Tag: laffer curve

Dissecting Obama’s Record on Tax Policy

The folks at the Center for Freedom and Prosperity have been on a roll in the past few months, putting out an excellent series of videos on Obama’s economic policies.

Now we have a new addition to the list. Here’s Mattie Duppler of Americans for Tax Reform, narrating a video that eviscerates the President’s tax agenda.

I like the entire video, as you can imagine, but certain insights and observations are particularly appealing.

1. The rich already pay a disproportionate share of the total tax burden - The video explains that the top-20 percent of income earners pay more than 67 percent of all federal taxes even though they earn only about 50 percent of total income. And, as I’ve explained, it would be very difficult to squeeze that much more money from them.

2. There aren’t enough rich people to fund big government - The video explains that stealing every penny from every millionaire would run the federal government for only three months. And it also makes the very wise observation that this would be a one-time bit of pillaging since rich people would quickly learn not to earn and report so much income. We learned in the 1980s that the best way to soak the rich is by putting a stop to confiscatory tax rates.

3. The high cost of the death tax - I don’t like double taxation, but the death tax is usually triple taxation and that makes a bad tax even worse. Especially since the tax causes the liquidation of private capital, thus putting downward pressure on wages. And even though the tax doesn’t collect much revenue, it probably does result in some upward pressure on government spending, thus augmenting the damage.

4. High taxes on the rich are a precursor to higher taxes on everyone else - This is a point I have made on several occasions, including just yesterday. I’m particularly concerned that the politicians in Washington will boost income tax rates for everybody, then decide that even more money is needed and impose a value-added tax.

The video also makes good points about double taxation, class warfare, and the Laffer Curve.

Please share widely.

Higher Taxes on the Rich Are a Precursor to Higher Taxes on the Rest of Us

President Obama repeatedly assures us that he only wants higher taxes on the rich as part of his class-warfare agenda.

But I don’t trust him. In part because he’s a politician, but also because there aren’t enough rich people to finance big government (not to mention that the rich easily can alter their financial affairs to avoid higher tax rates).

Honest leftists are beginning to admit that their real target is the middle class. Here are a few examples.

In other words, politicians often say they want to tax the rich, but the real target is the middle class. Indeed, this is the history of tax policy. In a post earlier this year, warning the folks in the Cayman Islands not to impose an income tax, I noted how the U.S. income tax began small and then swallowed up more and more people.

[T]he U.S. income tax began in 1913 with a top rate of only 7 percent and it affected less than 1 percent of the population. But that supposedly benign tax has since become a monstrous internal revenue code that plagues the nation today.

The same thing is true elsewhere in the world.

Allister Heath explains for London’s City A.M. newspaper.

The introduction of income taxes around the world have tended to follow a very similar pattern over the past couple of centuries. First, we get generally low income tax rates, with most people exempt and with the highest rate only affecting a few people relatively lightly. Eventually, tax rates shoot up for everybody – including to crippling levels for top earners – and millions more are caught by income tax. The next stage is that the ultra-high tax rates for top earners are reduced to manageable levels – but ever more people are brought into the tax system, with the higher brackets also catching vastly more folk.

By the way, you can see that Allister makes a reference to tax rates being reduced for top earners. That’s largely because many politicians learned an important lesson about the Laffer Curve. Sometimes, the best way to “soak the rich” is by lowering their tax rates. Unfortunately, President Obama still needs some remedial education on this topic.

Allister then looks at some specific United Kingdom data revealing how more and more middle class people are now subject to higher tax rates.

The biggest change in the UK has been the number of people paying what is now the 40p tax rate: up six-fold in thirty years, from 674,000 in 1979-80, 2.5m in 1999-2000 to 4.048m in 2011-12. This number will jump again to around 5m in 2014, according to the Institute for Fiscal Studies. When Margaret Thatcher came to power, just 2.6 per cent of taxpayers paid the top rate; by the time of the next election, 16.7 per cent will.

If Obama and other statists get their way, we’ll see similar statistic in the United States. Higher income tax rates for the rich will mean higher income tax rates for the rest of us. Though I’m even more worried about a value-added tax, which would be a huge burden on ordinary people and a revenue machine for greedy politicians.

It’s worth noting, by the way, that the American tax code actually is more “progressive” than the tax codes of Europe’s welfare states. This is largely because we don’t pillage poor and middle-class taxpayers with a VAT.

P.S.: Since I mentioned the Laffer Curve above, I should emphasize that the goal of good tax policy should be to maximize growth, not to maximize tax revenue.

P.P.S.: And don’t forget that poor and middle-income taxpayers also will be hurt because slower growth is an inevitable consequence when tax rates climb and the burden of government spending increases.

France’s Fiscal Suicide

I try to be self aware, so I realize that I have the fiscal version of Tourette’s. Regardless of the question that is asked, I’m tempted to blurt out that the answer is to reduce the burden of government spending.

But sometimes that’s exactly the right prescription, particularly for an economy weighed down by a bloated public sector. And, as you can see from this chart, the French welfare state is enormous.

Only Denmark has a bigger burden of government spending, but at least the Danes are astute enough to compensate with hyper-free market policies in other areas.

So is France also trying to offset the damage of excessive spending with good policy in other areas? Au contraire, President Hollande is compounding the damage with huge class-warfare tax hikes.

Here’s what the Wall Street Journal says about Hollande’s fiscal proposal—including the key revelation that spending will go up rather than  down.

Remember all that euro-babble before the French election about fiscal “austerity” harming growth? Well, meet the new austerity, same as the old austerity, which means higher taxes on the private economy and token discipline for the state. Growth is an afterthought. That’s the lesson of French President François Hollande’s new “fighting” budget, which is supposed to reduce the deficit to 3% of GDP from 4.5% and represent the country’s toughest belt-tightening in three decades. …More telling is that two-thirds of the €30 billion in so-called savings is new tax revenue, and one-third comes from slowing spending growth. Total public expenditure—already the second most lavish in Europe—will increase by €6 billion to 56.3% of GDP.

The spending cuts are fictional, but the tax increases are very, very real.

The real austerity will be imposed on taxpayers, and not only on the rich. Income above €150,000 will now be taxed at 45%, up from the current 41%. Mr. Hollande’s 75% tax rate on income over €1 million comes into effect for two years, reaping expected (and predictably paltry) revenue of €200 million. That’s dwarfed by the €1 billion from reducing the threshold for the “solidarity” tax on wealth to €800,000 from €1.3 million. The French Socialists will also now tax investment income at the same high rates as regular income. The rates have been 19% for capital gains, 21% for dividends and 24% for interest income. If Mr. Hollande’s goal is to send capital out of France, that should help.

Anybody want to take bets, by the way, on whether the “temporary” two-year 75 percent tax rate still exists three years from now?

I say yes, in large part because the tax almost surely will lose revenue because of Laffer Curve effects. But rather than learn the right lesson and repeal the tax, Hollande will argue it needs to be maintained because revenues are “unexpectedly” sluggish.

It’s also remarkable that Hollande wants to dramatically increase tax rates on capital gains, dividends, and interest. These are all examples of double taxation.

And when you factor in the taxes at both the personal and business level, these charts show that France already has the highest tax on dividends in the developed world and the third-highest tax on capital. And Hollande wants to make a terrible system even worse. Amazing.

I’ve already predicted that France will be the next major economy to suffer a fiscal crisis. I was too clever to give a date, but Hollande’s policies are accelerating the day of reckoning.

P.S. The WSJ also takes some well-deserved potshots at the latest fiscal plan in Spain. Since I endorsed Hollande in hopes that he would engage in suicidal fiscal policy, this post is focused on the French fiscal plan. But Spain also is a disaster.

George Leventhal Should Teach Paul Krugman about Public Finance and the Economics of Taxation

Montgomery County in Maryland is not exactly a hotbed of free market thinking or a bastion of limited government.

It’s one of the richest counties in the nation, but not because of entrepreneurship and wealth creation. Instead, it’s a bedroom community filled with over-paid bureaucrats, corrupt lobbyists, fat-cat contractors, and other ne’er-do-wells who commute into Washington and live off the blood, sweat, and tears of people in the economy’s productive sector.

To give you an idea of its political leanings, Obama won 72 percent of the vote in Montgomery County in 2008 and all nine members of the County Council are Democrats.

So you wouldn’t think this is a place where lawmakers ever have anything sensible to say about tax policy. But, lo and behold, one Councilman recognizes that there’s no Berlin Wall surrounding the County. As such, higher tax rates may not generated additional tax revenue if people vote with their feet.

You can listen to George Leventhal by clicking here, but here’s the relevant quote.

We may be reaching a tipping point with tax rates. There’s a point beyond which you can keep raising the tax rates, but you won’t get more revenue because if people leave the county or if new businesses don’t start you’re not getting new revenue.

For the uninitiated, Leventhal is talking about…gasp…the Laffer Curve.

Folks like Paul Krugman would like you to believe that the Laffer Curve is a twisted fantasy concocted by stooges for the rich. He writes that it is “junk economics” to consider the relationship between tax rates, taxable income, and tax revenue.

In the real world, though, at least some left-leaning lawmakers realize that higher tax rates backfire if the geese that lay the golden eggs fly away (as has happened in Italy, France, and the United Kingdom).

Maybe we can take up a collection and hire Mr. Leventhal to do a bit of economics tutoring for a certain Nobel laureate?

P.S. Just in case you’re not convinced by the experiences of a local politician, there is lots of empirical evidence for the Laffer Curve.

The Turbo-Charged Italian Version of the Laffer Curve

Thanks largely to the Laffer Curve, there are some impressive examples of failed tax increases in countries such as the United States, France, and the United Kingdom. But if there was a prize for the people who most vociferously resist turning over more of their income to government, the Italians would be the odds-on favorite to win.

When they’re not firebombing tax offices to show their displeasure, they’re taking to the high seas to escape.

Here are some excerpts from a report in the UK-based Telegraph about runaway yachts.

Thousands are weighing anchor and fleeing with their gin palaces to quiet corners of the Mediterranean to escape a tax evasion crackdown – part of efforts by the government of Mario Monti, the prime minister, to tackle Italy’s €1.9 trillion public debt. …in the ports and marinas they are going after the owners of luxury yachts. Uniformed officers of the Guardia di Finanza, or tax police, are performing on-the-spot checks, boarding boats and checking owners’ details against their tax records. …The unwelcome attention has led many yacht owners to flee Italy’s marinas for friendlier foreign ports, from Corsica and the Cote d’Azur in the west to Croatia, Slovenia, Montenegro and Greece in the east. Others are heading southwards, to Malta and Tunisia - where they can access their boats on low-cost budget flights from Italy for a fraction of the tax bill they might otherwise face.

Not surprisingly, a lot of middle-class people are suffering because of lost business.

Around 30,000 yachts have fled Italy this year, costing €200 million in lost revenue from mooring fees, port services and fuel sales, according to Assomarinas, the Italian Association of Marinas. “We’ve lost 10 to 15 per cent of our regular customers,” said Roberto Perocchio, the president of Assomarinas. “This is the worst crisis in Italian boating history. The authorities are using scare tactics and creating a climate of fear.” …Plans for a further 30,000 new berths have been put on hold. Business is down by more than a third in many marinas, with some half empty compared to last summer. “We’ve lost 40 boats in the last few months, all between 20 and 25 metres long,” said Giovanni Sorci, director of a marina at Rimini, on the Adriatic coast. “Most went to Slovenia – in fact it is so popular that there’s now barely a berth to be had there. …At Porto Rotondo in Sardinia, Giacomo Pileri, the general manager of a 700-berth marina, said at least 150 boats had fled to nearby Corsica. …A steep new tax of up to €700 per day on the largest yachts mooring in Italian ports, introduced by the Monti government in December, was watered down in March to exclude foreign-owned boats. But it has further fuelled the exodus of Italian boats abroad.

And it’s not just yachts that are being targeted by a revenue-hungry government. Here’s a remarkable report from Reuters on what’s happened to the luxury car market (h/t: suyts space).

Italians spooked by rising car taxes and highly publicized tax fraud spot checks cut back their purchases of Fiat’s high-end sports car brands Ferrari and Maserati in the first quarter of 2012, an industry body said on Tuesday. Ferrari sales slumped 51.5 percent, in Italy, and Maserati sales plummeted by 70 percent, said Italian car dealers group Federauto in a statement. Prime Minister Mario Monti’s government has stepped up its fight on tax evasion with spot checks on supercar drivers, as well as higher taxes on large cars. “These figures show how the choices made by the government are literally terrorizing potential clients,” said Federauto chairman Filippo Pavan Bernacchi.

I assume those awful sales numbers are partly because the economy is weak, but well-to-do Italians obviously don’t want to attract attention from the tax police.

The moral of the story is that Italy’s government should try a new strategy. The politicians need to understand that taxpayers don’t meekly acquiesce, like lambs in a slaughterhouse.

Heck, even the folks at the International Monetary Fund (a crowd not known for rabid free-market sympathies) have acknowledged that excessive taxation is the leading cause of the shadow economy.

So rather than trying to squeeze more blood from an unwilling stone, maybe the Italian government should junk the current tax code and adopt a simple and fair flat tax.

To conclude, here’s Part II of the three-part video series on the Laffer Curve, which focuses on historical evidence (including what happened to the yacht market in the U.S. when politicians went after the “rich”).

Sort of makes you wonder why politicians never seem to learn from their mistakes - especially when thoughtful people like me give them free lessons about the relationship between tax rates, tax revenue, and taxable income.

P.S. While I’m very happy to defend tax evasion in cases where government is excessive, venal, and/or corrupt, I suspect that Italians would evade even if they lived under a Hong Kong-style fiscal regime. If that ever happened (don’t hold your breath), even I wouldn’t get upset about crackdowns on yacht owners and Maserati drivers who aren’t declaring any income.

If Tax Policy Is any Indication, Birthers Should Accuse Obama of Being Born in Denmark

I’m not a big fan of government conspiracy theories, largely because the people in Washington are too bloody incompetent to do anything effectively. Heck, sometimes they can’t even waste money properly even though they have lots of practice.

But it recently crossed my mind that maybe President Obama was born in Denmark. Not in a serious way, of course, but you’ll understand my thought process when you read this passage from a report by the government-appointed Danish Economic Council. It doesn’t mention the Laffer Curve, but the report openly states that an increase in the top tax rate would lose revenue because of changes in taxpayer behavior.

…increased taxation on high income earners in Denmark at best is revenue neutral, and may even reduce total tax revenue. This result applies whether one considers the top 10, the top 5 or the top 1 per cent income group. …Using the base estimate of the elasticity of taxable labour income of 0.2, the conclusion is thus that the existing Danish tax system implies an effective tax rate on high income earners that is above - though close to - the tax rate that generates the highest tax revenue. …As an example, the revenue effect of an increase in the marginal tax rate by 6 percentage points for high-income earners is calculated. Using the base estimate of the behavioural response to taxation, this leads to a revenue loss of about ½ billion DKK. …Overall, the scope for acquiring extra tax revenue from high income earners in Denmark is very limited.

Yet there are some politicians in Denmark who want to raise tax rates, even though the damage to the economy will be so significant that the government loses revenue!

If you’re thinking this sounds familiar, you probably remember President Obama’s infamous statement during the 2008 campaign that he wanted to raise the capital gains tax rate for reasons of “fairness” regardless of whether tax revenues decreased (if you think I’m somehow exaggerating or distorting his words, just go to the 4:20 mark of this video).

By the way, the Danish study probably understates how much revenue the government would lose. Their base estimate about the elasticity of taxable labor income (economist jargon for how sensitive labor income is to changes in tax rates) is much lower than Alan Reynolds reported in his recent Wall Street Journal column.

Rich people, unlike the rest of us, have tremendous ability to change the timing, composition, and level of their income, which is a big reason why upper-income taxpayers paid much more to the IRS in the 1980s after President Reagan slashed the top tax rate from 70 percent to 28 percent.

I’m constantly amazed - in a bad way - that politicians and bureaucrats have been so successful in resisting the insights of the Laffer Curve. The U.S. Treasury Department, for instance, is to the left of the Danish Economic Council and basically assumes that tax policy has no impact on economic performance. The same can be said about the Joint Committee on Taxation on Capitol Hill.

This has to be a case of leftist ideology trumping reality, because the evidence for the Laffer Curve is quite powerful - some of it even being produced by international bureaucracies.

None of this is to suggest that “all tax cuts pay for themselves.” That only happens in unusual cases where a group of taxpayers - such as wealthy entrepreneurs and investors - have considerable flexibility in their economic affairs.

In most cases, the government will collect more revenue when tax rates increase. This is because the impact of the change in the tax rate is larger than the impact of the change in taxable income.

But the real question is whether it is ever a good idea to reduce private economic output in order to give politicians more money to spend. To sensible people, that’s the most important insight of the Laffer Curve.

P.S. While this discussion has focused on the foolishness of setting tax rates so high that the government loses revenue, this does not mean politicians should seek the revenue-maximizing tax rate. The ideal point on the Laffer Curve is the growth-maximizing tax rate.

The Laffer Curve Wreaks Havoc in the United Kingdom

Back in 2010, I excoriated the new Prime Minister of the United Kingdom, noting that David Cameron was increasing tax rates and expanding the burden of government spending (including an increase in the capital gains tax!).

I also criticized Cameron for leaving in place the 50 percent income tax rate imposed by his feckless predecessor, and was not surprised when experts began to warn that this class-warfare tax hike might actually result in less revenue because the reduction in taxable income could be more significant than the increase in the tax rate.

In other words, bad policy might lead to a turbo-charged version of the Laffer Curve.

Allow me to elaborate. In most cases, punitive tax hikes do raise revenue, but not as much as politicians predict. As explained in this three-part video series, this is because it takes a very significant reduction in taxable income to offset the revenue-generating impact of the higher tax rate.

But if a tax increase imposes a lot of damage and taxpayers have enough flexibility in their financial affairs, then it’s possible that a tax hike can lose revenue (or, as we saw with Reagan’s “tax cuts for the rich,” a well-designed reduction in tax rates can actually generate higher revenue).

With that background knowledge, let’s now take a closer look at David Cameron’s tax increases. They’ve been in place for a while, so we can look at some real-world data. Allister Heath of City AM has the details.

Something very worrying is happening to the UK’s public finances. Income tax and capital gains tax receipts fell by 7.3 per cent in May compared with a year ago, according to official figures. Over the first two months of the fiscal year, they are down by 0.5 per cent. This is merely the confirmation of a hugely important but largely overlooked trend: income and capital gains tax (CGT) receipts were stagnant in 2011-12, edging up by just £414m to £151.7bn, from £151.3bn, a rise of under 0.3 per cent. By contrast, overall tax receipts rose 3.9 per cent.

Is this because the United Kingdom is cutting tax rates? Nope. As we mentioned in the introduction, Cameron is doing just the opposite.

…overall taxes on labour and capital have been hiked: the 50p tax was introduced from April 2010 (and will fall to a still high 45p in April 2013), those earning above £150,000 have lost their personal allowance, CGT has risen to 28 per cent, many workers have been dragged into higher tax thresholds, and so on. In theory, if one were to believe the traditional static model of tax, beloved of establishment economists, this should have meant higher receipts, not lower revenues.

So what’s the problem? Well, it seems that there’s thing called the Laffer Curve.

…there is a revenue-maximising rate of tax – and that if you set rates too high, you raise less because people work less, find ways of avoiding tax or quit the country. The world isn’t static, it is dynamic; people respond to tax rates, just as they respond to other prices. Laffer told a gathering at the Institute of Economic Affairs that this is definitely true in the UK today – and the struggling tax take revealed in the official numbers suggest that he is right. Tax rates and levels are so high as to be counterproductive: slashing capital gains tax would undoubtedly increase its yield, for example. Many self-employed workers are delaying incomes as much as possible until the new, lower top rate of tax kicks in.

Allister’s column also makes the critical point that not all taxes are created equal.

…higher VAT is also damaging growth, though it is still yielding more. Some taxes can still raise more – but try doing that with income tax, CGT or corporation tax and the result is now clearly counter-productive. These taxes are maxed out; they have been pushed beyond their ability to raise revenues.

Last but not least, he makes an essential point about the role of bad spending policy.

The problem is that spending is too high – central government current expenditure is up by 3.7 per cent year on year in April-May – not that taxes are too low. The result is that the April-May budget deficit reached £30.7bn, some £6.2bn higher than a year ago.

By the way, you won’t be surprised to learn that Paul Krugman has been whining about “spending cuts” in the United Kingdom, even though the burden of the public sector has been climbing. But given his outlandish errors about Estonia, we shouldn’t be surprised.

But that’s not the point of this post. The relevant question is why do politicians pursue bad policy and why do some economists aid and abet bad policy?

For politicians, I think the answer is easy. They simply care about getting elected and holding power. So if they think class-warfare tax policy is the way of achieving those narcissistic goals, they’ll push higher tax rates. Even if it means lower revenue, notwithstanding their usual desire to have more money so they can buy more votes.

I’m more mystified by the behavior of economists. Let’s look at a couple of examples. Justin Wolfers and Mark Thoma recently cited some survey data to claim that the Laffer Curve was universally rejected by the profession.

But as James Pethokoukis of the American Enterprise Institute explained, the survey actually showed just the opposite, with economists by a margin of nearly 5-1 agreeing that lower tax rates could boost GDP (and therefore taxable income).

Those economists did say that a reduction in tax rates, based on current levels, would not cause taxable income to jump by a large enough amount to fully offset the revenue-losing impact of the lower tax rate. But the Laffer Curve says that only happens in extreme circumstances, so there’s zero contradiction.

So why did Wolfers and Thoma create a straw man in an attempt to discredit the Laffer Curve?

I have no idea, but Republican politicians probably deserve some of the blame. Too many of them make silly claims that “all tax cuts pay for themselves,” even when talking about new credits and deductions that have no positive impact on economic performance.

To the extent that Wolfers, Thoma, and others think that’s what the Laffer Curve is all about, then their skepticism is warranted.

But if that’s the case, they should read what Art Laffer actually wrote so they can be more accurate in the future. Or they can watch these three videos.

Part I describes the theory.

Part II describes the evidence.

And Part III explains the sloppy and inaccurate revenue-estimating methodology of the Joint Committee on Taxation.

But if they think I’m too biased or that Art is similarly misguided, then they should look at some of the evidence produced by other economists.

The sooner they get up to speed on these issues, the sooner they can help give politicians good advice so that the Laffer Curve doesn’t cause more unpleasant surprises.