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Posts Tagged ‘Laffer Curve’

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

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

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

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

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

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

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

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Jeffrey Sachs of Columbia University is a big booster of the discredited notion that foreign aid is a cure-all for poverty in the developing world, but he is now branching out and saying silly things about policy in other areas.

In a column for the Financial Times, he complains that tax competition is forcing governments to “race to the bottom” with regards to tax rates. The answer, he wants us to believe, is some sort of global tax cartel. Sort of an “OPEC for politicians” that will facilitate the imposition of higher tax rates.

Only international co-operation can now solve what is becoming a runaway social crisis in many high-income countries. …With capital globally mobile, moreover, governments are now in a race to the bottom with regard to corporate taxation and loopholes for personal taxation of high incomes. Each government aims to attract mobile capital by cutting taxes relative to others. …countries cannot act by themselves. Even the social democracies of northern Europe, with their balanced budgets and high tax rates, are increasingly being pulled into the vortex of tax cutting and the race to the bottom. …recent trends…require increased, not decreased, taxation of higher incomes, including corporate profits; and that tax and regulatory co-ordination across countries are vital to prevent a ruinous fiscal race to the bottom.

If this overwrought rhetoric is true, it would mean that governments have been starved of revenue because of race-to-the-bottom tax cuts for evil corporations and sinister rich people. Well, it is true that tax competition over the past 30-plus years has resulted in lower tax rates. But do lower tax rates mean less tax revenue, as implied by Sachs’ analysis?

At the risk of being impolite and shattering anyone’s illusions, let’s actually see what happened to the overall tax burden on both personal and corporate income.

This chart, showing the average for industrialized nations, shows that Sachs and his ilk are wrong. Way wrong. Tax rates have come down, but the overall tax burden actually has increased. So while there may be a race to less-destructive tax rates, there certainly isn’t a race to bottom for tax revenue.

Hmmm….lower tax rates and higher tax revenue. That seems vaguely familiar. Maybe it has something to do with “supply-side economics.” One can only wonder if Sachs has heard about that strange idea known as the Laffer Curve.

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

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

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

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

…on one subject, Europe’s soccer stars have an important message for Americans:

Tax rates.

It turns out that highly paid soccer players are sensitive to taxes. They tend to move to those nations that give them a break. Why is Spain’s top league a sudden soccer powerhouse? One reason is tax policy. Why are Denmark and Belgium’s leagues stronger than in other similar countries? Ditto.

In perhaps the first study to provide compelling evidence of a link between tax rates and worker migration, three economists look at this highly paid, highly mobile workforce and make several surprising conclusions:

1) Top marginal tax rates matter to big earners.

2) If you’re going to cut taxes to lure such highly skilled workers, make it a big tax cut. Otherwise, it won’t have much effect.

…Professor Saez and his colleagues found something striking: The leagues in low-tax nations attracted better players and had better teams.

The effect was also pronounced in individual nations that reformed their taxes. For example, Spain in 2004 introduced a new flat rate of 24 percent for foreign soccer players, nearly half the top marginal rate it charged its residents. After that law – called the “Beckham law” because British star David Beckham took advantage of it – Spain saw its share of foreign players increase while the foreign talent in nearby Italy shrank. Tax cuts for foreign players in Denmark and Belgium had similar effects.

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

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

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

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

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

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

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

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

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

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I write about the Laffer Curve so often that I’m surprised people don’t run away screaming. But I’ll continue to be a pest because I want people to understand that you can’t just look at changes in tax rates when predicting changes in tax revenue. You also have to consider changes in taxable income.

Simply stated, my goal is for people to recognize that higher tax rates lower incentives to earn and report income and lower tax rates increase incentives to earn and report income. However, I also want people to understand that this doesn’t mean “all tax cuts pay for themselves.” That only happens in very rare cases. Moreover, it would be good if people recognized that there are lots of factors that influence the economy’s performance, and it’s therefore important to be cautious when making claims about the relationships between tax rates, taxable income, and tax revenue.

So we many not be able to precisely measure the impact of the Laffer Curve, we know it’s there and we know it can be very significant. We also know that economic incentives are not constrained by national borders. The Laffer Curve exists even in nations where politicians generally are not sympathetic to good tax policy. France naturally comes to mind, and here are some excerpts from a new report from Pierre Garello. He examines recent changes in tax rates and the tax base, and finds that better tax policy is having a positive impact.

In 2006 a major change was implemented in France regarding the income tax. Not only the top marginal rate was lowered (from 48.09% to 40.00%), but the same treatment was applied to the other rates. Also, the number of brackets was reduced from 7 to 5. As a result, whatever the level of taxable income, the rate applied was lower after the changes took place than before. …the tax base was also enlarged. In particular, while 20% of gross income from salaries was until then automatically deduced to compute the level taxable income, this was no longer the case with income earned in 2006 and after. …Based on data from the French Public Finances General Directorate (DGFiP) we can see that the impact was a minor drop in tax revenues from the 2006 personal income followed by a slightly higher increase in PIT revenues from 2007 earnings. As illustrated by the graph below, the successive cuts in marginal tax rates between 1995 and 2007 have resulted in higher tax revenues.

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It may not be very nice to say “I told you so” when the warnings you issue become reality, but I’m not a nice person (at least when it comes to greedy politicians imposing stupid policy).

So I’ll openly admit that I’m happy to read that entrepreneurs and job creators already are beginning to escape the kleptocrat politicians in Illinois. Here are a few highlights of an article in the News-Gazette.

The founder of Jimmy John’s said he has applied for Florida residency and may recommend that his corporate headquarters move out-of-state as a result of the Illinois tax increases enacted last week. Jimmy John Liautaud told The News-Gazette on Tuesday that he is angry about the moves, which boosted the individual income tax from 3 percent to 5 percent and the corporate income tax from 7.3 percent to 9.5 percent. “All they do is stick it to us,” he said, adding that the Legislature and governor showed “a clear lack of understanding.” …Jimmy John’s, which has its corporate headquarters on Fox Drive in Champaign, has more than 1,000 sandwich shops nationwide, many of them franchise operations. Champaign has been its corporate base, but Liautaud said it will not necessarily continue that way. …Once he collects information on alternative sites, he will present it to the company’s board of directors and ask the board to decide. As for himself, “my family and I are out of here,” he said. …Jimmy John’s employs 100 at the corporate office in Champaign and has 190 other employees who work elsewhere but come to Champaign every four weeks, Liautaud said. …He said he’s sick of being “pummeled.” “I’m not sophisticated enough, smart enough or politically correct enough to absorb it all,” he said. Jimmy John’s offices occupy 23,000 square feet on Fox Drive, and Liautaud said he had considered buying a 20,000-square-foot building just north of those offices. Those plans went out the window with the tax increase, he said. …James North, president of Jimmy John’s, echoed many of the same sentiments. “I absolutely love it here,” North said. “But when you do the math, it doesn’t add up. Florida looks pretty nice right now.”

It goes without saying, of course, that Illinois is not the only short-sighted state. New York politicians also have a fetish for driving taxpayers to other states.

A special welcome to Instapundit and NRO readers, and an addendum. This example of people and businesses escaping bad policy by crossing borders is more than just a cheerful anecdote. It is part of a process known as tax competition, which  is a powerful force for better policy between both states and nations.

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The Laffer Curve is one of my favorite issues (see here, here, here, here, here, etc). But it is a very frustrating topic. Half my time is spent trying to convince left-leaning people that the Laffer Curve exists. I use common-sense explanations. I cite historical examples. I even use information from left-of-center institutions in hopes that they will be more likely to listen.

The other half of my time is spent trying to educate right-leaning people that the Laffer Curve does not mean that “all tax cuts pay for themselves.” I relentlessly try to make them understand that there is a big difference between pro-growth tax cuts that increase incentives for productive behavior and therefore lead to more taxable income and other tax cuts such as child credits that have little or no impact on economic performance.

Given my focus on this issue (some would say I’m tenacious, others that I’m bizarrely fixated), I was excited to see a column from the editor of a business paper in the United Kingdom about a tax increase that backfired in a truly spectacular fashion. It deals with the taxation of rich foreigners, called “non-doms,” who often choose to live in London because the U.K. government does not tax them on their foreign income. But then the Labor Party, with the support of spineless Tories, imposed an annual fee of £30,000 (about $45,000-$50,000) on these highly productive people.

The rest, as they say, is history.Here’s a long extract, but you should read the entire article.

Figures out last night confirmed yet again that crippling tax hikes are driving people and economic activity away from Britain. Rather than raising extra tax receipts to plug Britain’s budget deficit, there is growing evidence that the raids are actually reducing the amount of money collected by the taxman, thus inflicting even greater debt on the rest of us. Our predicament is depressing almost beyond words.

The number of non-doms living in the UK collapsed by 16,000 in 2008-09, the most recent year for which data is available, according to yesterday’s figures. This is a dramatic decline: an 11.6 per cent drop from 139,000 in 2007-08 to 123,000. When in April 2008 Labour – egged on by the Conservatives – introduced an annual levy of £30,000 for those who had claimed non-dom status for seven years, pundits dismissed the tax as too low to make a difference.

…Non-doms are people who originated overseas and pay UK tax on their UK earnings but no tax on their foreign income. The original non-doms were Greek shipping moguls who fled their socialist country to base themselves (and their businesses) in London. Until recently, the UK fought to attract such people; they pay a lot of UK tax and are often employers or high spenders. Yesterday’s figures actually underplay the true extent of the exodus: the departure of non-doms is bound to have accelerated in 2009-10 and will continue in the coming years as a result of the 50p tax rate, the hike in capital gains tax, the extra national insurance contributions and the near-hysterical war on financiers and myriad other attacks on wealth-creators and foreign investors that are now routine in this country.

…The Treasury told us 5,400 non-doms opted to pay the fee. This means that the taxman raised an extra £162m. The Treasury wouldn’t or couldn’t give us any more information, so I’ve made a few guesstimates to work out the net cost of the tax raid. Being over-generous to the government, it might be that half the missing non-doms are now full taxpayers. Let’s assume they are paying an extra £15,000 in tax each. That would make another £120m in tax, taking the total to £282m. Let’s then assume that the 8,000 missing non-doms would have paid £50,000 each in UK income tax, capital gains tax, VAT and stamp duty – the gross loss jumps to £400m, which means that the Treasury is £118m worse off. The real loss is almost certainly much higher.

In other words, this is one of those rare cases where a tax increase is so punitive that the government winds up losing money. In a logical world, this should be an opportunity for the left and right to unite for lower taxes. The left would get more money to spend and the right would get the satisfaction of better tax policy. This assumes, however, that the left is more motivated by revenue maximization than it is by a class-warfare impulse to punish the rich. As Obama said during a Democratic debate in 2008, he didn’t care whether higher taxes raised more revenue.

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