global markets.

This list could continue, but I think you get the point. American leftists are like malfunctioning Chatty Cathy Dolls. No matter how many times you pull the string, all that comes out is “tax the rich.”

Needless to say, that’s both tiresome and empty.

At some point, it would be nice for Obama and other statists to actually identify how much is enough.

  1. For instance, should any taxpayer ever have to give more than 40 percent of their income to government? More than 50 percent? Perhaps over 100 percent, like the 8,000 French household that had every penny of earnings confiscated in 2012?
  2. And what’s the “fair share” for the rich? Should they pay 40 percent of the tax burden? Or 50 percent? Or more?
  3. Heck, it might not be a bad idea to actually identify the rich. Is a household “rich” if annual income climbs above $200,000? Or do we simply define rich people as being anyone in the top 10 percent, or top 20 percent?

For what it’s worth, I don’t care about the answers to these questions because I favor a simple and fair flat tax that doesn’t punish people for contributing more to the economy’s output. I simply want the government to treat everyone equally and collect revenue in the least-destructive manner.

That being said, I imagine that Obama and other leftists would hem and haw if any reporters actually acted like journalists and asked tough questions. In their hearts, the class-warfare types probably want to go back to the 70 percent-plus top tax rates of the Jimmy Carter era. But they presumably wouldn’t want to openly confess those views.

Just in case Obama (or Pelosi, Reid, etc) ever are pressed to answer these questions, here are numbers that should help put their answers in context.

First, here’s a chart from the experts at the Tax Foundation and it reveals that the top-10 percent of taxpayers finance about 70 percent of the federal income tax.

The typical left-wing response to this kind of data is to complain that it doesn’t include the Social Security payroll tax and other levies.

That’s a semi-fair point, and it’s true that the so-called “FICA” tax (at least the part that goes to Social Security) is not “progressive.” Instead, it’s a flat-rate levy. Moreover, the portion of the payroll tax used to fund Social Security is only imposed on income up to $118,500, which leads many leftists to say the system is regressive.

That’s inaccurate for the simple reason that Social Security’s benefit formula is far more generous to lower-income taxpayers. It’s also worth pointing out that the program is supposed to be a form of social insurance, not a redistribution scheme (though it’s actually both).

And that point is a perfect segue for the next chart. Mark Perry of the American Enterprise Institute used numbers from the Congressional Budget Office to measure the net effect (taxes and spending) of fiscal policy for the five income quintiles.

As you can see, the bottom 60 percent are net recipients and the top 20 percent are basically pulling the wagon for everyone.

Remember, this chart doesn’t mean that the bottom 60 percent don’t pay any tax. It just means that they get more money from the government, on average, than they put into the system.

Now that I’ve shared some numbers, let’s close with some economic analysis.

Obama’s class-warfare agenda is wrong because it’s unfair and discriminatory. But it’s also terribly misguided because high tax rates are bad for growth and competitiveness.

Besides, there is a point at which high tax rates don’t generate much, if any, additional revenue. Simply stated, rich taxpayers have considerable control over the timing, level, and composition of their income. And that means they can reduce their taxable income when tax rates increase.

My video on class warfare has more information. Make sure to pay extra-close attention at the 4:35 mark.

P.S. If you don’t believe my argument about rich people having the ability to alter their taxable income, check out the IRS data from the 1980s.

P.P.S. Only a fool (or a malicious person) wants to be at the revenue-maximizing point of the Laffer Curve. The right goal is to set tax rates at the growth-maximizing level.

P.P.P.S. For what it’s worth, a poll in 2012 found that 75 percent of Americans think the top tax rate should be no higher than 30 percent. That can’t be very comforting data for the hate-and-envy crowd.

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Many statists are worried that Republicans may install new leadership at the Joint Committee on Taxation (JCT) and Congressional Budget Office (CBO).

This is a big issue because these two score-keeping bureaucracies on Capitol Hill tilt to the left and have a lot of power over fiscal policy.

The JCT produces revenue estimates for tax bills, yet all their numbers are based on the naive assumption that tax policy generally has no impact on overall economic performance. Meanwhile, CBO produces both estimates for spending bills and also fiscal commentary and analysis, much of it based on the Keynesian assumption that government spending boosts economic growth.

I personally have doubts whether GOPers are smart enough to make wise personnel choices, but I hope I’m wrong.

Matt Yglesias of Vox also seems pessimistic, but for the opposite reason.

He has a column criticizing Republicans for wanting to push their policies by using “magic math” and he specifically seeks to debunk the notion – sometimes referred to as dynamic scoring or the Laffer Curve – that changes in tax policy may lead to changes in economic performance that affect economic performance.

He asks nine questions and then provides his version of the right answers. Let’s analyze those answers and see which of his points have merit and which ones fall flat.

But even before we get to his first question, I can’t resist pointing out that he calls dynamic scoring “an accounting gimmick from the 1970s” in his introduction. That is somewhat odd since the JCT and CBO were both completely controlled by Democrats at the time and there was zero effort to do anything other than static scoring.

I suppose Yglesias actually means that dynamic scoring first became an issue in the 1970s as Ronald Reagan (along with Jack Kemp and a few other lawmakers) began to argue that lower marginal tax rates would generate some revenue feedback because of improved incentives to work, save, and invest.

Now let’s look at his nine questions and see if we can debunk his debunking.

1. The first question is “What is dynamic scoring?” and Yglesias responds to himself by stating it “is the idea that when estimating the budgetary impact of changes in tax policy, you ought to take into account changes to the economy induced by the policy change” and he further states that it “sounds like a reasonable idea.”

But then he says the real problem is that conservatives exaggerate and “say that large tax cuts will have a relatively small impact on the deficit  — or even that they make the deficit smaller” and that they “cite an idea known as the Laffer Curve to argue that tax cuts increase growth so much that tax revenues actually rise.”

He’s sort of right. There are definitely examples of conservatives overstating the pro-growth impact of tax cuts, particularly when dealing with proposals – such as expanded child tax credits – that presumably will have no impact on economic performance since there is no change in marginal tax rates on productive behavior.

But notice that he doesn’t address the bigger issue, which is whether the current approach (static scoring) is accurate and appropriate even when dealing with major changes in marginal tax rates on work, saving, and investment. That’s what so-called supply-side economists care about, yet Yglesias instead prefers to knock down a straw man.

2. The second question is “What is the Laffer Curve?” and Yglesias answer his own question by asserting that the “basic idea of the curve is that sometimes lower tax rates lead to more tax revenue by boosting economic growth.” He then goes on to ridicule the notion that tax cuts are self-financing, even citing a column by National Review’s Kevin Williamson.

Once again, Yglesias is sort of right. Some Republicans have made silly claims, but he mischaracterizes what Williamson wrote.

More specifically, he’s wrong in asserting that the Laffer Curve is all about whether tax cuts produce more revenue. Instead, the notion of the curve is simply that you can’t calculate the revenue impact of changes in tax rates without also measuring the likely change in taxable income. The actual revenue impact of changes in tax rates will then depend on whether you’re on the upward-sloping part of the curve or downward-sloping part of the curve.

The real debate is the shape of the curve, not whether a Laffer Curve exists. Indeed, I’m not aware of a single economist, no matter how far to the left (including John Maynard Keynes), who thinks a 100 percent tax rate maximizes revenue. Yet that’s the answer from the JCT. Moreover, the Laffer Curve also shows that tax increases can impose very high economic costs even if they do raise revenue, so the value of using such analysis is not driven by whether revenues go up or down.

3. The third question is “So do tax cuts boost economic growth?” and Yglesias responds by stating “the credible research on the matter is very very mixed.” But he follows that response by citing research which concluded that “a tax cut financed by reductions in wasteful spending or social assistance for the elderly would boost growth.”

But that leaves open the question as to whether the economy does better because of the lower tax burden, the lower spending burden, or some combination of the two effects. But I’ll take any of those three answers.

So is he “sort of right” again? Not so fast. Yglesias also cites the Congressional Research Service (which rubs me the wrong way) and a couple of academic economists who concluded that there is “no systematic correlation between the level of taxation and the level of economic growth.”

The bottom line is that there’s no consensus on the economic impact of taxation (in part because it is difficult to disentangle the impact of taxes from the impact on spending, and that’s not even including all the other policies that determine economic performance). But I still think Yglesias is being a bit misleading because there is far more consensus on the economic impact of marginal tax rates and debates about the Laffer Curve and dynamic scoring very often revolve around those types of tax policies.

4. The fourth question is “How does tax scoring work now?” and Yglesias respond to himself by noting that the various score-keeping bureaucracies measure “demand-side effects” and “behavioral effects.”

He’s right, but CBO uses so-called demand-side effects to justify Keynesian spending, so that’s not exactly reassuring news for people who focus more on real-world evidence.

And he’s also right that JCT measures changes in behavior (such as smokers buying fewer cigarettes if the tax goes up), and this type of analysis (sometimes called microeconomic dynamic scoring) certainly is a good thing.

But the real controversy is about macroeconomic dynamic scoring, which we’ll address below.

5. The fifth question is “Can we take a break from all this macroeconomic modeling?” and is simply an excuse for Yglesias to make a joke, though I can’t tell whether he is accusing Reagan supporters of being racists or mocking some leftists for accusing Reagan supporters of being racist.

So I’m not sure how to react, other than to recommend the fourth video at this link if you want some real Reagan humor.

6. The sixth question is “What do current scoring methods leave out?” and Yglesias accurately notes that what “dynamic-scoring proponents want is a model of macroeconomic consequences. They think that a country with lower tax rates will see more investment in physical and human capital, leading to more productivity, and more economic growth.”

He even cites my blog post from last month and correctly describes me as believing that it is “self-evidently ridiculous that the current CBO model says higher tax rates would lead to faster economic growth via lower deficits.”

I also think he is fair in pointing out that “people sharply disagree about how much tax rates actually influence economic growth” and that “the whole terrain is enormously contested.”

But this is why I think my view is the reasonable middle ground. At one extreme you find (at least in theory) some over-enthusiastic Republican types who argue that all tax cuts are self-financing. At the other extreme you find the JCT saying tax policy has no impact on the economy and actually arguing that you maximize tax revenue with 100 percent tax rates. I suspect that Yglesias, if pressed, will agree the JCT approach is nonsensical.

So why not have the JCT – in a fully transparent manner – begin to incorporate macroeconomic analysis?

7. The seventh question is “Has dynamic scoring ever been tried?” and Yglesias self-responds by pointing out that a Treasury Department dynamic analysis of the 2001 and 2003 tax cuts come to the conclusion that “the resulting budget impact would be 7 percent smaller than what was suggested by conventional scoring methods.” and “ended with the conclusion that the Bush tax cuts substantially decreased revenue.”

In other words, dynamic analysis was not used to imply that tax cuts are self-financing. Indeed, the dynamic score in the example of what would happen if the Bush tax cuts were made permanent turned out to be very modest.

So why, then, are folks on the left so determined to block reforms that – in practice – don’t yield dramatic changes in numbers? My own guess, for what it’s worth, is that they don’t want any admission or acknowledgement that lower tax rates are better for growth than higher tax rates.

8. The eight question is “Why are we talking about dynamic scoring now?” and Yglesias answers his own question by accurately stating that “the Republican takeover of Congress starting in 2015 gives the GOP an opportunity to either change the scoring rules, change the personnel in charge of the scoring, or both.”

He’s not just sort of right. He’s completely right. I have no disagreements.

9. The ninth question is “Why does the score matter?” and his self-response is “the scores matter because perceptions matter in politics.” In other words, politicians don’t want to be accused of enacting legislation that is predicted to increase red ink.

Yglesias is also right when he writes that this “effect shouldn’t be exaggerated. In the past, Republicans haven’t hesitated to vote for tax measures that the CBO says will increase the deficit. That’s because they have a strong preference for low tax rates.”

At the risk of being boring, I also think he’s right about the degree to which scores matter.

The bottom line is that questions #1, #2, #3, and #6 are the ones that matter. Yglesias makes plenty of reasonable points, but I think his argument ultimately falls flat because he spends too much time attacking the all-tax-cuts-pay-for-themselves straw man and not enough time addressing whether it is reasonable for the JCT to use a methodology that assumes taxes have no effect on the overall economy.

But I expect to hear similar arguments, expressed in a more strident fashion, if Republicans take prudent steps – starting with personnel changes – to modernize the JCT and CBO apparatus.

P.S. While tax cuts usually do lead to revenue losses, there is at least one very prominent case of lower tax rates leading to more revenue.

P.P.S. If the JCT approach is reasonable, why do the overwhelming majority of CPAs disagree? Is it possible that they have more real-world understanding of how taxpayers (particularly upper-income taxpayers) respond when tax rates change?

P.P.P.S. If the JCT approach is reasonable, why do international bureaucracies so often produce analysis showing a Laffer Curve?

There’s also some nice evidence from Denmark, Canada, France, and the United Kingdom.

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The Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) are congressional bureaucracies that wield tremendous power on Capitol Hill because of their role as fiscal scorekeepers and referees.

Unfortunately, these bureaucracies lean to the left. When CBO does economic analysis or budgetary estimates, for instance, the bureaucrats routinely make it easier for politicians to expand the burden of government spending. The accompanying cartoon puts it more bluntly.

And when JCT does revenue estimates, the bureaucrats grease the skids for anti-growth tax policy by overstating revenue losses from lower tax rates and overstating revenue gains from higher tax rates.

Here are some examples of CBO’s biased output.

The CBO – over and over again – produced reports based on Keynesian methodology to claim that Obama’s so-called stimulus was creating millions of jobs even as the unemployment rate was climbing.

CBO has produced analysis asserting that higher taxes are good for the economy, even to the point of implying that growth is maximized when tax rates are 100 percent.

Continuing a long tradition of under-estimating the cost of entitlement programs, CBO facilitated the enactment of Obamacare with highly dubious projections.

CBO also radically underestimated the job losses that would be caused by Obamacare.

When purporting to measure loopholes in the tax code, the CBO chose to use a left-wing benchmark that assumes there should be double taxation of income that is saved and invested.

On rare occasions when CBO has supportive analysis of tax cuts, the bureaucrats rely on bad methodology.

But let’s not forget that the JCT produces equally dodgy analysis.

The JCT was wildly wrong in its estimates of what would happen to tax revenue after the 2003 tax rate reductions.

Because of the failure to properly measure the impact of tax policy on behavior, the JCT significantly overestimated the revenues from the Obamacare tax on tanning salons.

The JCT has estimated that the rich would pay more revenue with a 100 percent tax rate even though there would be no incentive to earn and report taxable income if the government confiscated every penny.

This means the JCT is more left wing than the very statist economists who think the revenue-maximizing tax rate is about 70 percent.

Unsurprisingly, the JCT also uses a flawed statist benchmark when producing estimates of so-called tax expenditures.

Though I want to be fair. Sometimes CBO and JCT produce garbage because they are instructed to put their thumbs on the scale by their political masters. The fraudulent process of redefining spending increases as spending cuts, for instance, is apparently driven by legislative mandates.

But the bottom line is that these bureaucracies, as currently structured and operated, aid and abet big government.

Regarding the CBO, Veronique de Rugy of Mercatus hit the nail on the head.

The CBO’s consistently flawed scoring of the cost of bills is used by Congress to justify legislation that rarely performs as promised and drags down the economy. …CBO relies heavily on Keynesian economic models, like the ones it used during the stimulus debate. Forecasters at the agency predicted the stimulus package would create more than 3 million jobs. …What looks good in the spirit world of the computer model may be very bad in the material realm of real life because people react to changes in policies in ways unaccounted for in these models.

And the Wall Street Journal opines wisely about the real role of the JCT.

Joint Tax typically overestimates the revenue gains from raising tax rates, while overestimating the revenue losses from tax rate cuts. This leads to a policy bias in favor of higher tax rates, which is precisely what liberal Democrats wanted when they created the Joint Tax Committee.

Amen. For all intents and purposes, the system is designed to help statists win policy battles.

No wonder only 15 percent of CPAs agree with JCT’s biased approach to revenue estimates.

So what’s the best way to deal with this mess?

Some Republicans on the Hill have nudged these bureaucracies to make their models more realistic.

That’s a helpful start, but I think the only effective long-run option is to replace the top staff with people who have a more accurate understanding of fiscal policy. Which is exactly what I said to Peter Roff, a columnist for U.S. News and World Report.

…the new congressional leadership should be looking at ways to reform the way the institution does its business – and the first place for it to start is the Congressional Budget Office. Most Americans don’t know what the CBO is, how it was created or what it does. They also don’t know how vitally important it is to the legislative process, especially where taxes, spending and entitlement reform are concerned. As Dan Mitchell, a well-respected economist with the libertarian Cato Institute, puts it in an email, the CBO “has a number-crunching role that gives the bureaucracy a lot of power to aid or hinder legislation, so it is very important for Republicans to select a director who understands the economic consequences of excessive spending and punitive tax rates.”

Heck, it’s not just “very important” to put in a good person at CBO (and JCT). As I’ve written before, it’s a test of whether the GOP has both the brains and resolve to fix a system that’s been rigged against them for decades.

So what will happen? I’m not sure, but Roll Call has a report on the behind-the-scenes discussions on Capitol Hill.

Flush from their capture of the Senate, Republicans in both chambers are reviewing more than a dozen potential candidates to succeed Douglas W. Elmendorf as director of the Congressional Budget Office after his term expires Jan. 3. …The appointment is being closely watched, with a number of Republicans pushing for CBO to change its budget scoring rules to use dynamic scoring, which would try to account for the projected impact of tax cuts and budget changes on the economy.

So who will it be? The Wall Street Journal weighs in, pointing out that CBO has been a tool for the expansion of government.

…the budget rules are rigged to expand government and hide the true cost of entitlements. CBO scores aren’t unambiguous facts but are guesses about the future, biased by the Keynesian assumptions and models its political masters in Congress instruct it to use. Republicans who now run Congress can help taxpayers by appointing a new CBO director, as is their right as the majority. …The Tax Foundation’s Steve Entin would be an inspired pick.

I disagree with one part of the above excerpt. Steve Entin is superb, but he would be an inspired pick for the Joint Committee on Taxation, not the CBO.

But I fully agree with the WSJ’s characterization of the budget rules being used to grease the skids for bigger government.

In a column for National Review, Dustin Siggins writes that Bill Beach, my old colleague from my days at the Heritage Foundation, would be a good choice for CBO.

…few Americans may realize  that the budget process is at least as twisted as the budget itself. While one man can’t fix it all, Republicans who want to be taken seriously about budget reform should approve Bill Beach to head the Congressional Budget Office (CBO). Putting the right person in charge as Congress’s official “scorekeeper” would be an important first step in proving that the party is serious about honest, transparent, and efficient government. …CBO has several major structural problems that a new CBO director should fix.

Hmm… Entin at JCT and Beach at CBO. That might even bring a smile to my dour face.

But it doesn’t have to be those two specific people. There are lots of well-regarded policy scholars who could take on the jobs of reforming and modernizing the work of JCT and CBO.

But that will only happen if Republicans are willing to show some fortitude. And that means they need to be ready to deal with screeching from leftists who want to maintain their control of these institutions.

For example, Peter Orszag, a former CBO Director who then became Budget Director for Obama (an easy transition), wrote for Bloomberg that he’s worried GOPers won’t pick someone with his statist views.

The Congressional Budget Office should be able to celebrate its 40th anniversary this coming February with pride. …The occasion will be ruined, however, if the new Republican Congress breaks its long tradition of naming an objective economist/policy analyst as CBO director, when the position becomes vacant next year, and instead appoints a party hack.

By the way, it shows a remarkable lack of self-awareness for someone like Orszag to complain about the possibility of a “party hack” heading up CBO.

In any event, that’s just the tip of the iceberg. I fully expect we’ll also see editorials very soon from the New York Times, Washington Post, and other statist outlets about the need to preserve the “independence” of CBO and JCT.

Just keep in mind that their real goal is to maintain their side’s control over the process.

P.S. There’s another Capitol Hill bureaucracy, the Congressional Research Service, that also generates leftist fiscal policy analysis. Fortunately, the CRS doesn’t have any scorekeeper or referee role, so it doesn’t cause nearly as much trouble. Nonetheless, any bureaucracy that produces “research” about higher taxes being good for the economy needs to be abolished or completely revamped.

P.P.S. This video explains the Joint Committee on Taxation’s revenue-estimating methodology. Pay extra attention to the section beginning around the halfway point, which deals with a request my former boss made to the JCT.

P.P.P.S. If you want to see some dramatic evidence that lower tax rates don’t necessarily lead to less revenue, check out this amazing data from the 1980s.

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In my writings on the Laffer Curve, I probably sound like a broken record because I keep warning that a nation should never be at the revenue-maximizing point.

That’s because there’s lots of good research showing that there are ever-increasing costs to the economy as tax rates approach that level.

So the question that policy makers should ask themselves is whether they’re willing to impose $10 or $20 of damage to the private sector in order to collect $1 of additional revenue.

New we have further evidence. Let’s take a look at a new study by economists from Spain, Arizona, and California. Here’s the issue they decided to study.

As top earners account for a disproportionate share of tax revenues and face the highest marginal tax rates, such proposals lead to a natural tradeoff regarding tax revenue. On the one hand, increases in tax revenue are potentially non-trivial given the income generated by high-income households. On the other hand, the implementation of such proposals would increase marginal tax rates precisely where they are at their highest levels, and thus where the individual responses are expected to be larger. Therefore, revenue increases might not materialise.

And here’s what they found.

…the increase in overall tax collections – including tax collections at the local and state level and from corporate income taxes – is much smaller: 1.6%. Figure 2 shows why. As τ increases there is a substantial decline in labour supply, the capital stock, and aggregate output across steady states. Aggregate output, for example, declines by almost 12% when τ = 0.13. Hence, the government collects taxes from a smaller economy… The message from these findings is clear. There is not much available revenue from revenue-maximising shifts in the burden of taxation towards high earners…and that these changes have non-trivial implications for economic aggregates.

The key takeaways from that passage are the findings about “a smaller economy” and the fact that there are “non-trivial implications for economic aggregates.”

That means less prosperity.

And the authors even acknowledge that the damage to the productive sector is presumably larger than what they found in this research.

…it is important to reflect on the absence of features in our model that would make our conclusions even stronger. First, we have abstracted away from human capital decisions that would be negatively affected by increasing progressivity. Since investments in individual skills are not invariant to changes in tax progressivity, larger effects on output and effective labour supply – relative to a case with exogenous skills – are to be expected. Second, we have not modelled individual entrepreneurship decisions and their interplay with the tax system. Finally, we have not modelled a bequest motive, or considered a dynastic framework more broadly. In these circumstances, it is natural to conjecture that the sensitivity of asset accumulation decisions to changes in progressivity would be larger than in a life-cycle economy. Hence, even smaller effects on revenues would follow.

Richard Rahn’s latest column in the Washington Times also looks at this issue, reviewing the work of James Mirrlees, an economist who was awarded a Nobel Prize in 1996.

Back in 1971, a Scottish economist by the name of James A. Mirrlees wrote a groundbreaking paper, in which he attempted to answer the question of what an optimum income-tax regime would look like… Mr. Mirrlees had been an adviser to the British Labor Party, which supported the high tax rates in effect at that time. He did a careful analysis of the variation of people’s skills and the effect tax rates had on their incentives to earn. Much to his surprise, he found the optimum tax rate on high earners was about 20 percent… In his 1971 paper, Mr. Mirrlees concluded, “I must confess that I had expected the rigorous analysis of income taxation in the utilitarian manner to provide an argument for high tax rates. It has not done so.”

In other words, tax rates above 20 percent ultimately are self-defeating – even if you’re a statist and you want to maximize the size of the welfare state.

And there’s plenty of data from around the world on specific case studies that show the negative impact of class-warfare taxation, including research from the United States, Denmark, Canada, France, and the United Kingdom.

And here’s Part II of my video series on the Laffer Curve, which provides additional evidence.

P.S. If you want some good data showing why Krugman and other class warriors are wrong about tax rates, Alan Reynolds did a very good job of skewering their analysis.

P.P.S. The right tax rate is the one that finances the legitimate functions of government, and not one penny more.

P.P.P.S. Since we’re discussing the Laffer Curve and class-warfare taxation, it’s appropriate to share this very encouraging survey of economists. They were asked whether they agreed with the fundamental premise of Thomas Piketty’s work on inequality and taxation.

Wow. This is about as close as you can get to unanimous rejection as you can get.

By the way, even if 2-3 percent of economists are right, that still doesn’t justify Piketty’s policy prescriptions.

P.P.P.P.S. In addition to writing about taxation, Richard is the creator of the famous Rahn Curve.

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What’s the relationship between the Rahn Curve and the Laffer Curve?

For the uninitiated, the Rahn Curve is the common-sense notion that some government is helpful for prosperous markets but too much government is harmful to economic performance.

Even libertarians, for instance, will acknowledge that spending on core “public goods” such as police protection and courts (assuming, of course, low levels of corruption) can enable the smooth functioning of markets.

Some even argue that government spending on human capital and physical capital can facilitate economic activity. For what it’s worth, I think that the government’s track record in those areas leaves a lot to be desired, so I’d prefer to give the private sector a greater role in areas such as education and highways.

The big problem, though, is that most government spending is for programs that are often categorized as “transfers” and “consumption.” And these are outlays that clearly are associated with weaker economic performance.

This is why small-government economies such as Hong Kong and Singapore tend to grow faster than the medium-government economies such as the United States and Australia. And it also explains why growth is even slower is big-government economies such as France and Italy.

The Laffer Curve, for those who don’t remember, is the common-sense depiction of the relationship between tax rates and tax revenue.

The essential insight is that taxable income is not fixed (regardless of the Joint Committee on Taxation’s flawed methodology).

When tax rates are low, people will earn and report lots of income, but when tax rates are high, taxpayers figure out ways of reducing the amount of taxable income they earn and report to government.

This is why, for instance, the rich paid much more to the IRS after Reagan lower the top tax rate from 70 percent to 28 percent.

So why am I giving a refresher course on the Rahn Curve and Laffer Curve?

Because I’ve been asked on many occasions whether there is a relationship between the two concepts and I’ve never had a good answer.

But I’m happy to call attention to the good work of other folks, so here’s a very well done depiction of the relationship between the two curves (though in this case the Rahn Curve is called the Armey Curve).

I should hasten to add, by the way, that I don’t agree with the specific numbers.

I think the revenue-maximizing rate is well below 45 percent and I think the growth-maximizing rate is well below 30 percent.

But the image above is spot on in that it shows that a nation should not be at the revenue-maximizing point of the Laffer Curve.

Since I’m obviously a big fan of the Rahn Curve and I also like drawing lessons from cross-country comparisons, here’s a video on that topic from the Center for Freedom and Prosperity.

Well done, though I might quibble on two points, though the first is just the meaningless observation that the male boxer is not 6′-6″ and 250 lbs.

My real complaint (and this will sound familiar) is that I’m uneasy with the implication around the 1:45 mark that growth is maximized when government spending consumes 25 percent of economic output.

This implies, for instance, that government in the United States was far too small in the 1800s and early 1900s when the overall burden of government spending was about 10 percent of GDP.

But I suppose I’m being pedantic. Outlays at the national, state, and local level in America now consume more than 38 percent of economic output according to the IMF and we’re heading in the wrong direction because of demographic changes and poorly designed entitlement programs.

So if we can stop government from getting bigger and instead bring it back down to 25 percent of GDP, even I will admit that’s a huge accomplishment.

Libertarian Nirvana would be nice, but I’m more concerned at this point about simply saving the nation from becoming Greece.

P.S. I’ve shared numerous columns from Walter Williams and he is one of America’s best advocates of individual liberty and economic freedom.

Now there’s a documentary celebrating his life and accomplishments. Here’s a video preview.

Given Walter’s accomplishments, you won’t be surprised to learn that there’s another video documentary about his life.

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I’m a big advocate of the Laffer Curve.

Simply stated, it’s absurdly inaccurate to think that taxpayers and the economy are insensitive to changes in tax policy.

Yet bureaucracies such as the Joint Committee on Taxation basically assume that the economy will be unaffected and that tax revenues will jump dramatically if tax rates are boosted by, say, 100 percent.

In the real world, however, big changes in tax policy can and will lead to changes in taxable income. In other words, incentives matter. If the government punishes you more for earning more income, you will figure out ways to reduce the amount of money you report on your tax return.

This sometimes means that people will choose to be less productive. Why bust your derrière, after all, if government confiscates a big chunk of your additional earnings? Why make the sacrifice to set aside some of your income when the government imposes extra layers of tax on saving and investment? And why allocate your money on the basis of economic efficiency when you can reduce your taxable income by dumping your investments into something like municipal bonds that escape the extra layers of tax?

Or people can decide to hide some of the money they earn from the grasping claws of the IRS. Contractors can work off the books. Workers can take wages under the table. Business owners can overstate their expenses in order to reduce taxable income.

To reiterate, people respond to incentives. And that means you can’t estimate what will happen to tax revenues simply by looking at changes in tax rates. You also need to look at what’s happening to the amount of income people are willing to both earn and report.

Which is why I’m interested in some new research from two Canadian economists, one from the University of Toronto and one from the University of British Columbia. They looked at how rich people in Canada responded when their tax rates were altered.

Here are some excerpts from the study, published by the National Bureau of Economic Research.

In this paper we estimate the elasticity of reported income using the sub-national variation across Canadian provinces. …Comparing across provinces and through time, we find that elasticities are large for incomes at the top of the income distribution… The provincial tax rates for high earners vary strongly across the country, ranging from a low of 10 percent in Alberta to a high of 25.75 in Quebec. …at the top of the income distribution…these taxpayers have access to substantial financial advice that may facilitate tax avoidance. …We pay particular attention to the categories for $250,000 and those that report income between $150,000 and $250,000 as that income range is the closest to the P99 cutoff on which we focus.

Interestingly, the economists state that upper-income taxpayers should be less sensitive to tax rates today because less of their income is from investments.

…the source of incomes among those at the top has shifted substantially over the last half century from capital income toward earned income. All else equal, this change would tend to make income shifting or tax avoidance more difficult now than in earlier times.

Yet their results suggest that the taxable income of highly productive Canadians (those with incomes in the top 1 percent or the top 1/10th of 1 percent) is very sensitive to changes in tax rates.

The third column has the results for the bottom nine tenths of the top one percent, P99 to P99.9. Here, the estimate is a positive and significant 0.364. Finally, the top P99.9 percentile group shows an elasticity of 1.451, which is highly significant and large. …our estimate of 0.689 for P99 is high, and 1.451 for P99.9 very high.

And because rich people can raise or lower their taxable income in response to changing tax rates, this has big Laffer Curve implications.

According to the research, the revenue-maximizing tax rate for the top 1 percent is 44.4 percent and the revenue-maximizing tax rate for the even more successful top 1/10th of 1 percent is 27.5 percent!

The magnitude of our estimates can be put into context by calculating the revenue-maximizing tax rate τ∗, which is the rate corresponding to the peak of the so-called ‘Laffer Curve’. At this point, an incrementally higher rate will raise no further net revenue as the mechanical effect of the tax increase will be completely offset by the behavioural response of lower taxable income. …Plugging a = 1.81 and e = 0.689 into equation (8) yields an estimate for τ∗ of 44.4 percent. In Figure 1, four provinces have a top marginal tax rate for 2013 under 44.4 percent and six provinces are higher. Using the P99.9 estimate of 1.451, the revenue maximizing tax rate τ∗ would be only 27.5 percent. If true, this would suggest all provinces could increase revenue by lowering the tax rate for those in income group P99.9.

By the way, you read correctly, the revenue-maximizing tax rate for the super rich is lower than the revenue-maximizing tax rate for the regular rich.

This almost certainly is because very rich taxpayers get a greater share of their income from business and investment sources, and thus have more control over the timing, level, and composition of their earnings. Which means they can more easily suppress their income when tax rates go up and increase their income when tax rates fall.

That’s certainly what we see in the U.S. data and I assume Canadians aren’t that different.

But now it’s time for a big caveat.

I 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 the amount of revenue coming from any taxpayers. If tax rates are near the revenue-maximizing point, it implies a huge loss of private output per additional dollar collected by government.

As I’ve repeatedly argued, we want to be at the growth-maximizing point on the Laffer Curve. And that’s the level of tax necessary to finance the few legitimate functions of government.

That being said, the point of this blog post is to show that Obama, Krugman, and the rest of the class-warfare crowd are extremely misguided when they urge confiscatory tax rates on the rich.

Unless, of course, their goal is to punish success rather than to raise revenue.

P.S. Check out the IRS data from the 1980s on what happened to tax revenue from the rich when Reagan dropped the top tax rate from 70 percent to 28 percent.

I’ve used this information in plenty of debates and I’ve never run across a statist who has a good response.

P.P.S. I also think this polling data from certified public accountants is very persuasive.

I don’t know about you, but I suspect CPAs have a much better real-world understanding of the impact of tax policy than the bureaucrats at the Joint Committee on Taxation.

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I’ve already shared a bunch of data and evidence on the importance of low tax rates.

A review of the academic evidence by the Tax Foundation found overwhelming support for the notion that lower tax rates are good for growth.

An economist from Cornell found lower tax rates boost GDP.

Other economists found lower tax rates boost job creation, savings, and output.

Even economists at the Paris-based OECD have determined that high tax rates undermine economic performance.

And it’s become apparent, with even the New York Times taking notice, that high tax rates drive away high-achieving people.

We’re going to augment this list with some additional evidence.

In a study published by a German think tank, three economists from the University of Copenhagen in Denmark look at the impact of high marginal tax rates on Danish economic performance.

Here’s what they set out to measure.

…taxation distorts the functioning of the market economy by creating a wedge between the private return and the social return to a reallocation of resources, leaving socially desirable opportunities unexploited as a result. …This paper studies the impact of taxation on the mobility and allocation of labor, and quantifies the efficiency loss from misallocation of labor caused by taxation. …labor mobility responses are fundamentally different from the hours-of-work responses of the basic labor supply model… Our analysis builds on a standard search theoretic framework… We incorporate non-linear taxation into this setting and estimate the structural parameters of the model using employer-employee register based data for the full Danish population of workers and workplaces for the years 2004-2006. The estimated model is then used to examine the impact of different changes in the tax system, thereby characterizing the distortionary effects of taxation on the allocation of labor.

They produced several sets of results, including a look at the additional growth and output generated by moving to a system of lump-sum taxation (which presumably eliminates all disincentive effects).

But even when they looked at more modest reforms, such as a flat tax with a relatively high rate, they found the Danish economy would reap significant benefits.

…it is possible to reap a very large part of the potential efficiency gain by going “half the way”and replace the current taxation with a ‡at tax rate of 30 percent on all income. This shift from a Scandinavian tax system with high marginal tax rates to a level of taxation in line with low-tax OECD countries such as the United States increases total income by 20 percent and yields an efficiency gain measured in proportion to initial income of 10 percent. …a transition from a Scandinavian system with high marginal taxes to a system along the lines of low-tax OECD countries such as the United States. This reduces the rate of non-employment by around 10 percentage points, increases aggregate income by almost 20 percent (relative to the Scandinavian income level), and gives an efficiency gain measured in proportion to income of 9.9 percent. Thus, almost 80 percent of the efficiency loss from marginal taxation (9.7% divided by 12.4%) would be eliminated by shifting from a Scandinavian tax system to the system of a low-tax OECD country according to these estimates.

The authors also confirmed that lower tax rates would generate revenue feedback. In other words, the Laffer Curve exists.

We may also use the reform experiment to compute the marginal excess burden of taxation as described above. When measured in proportion to the mechanical loss of tax revenue, we obtain an estimate of 87 percent. …this estimate also corresponds to the degree of self-financing of the tax cut. Thus, the increase in tax revenue from the behavioral response is 87 percent of the mechanical loss in tax revenue.

Too bad we can’t get the Joint Committee on Taxation in Washington to join the 21st Century. Those bureaucrats still base their work on the preposterous assumption that taxes have no impact on overall economic performance.

Since we just looked at a study of the growth generated by reducing very high tax rates, let’s now consider the opposite scenario. What happens if you take medium-level tax rates and raise them dramatically?

The Tax Foundation looks at precisely this issue. The group estimated the likely results if lawmakers adopted the class-warfare policies proposed by Thomas Piketty.

Piketty suggests higher taxes on the wealthiest among us. He calls for a global wealth tax, and he recommends establishing a top income tax rate of 80 percent, with a next-to-top income tax rate of 50 or 60 percent for the upper-middle class. …This study…provides quantitative estimates of what his proposed tax rates would mean for capital formation, jobs, the level of income, and government revenue. This study also estimates how Piketty’s proposed income tax rates would affect the distribution of income in the United States.

Piketty, of course, thinks that even confiscatory levels of taxation have no negative impact on economic performance.

Piketty claims people (or at least the upper-income people he would tax so heavily) are totally insensitive to marginal tax rates. In his world view, upper-income taxpayers will work and invest just as much as before even if dramatically higher taxes reduce their after-tax rewards to a fraction of what they were previously. …Piketty’s vision of the world strains credulity.

When the Tax Foundation crunched the numbers, though, its experts found that Piketty’s proposal would be devastating.

Under Piketty’s 55 and 80 percent tax brackets, people in the new, ultra-high tax brackets will work and invest less because they will be able to keep so little of the reward from the last hour of work and the last dollar of investment. …As the supplies of labor and capital in the production process decline, the economy’s output will also contract. Although it is only people with upper incomes who will directly pay the 55 and 80 percent tax rates, people throughout the economy will indirectly bear some of the tax burden. For example, the average person’s wages will be lower than otherwise because middle-income workers will have less equipment and software to enhance their productivity, and wages depend on productivity. Similarly, people throughout the economy will have fewer employment opportunities and will lose desirable goods and services, because businesses will grow more slowly and be less innovative.

The magnitude of the damage would depend on whether the higher tax rates also applied to dividends and capital gains. Here’s what the Tax Foundation estimated would happen to the economy if dividends and capital gains were not hit with Piketty-style tax rates.

These are some very dismal numbers.

But now look at the results if tax rates also are increased on dividends and capital gains. The dramatic increase in double taxation (dwarfing what Obama wanted) would have catastrophic consequences for overall investment (the “capital stock”). This would lead to a big loss in jobs and a dramatic reduction in overall economic output.

The Tax Foundation then measures the impact of these policies on the well-being of people in various income classes.

Needless to say, upper-income taxpayers suffer substantial losses. But the rest of us also suffer as well.

…the poor and middle class would also lose. They would suffer a large, but indirect, tax burden as a result of the smaller economy. Their after-tax incomes would fall over 3 percent if capital gains and dividends retain their current-law tax treatment and almost 17 percent if capital gains and dividends are taxed like ordinary income.

And since I’m sure Piketty and his crowd would want to subject capital gains and dividends to confiscatory tax rates, the 17 percent drop is a more realistic assessment of their economic agenda.

Though, to be fair, Piketty-style policies would make society more “equal.” But, as the Tax Foundation notes, some methods of achieving equality are very bad for lower-income people.

…a reasonable question to ask is whether a middle-income family is made better off if their income drops 3.2 percent while the income of a family in the top 1 percent drops 21.0 percent, or their income plummets 16.8 percent while the income of a family in the top 1 percent plummets 43.3 percent.

Of course, if Margaret Thatcher is correct, the left has no problem with this outcome.

But for those of us who care about better lives for ordinary people, this is confirmation that envy isn’t – or at least shouldn’t be – a basis for tax policy.

Sadly, that’s not the case. We’ve already seen the horrible impact of Hollande’s Piketty-style policies in France. And Obama said he would be perfectly content to impose higher tax rates even if the resulting economic damage is so severe that no additional revenue is collected.

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It boggles the mind to think that the United States now has the highest corporate tax rate in the industrialized world.

But it’s even more amazing that America arguably has the most punitive corporate tax rate in the entire world.

Here’s some of what I wrote on the topic for today’s U.K.-based Telegraph.

…the United States has the highest corporate tax rate in the developed world (and the highest in the entire world, according to KPMG, if you ignore the United Arab Emirates’ severance tax on oil companies). …The central government in Washington imposes a 35pc rate on corporate income, with most states then adding their own levies, with the net result being an average corporate rate of 39.1pc. This compares with 37pc in Japan, which has the dubious honour of being in second place, according to the tax database of the Organisation for Economic Co-operation and Development (OECD). …if you broaden the analysis, it becomes even more evident that the United States has fallen behind in the global shift to more competitive corporate tax systems. The average corporate tax for OECD nations has dropped to 24.8pc. For EU nations, the average corporate tax is even lower, with a rate of less than 22pc. And don’t forget the Asian Tiger economies, with Singapore, Taiwan and Hong Kong all clustered around 17pc, as well as the fiscal paradises that don’t impose any corporate income tax, such as Bermuda and the Cayman Islands.

I also explain that America’s system of “worldwide” taxation exacerbates the anti-competitive nature of the U.S. tax system for companies trying to compete in global markets.

And I warn why making “inversions” illegal is a misguided and self-defeating response.

Blocking inversions…is like breaking the thermometer because you don’t like the temperature. It simply masks the underlying problem. In the long run, the United States will lose jobs and investment because of bad corporate tax policy, regardless of whether companies have the right to invert.

In other words, America desperately needs a lower corporate tax rate.

The crowd in Washington, however, says American can’t “afford” a lower corporate tax rate. The amount of foregone revenue would be too large, they claim.

Yet let’s look at what happened when Canada lowered its corporate tax burden. Here’s a chart prepared by the Tax Foundation.

The Tax Foundation augmented the chart with some important commentary on why companies are attracted to Canada.

Part of the attraction is the substantial tax reforms that occurred over the last 15 years in Canada. First among these is the dramatic reduction in the corporate tax rate, from 43 percent in 2000 to 26 percent today.

What about tax revenue?

The U.S. currently has a corporate tax rate of 39 percent, but lawmakers are reluctant to do what Canada did, i.e. lower the tax rate, for fear of losing tax revenue. …According to OECD data, corporate tax revenue increased following Canada’s corporate tax rate cuts that began in 2000. …Corporate tax revenue as a share of GDP in Canada has averaged 3.3 percent since 2000, while it averaged 2.9 percent over the years 1988 to 2000, when Canada’s corporate tax rate was 43 percent.

My colleague Chris Edwards also reviewed this issue (and he’s a former Canadian, so pay close attention).

Here’s his chart showing the corporate tax rates imposed at the national level by both the U.S. government and the Canadian government.

As you can see, the rates were somewhat similar between 1985 and 2000, with the Canadians having a slight advantage. But then Canada opened up  a big lead over America by dropping the central government tax rate on corporations to 15 percent.

So what happened to corporate tax revenue?

As you can see from his second chart, receipts are very volatile based on economic performance. But the Canadian government is collecting more revenue, measured as a share of total economic output, than the American government.

In spite of having a lower tax rate. Or perhaps it would be more accurate to say the Canadians are generating more corporate tax revenue because of the lower tax rate.

In other words, the Laffer Curve is alive and well.

Not that we should be surprised. Scholars at the American Enterprise Institute estimate that the revenue-maximizing corporate tax rate is about 25 percent, far below the 39.1 percent rate imposed on companies in the United States.

And Tax Foundation experts calculate that the revenue-maximizing rate even lower, down around 15 percent.

P.S. Don’t forget that when politicians impose high tax burdens on companies, the real victims are workers.

P.P.S. And since America’s corporate tax system ranks below even Zimbabwe, we’re in real trouble.

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What do cigarettes and capital gains have in common?

Well, they both start with the same letter, so maybe the Cookie Monster could incorporate them into his favorite song, but I’m thinking about something else. Specifically, both cigarettes and capital gains tell us something important about tax policy, the Laffer Curve, and the limits of political bullying.

In both cases, there are folks on the left who disapprove of these two “c” words and want to penalize them with high tax rates.

But it turns out that both cigarettes and capital gains are moving targets, so the politicians are grossly mistaken if they think that punitive taxation will generate a windfall of revenue.

I’ve already discussed why it’s senseless to impose high tax rates on capital gains. Simply stated, people can avoid the tax by not selling assets.

This might not be an ideal way of managing one’s investments, and it certainly isn’t good for the economy if it discourages new investment and prevents people from shifting existing investments into more productive uses, but it’s very effective as a strategy for individuals to protect against excessive taxation.

We see something quite similar with cigarettes. People can simply choose to buy fewer smokes.

Michel Kelly-Gagnon of Canada’s Montreal Economic Institute explains why higher tobacco taxes are not a guaranteed source of revenue for the political class.

Tax increases do not in each and every case lead to increases in government revenues. …When taxes on the consumption of a good are too high, you can get to a point where taxable consumption decreases and government revenues diminish rather than increase. Or at any rate, they don’t increase as much as what would be expected given the tax increase. This phenomenon constrains government’s ability to levy taxes. …There have been numerous examples in Canada of excessive taxes having a negative impact on government revenues. As shown by my colleagues Jean-François Minardi and Francis Pouliot in a study published last January ., there’s been three “Laffer moments” when it comes to tobacco tax revenues in Quebec since 1976. Whenever the level of taxation exceeded $15 per carton, the proceeds of the tobacco taxes eventually diminished. These are no isolated incidents. Laffer shows that the theory is confirmed by the experience of Cyprus, Denmark, Germany, Great Britain, Greece, Ireland, Latvia, Portugal, and Sweden.

Here’s a chart from his column showing how tax revenue has dropped in Quebec when the tax burden became too onerous.

Michel then acknowledges that some people will be happy about falling revenue because it presumably means fewer smokers.

But that’s not necessarily true.

While it is true that some people are deterred from smoking by tax increases, this is not the case of all smokers. Some avoid taxes by buying contraband cigarettes. Tax increases have no effect on the health of these smokers.

And because the tax burden is so severe, the underground economy for cigarettes is booming.

The folks at Michigan’s Mackinac Center have some remarkable and thorough estimates.

Since 2008, Mackinac Center for Public Policy analysts have periodically published estimates of cigarette smuggling in 47 of the 48 contiguous states. The numbers are quite shocking. In 2012, more than 27 percent of all Michigan in-state consumption was smuggled. In New York, almost 57 percent of all cigarettes consumed in the state were also illicit. This has profound effects on the revenue generated by state (and sometimes local) government. …We estimate nationwide revenue losses due to cigarette smuggling at $5.5 billion, a statistic consistent with the Bureau of Alcohol, Tobacco, Firearms and Explosives’ $5 billion estimate for 2009.

Here are the numbers for each state.

If all this evidence isn’t enough for you, I also encourage a look at the impact of higher tobacco taxes in Ireland, the United States, and Bulgaria and Romania.

Heck, even the city of Washington, DC, serves as a perverse role model on the foolishness of over-taxation.

P.S. Since this column focuses on the Laffer Curve and tobacco taxation, I would be remiss if I didn’t point out that Art Laffer recently put together a Handbook of Tobacco Taxation – Theory and Practice.

P.P.S. Art implies, at least indirectly, that policy makers should set the tax rate on tobacco at the revenue-maximizing level. That is far better than having the rate above the revenue-maximizing level, to be sure, but it rubs me the wrong way. I will repeat to my final day on earth that the growth-maximizing tax rate is far superior to the revenue-maximizing tax rate.

P.P.P.S. I’m currently in Australia for a series of speeches on fiscal policy. But as you can see from this photo, the PotL and I managed to find time to act like shameless tourists.

Tourists in Oz

P.P.P.P.S. Since I’m imitating Crocodile Dundee in the photo, I should close by noting that Paul Hogan (the actor who played Crocodile Dundee) has been harassed by the Australian tax police.

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When the new Tory-led government came to power in the United Kingdom, I was rather unimpressed.

David Cameron positioned himself as a British version of George W. Bush, full of “compassionate conservative” ideas to expand the burden of government.

But even worse than Bush, because Cameron also jacked up taxes when he first took office, including big increases in the capital gains tax and the value-added tax.

But I must admit that policy in recent years has moved in the right direction, at least with regard to corporate taxation.

Writing for the U.K.-based Telegraph, Jeremy Warner remarks that business activity has significantly strengthened.

A survey by EY, published on Monday, showed that the UK is continuing to pull away from the rest of Europe in terms of Foreign Direct Investment (FDI). The UK secured nearly 800 projects last year, the highest ever, accounting for around a fifth of all European FDI, far in advance of any other country. …Such investment is in turn helping to fuel Britain’s economic recovery… Go back 10 years and it was all the other way; companies were scrambling to leave the country and domicile somewhere else. It is perhaps the Coalition’s biggest unsung achievement that it has managed to reverse this flow.

So why has the United Kingdom experienced this economic rebound?

Lower corporate tax rates are key, Warner explains.

…it has done so largely through the tax system, where it has been as good as its promise to make the UK the most competitive in the G20. By next year, Britain will have the equal lowest headline rate of corporation tax – along with Russia and Saudi Arabia – in this eclectic group of economies, as well as at 20pc the lowest by some distance of the G7 major advanced economies. Other G7 countries range from 25pc to a crushing 38pc and 39pc in France and the US. …Britain has also halted the double taxation of repatriated foreign profits and the taxation of controlled foreign subsidiaries.

So the 20 percent corporate tax rate has yielded good results.

Now let’s connect the dots.

More economic activity means more income for taxpayers.

And more income means a bigger tax base.

Which means…can you guess?…yup, it means revenue feedback.

In other words, we have another piece of evidence that the Laffer Curve is very real.

…Reducing corporation tax has reversed the outflow of corporate head office functions, and doing so has substantially added to overall employment, output, income tax, national insurance and VAT receipts. Dynamic modelling by the UK Treasury has shown that lower tax rates are helping to drive a higher overall tax take. The “Laffer curve” lives. …Let business profit from its own enterprise. It’s amazing how effective this principle can be in generating growth, and yes, taxes, too.

If you want more evidence about the Laffer Curve, here’s one of the videos I narrated.

Warner points out, by the way, that the United Kingdom should not rest on its laurels.

If modest reductions in the corporate tax rate are good, then deeper cuts should be even better.

If comparatively minor changes like these to the competitiveness of the tax system can have such dramatic effects, just think what more serious, root and branch tax reform might achieve. In Singapore, the headline rate is 17pc, in Hong Kong 16.5pc and in Ireland just 12.5pc. There’s a way to go.

Though if The U.K. keeps moving in the right direction, that may arouse hostility and attacks from countries with uncompetitive tax systems.

Indeed, the statists at the European Commission have just launched an investigation of three countries for supposedly under-taxing companies.

Here are some blurbs from a report in the Wall Street Journal.

European Union regulators are preparing to open a formal investigation into corporate-tax regimes in Ireland, Luxembourg and the Netherlands… The probe by the European Commission, the EU’s executive arm, follows criticism in Europe of low tax rates paid by global corporations… The probe is likely to consider whether generous corporate-tax regimes in Ireland, Luxembourg and the Netherlands amount to illegal state aid. …The EU’s tax commissioner, Algirdas Semeta, has warned that the region “can no longer afford freeloaders who reap huge profits in the EU without contributing to the public purse.”

This is remarkable.

In the twisted minds of the euro-crats in Brussels, it is “state aid” if you let companies keep some of the money they earn.

This is horrible economics, but it’s even worse from a moral perspective.

A subsidy (or “state aid”) occurs when the government taxes money from Person A and gives it to Person B. But it’s a perversion of the English language to say that a subsidy takes place if Person A gets a tax cut.

By the way, this perverse mentality is not limited to Europe.

The “tax expenditure” concept in the United States is based on the twisted notion that a tax cut that results in more money in your pocket is economically (and morally) equivalent to a spending handout that puts more money in your pocket.

P.S. The United Kingdom also provides us with powerful evidence that the Laffer Curve plays a big role when there are changes in the personal income tax.

P.P.S. Notwithstanding a bit of good news on corporate tax, I’m not optimistic about the U.K.’s long-run outlook. Simply stated, the nation’s political elite is too statist.

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There’s an old saying that there’s no such thing as bad publicity.

That may be true if you’re in Hollywood and visibility is a key to long-run earnings.

But in the world of public policy, you don’t want to be a punching bag. And that describes my role in a book excerpt just published by Salon.

Jordan Ellenberg, a mathematics professor at the University of Wisconsin, has decided that I’m a “linear” thinker.

Here are some excerpts from the article, starting with his perception of my view on the appropriate size of government, presumably culled from this blog post.

Daniel J. Mitchell of the libertarian Cato Institute posted a blog entry with the provocative title: “Why Is Obama Trying to Make America More Like Sweden when Swedes Are Trying to Be Less Like Sweden?” Good question! When you put it that way, it does seem pretty perverse.  …Here’s what the world looks like to the Cato Institute… Don’t worry about exactly how we’re quantifying these things. The point is just this: according to the chart, the more Swedish you are, the worse off your country is. The Swedes, no fools, have figured this out and are launching their northwestward climb toward free-market prosperity.

I confess that he presents a clever and amusing caricature of my views.

My ideal world of small government and free markets would be a Libertopia, whereas total statism could be characterized as the Black Pit of Socialism.

But Ellenberg’s goal isn’t to merely describe my philosophical yearnings and policy positions. He wants to discredit my viewpoint.

So he suggests an alternative way of looking at the world.

Let me draw the same picture from the point of view of people whose economic views are closer to President Obama’s… This picture gives very different advice about how Swedish we should be. Where do we find peak prosperity? At a point more Swedish than America, but less Swedish than Sweden. If this picture is right, it makes perfect sense for Obama to beef up our welfare state while the Swedes trim theirs down.

He elaborates, emphasizing the importance of nonlinear thinking.

The difference between the two pictures is the difference between linearity and nonlinearity… The Cato curve is a line; the non-Cato curve, the one with the hump in the middle, is not. …thinking nonlinearly is crucial, because not all curves are lines. A moment of reflection will tell you that the real curves of economics look like the second picture, not the first. They’re nonlinear. Mitchell’s reasoning is an example of false linearity—he’s assuming, without coming right out and saying so, that the course of prosperity is described by the line segment in the first picture, in which case Sweden stripping down its social infrastructure means we should do the same. …you know the linear picture is wrong. Some principle more complicated than “More government bad, less government good” is in effect. …Nonlinear thinking means which way you should go depends on where you already are.

Ellenberg then points out, citing the Laffer Curve, that “the folks at Cato used to understand” the importance of nonlinear analysis.

The irony is that economic conservatives like the folks at Cato used to understand this better than anybody. That second picture I drew up there? …I am not the first person to draw it. It’s called the Laffer curve, and it’s played a central role in Republican economics for almost forty years… if the government vacuums up every cent of the wage you’re paid to show up and teach school, or sell hardware, or middle-manage, why bother doing it? Over on the right edge of the graph, people don’t work at all. Or, if they work, they do so in informal economic niches where the tax collector’s hand can’t reach. The government’s revenue is zero… the curve recording the relationship between tax rate and government revenue cannot be a straight line.

So what’s the bottom line? Am I a linear buffoon, as Ellenberg suggests?

Well, it’s possible I’m a buffoon in some regards, but it’s not correct to pigeonhole me as a simple-minded linear thinker. At least not if the debate is about the proper size of government.

I make this self-serving claim for the simple reason that I’m a big proponents of the Rahn Curve, which is …drum roll please… a nonlinear way of looking at the relationship between the size of government and economic performance. And just in case you think I’m prevaricating, here’s a depiction of the Rahn Curve that was excerpted from my video on that specific topic.

Moreover, if you click on Rahn Curve category of my blog, you’ll find about 20 posts on the topic. And if you type “Rahn Curve” in the search box, you’ll find about twice as many mentions.

So why didn’t Ellenberg notice any of this research?

Beats the heck out of me. Perhaps he made a linear assumption about a supposed lack of nonlinear thinking among libertarians.

In any event, here’s my video on the Rahn Curve so you can judge for yourself.

And if you want information on the topic, here’s a video from Canada and here’s a video from the United Kingdom.

P.S. I would argue that both the United States and Sweden are on the downward-sloping portion of the Rahn Curve, which is sort of what Ellenberg displays on his first graph. Had he been more thorough in his research, though, he would have discovered that I think growth is maximized when the public sector consumes about 10 percent of GDP.

P.P.S. Ellenberg’s second chart puts the U.S. and Sweden at the same level of prosperity. Indeed, it looks like Sweden is a bit higher. That’s certainly not what we see in the international data on living standards. Moreover, Ellenberg may want to apply some nonlinear thinking to the data showing that Swedes in America earn a lot more than Swedes still living in Sweden.

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