Tag: laffer curve

Real World Evidence for the Laffer Curve from the Government of Washington, DC

President Obama is proposing a series of major tax increases. His budget envisions higher tax rates on personal income, increased double taxation of dividends and capital gains, and a big increase in the death tax. And his health care plan includes significant tax hikes, including perhaps the imposition of the Medicare payroll tax on capital income – thus exacerbating the tax code’s bias against saving and investment. It is unclear why the White House is pursuing these punitive policies. The President said during the 2008 campaign that he favored soak-the-rich taxes even if they did not raise revenue, but his budget predicts the proposals will raise lots of money.

Because of the Laffer Curve, it is highly unlikely that all of this additional revenue will materialize if the President’s budget is approved. The core insight of the Laffer Curve is not that all tax increases lose money and that all tax cuts raise revenues. That only happens in rare circumstances. Instead, the Laffer Curve simply reveals that higher tax rates will lead to less taxable income (or that lower tax rates will lead to more taxable income) and that it is an empirical matter to figure out the degree to which the change in tax revenue resulting from the shift in the tax rate is offset by the change in tax revenue caused by the shift in the other direction for taxable income. This should be an uncontroversial proposition, and these three videos explain Laffer Curve theory, evidence, and revenue-estimating issues. Richard Rahn also gives a good explanation in a recent Washington Times column.

Interestingly, the DC government (which certainly is not a bastion of free-market thinking) has just acknowledged the Laffer Curve. As the excerpt below illustrates, an increase in the cigarette tax did not raise the amount of revenue that local politicians expected. The evidence is so strong that the city’s budget experts warn that a further increase will reduce revenue:

One of the gap-closing measures for the FY 2010 budget was an increase in the excise tax on cigarettes from $2.00 to $2.50 per pack. The 50 cent increase in the cigarette tax rate was projected to increase revenue but also reduce volume. Collections year-to-date point to a more severe drop in volumes than projected. Anecdotal evidence suggests that Maryland smokers who were purchasing in DC in FY 2008, because the tax rate in the District was less than the tax rate in Maryland, have shifted purchases back to Maryland now that the tax rate in the District is higher. Virginia analyzed the impact of demand when the federal rate went up by $0.61 in April and has been surprised that demand is much stronger than they had projected–raising the possibility that purchasing in DC has moved across the river.  Whatever the actual cause, because of the lower than anticipated collections, the estimate for cigarette tax revenue is revised downwards by $15.4 million in FY 2010 and $15.2 million in FY 2011. Given that cigarette tax rates in neighboring jurisdictions are now lower than that of the District, future increases in the tax rate will likely generate less revenue rather than more.

The Fox Butterfield Effect and the Laffer Curve

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

Recent IRS data show that rich people earned a record amount of income in 2007 and also faced their lowest effective tax rate in almost two decades. Proponents of soak-the-rich tax policy complain about these developments, as seen in the Bloomberg excerpt below, but they seem oblivious to the Laffer Curve insight that rich people earned more income in part because tax rates were lower. So if they penalize the rich with higher tax rates, as President Obama is proposing, they will be disappointed to discover that they collect considerably less revenue than predicted for the simple reason that wealthy taxpayers will respond by earning less taxable income.

The 400 highest-earning U.S. households reported an average of $345 million in income in 2007, up 31 percent from a year earlier, IRS statistics show. The average tax rate for the households fell to the lowest in almost 20 years. …The statistics underscore “two long-term trends: that income at the very top has exploded and their taxes have been cut dramatically,” said Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities, a Washington-based research group that supports increasing taxes on high-income individuals.

As an aside, it’s also worth noting that the IRS tax-rate numbers are very misleading. The tax burden on the rich has dropped largely because of lower tax rates on dividends and capital gains. But when the IRS says upper-income taxpayers had an average tax rate of 16.6 percent, this does not include the other layers of tax that are imposed. The corporate income tax is 35 percent (just counting the federal level), for instance, so the actual average tax rate on these forms of income is far higher. Double taxation is counterproductive to growth and competitiveness, though, which is why the correct tax rate on dividends and capital gains is zero. For more on the Laffer Curve, this three-part video series addresses theory, evidence, and the biased revenue-estimating process.

Revenge of the Laffer Curve, Part II

An earlier post revealed that higher tax rates in Maryland were backfiring, leading to less revenue from upper-income taxpayers. It seems New York politicians are running into a similar problem. According to an AP report, the state’s 100 richest taxpayers have paid $1 billion less than expected following a big tax hike. The story notes that several rich people have left the state, and all three examples are about people who have redomiciled in Florida, which has no state income tax. For more background information on why higher taxes on the rich do not necessarily raise revenue, see this three-part Laffer Curve video series (here, here, and here):

Early data from New York show the higher tax rates for the wealthy have yielded lower-than-expected state wealth.

…[New York Governor David] Paterson said last week that revenues from the income tax increases and other taxes enacted in April are running about 20 percent less than anticipated.

…So far this year, half of about $1 billion in expected revenue from New York’s 100 richest taxpayers is missing.

…State officials say they don’t know how much of the missing revenue is because any wealthy New Yorkers simply left. But at least two high-profile defectors have sounded off on the tax changes: Buffalo Sabres owner Tom Golisano, the billionaire who ran for governor three times and who was paying $13,000 a day in New York income taxes, and radio talk-show host Rush Limbaugh.

…Donald Trump told Fox News earlier this year that several of his millionaire friends were talking about leaving the state over the latest taxes.

Revenge of the Laffer Curve

Steve Moore and Art Laffer have an excellent column in today’s Wall Street Journal. They explain that high-tax states drive repel entrepreneurs and investors, leading to a pronounced Laffer Curve effect. Productive people either leave the state or choose to earn and report less taxable income. And because growth is weaker than in low-tax states, there also is a negative impact on lower-income and middle-class people:

Here’s the problem for states that want to pry more money out of the wallets of rich people. It never works because people, investment capital and businesses are mobile: They can leave tax-unfriendly states and move to tax-friendly states. …Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts. …Dozens of academic studies – old and new – have found clear and irrefutable statistical evidence that high state and local taxes repel jobs and businesses. …Examining IRS tax return data by state, E.J. McMahon, a fiscal expert at the Manhattan Institute, measured the impact of large income-tax rate increases on the rich ($200,000 income or more) in Connecticut, which raised its tax rate in 2003 to 5% from 4.5%; in New Jersey, which raised its rate in 2004 to 8.97% from 6.35%; and in New York, which raised its tax rate in 2003 to 7.7% from 6.85%. Over the period 2002-2005, in each of these states the “soak the rich” tax hike was followed by a significant reduction in the number of rich people paying taxes in these states relative to the national average.

Interestingly, the Baltimore Sun last week published an article noting that the soak-the-rich tax imposed last year is backfiring. There are fewer rich people, less taxable income, and lower tax revenue. To be sure, some of this is the result of a nationwide downturn, but the research cited by Moore and Laffer certainly suggest that the state revenue shortfall will continue even after than national economy recovers:

A year ago, Maryland became one of the first states in the nation to create a higher tax bracket for millionaires as part of a broader package of maneuvers intended to help balance the state’s finances and make the tax code more progressive. But as the state comptroller’s office sifts through this year’s returns, it is finding that the number of Marylanders with more than $1 million in taxable income who filed by the end of April has fallen by one-third, to about 2,000. Taxes collected from those returns as of last month have declined by roughly $100 million. …Karen Syrylo, a tax expert with the Maryland Chamber of Commerce, which lobbied against the millionaire bracket, said she has heard from colleagues who are attorneys and accountants that their clients moved out of state to avoid the new tax rate. She said that some Maryland jurisdictions boast some of the highest combined state and local income tax burdens in the country. “Maryland is such a small state, and it is so easy to move a few miles south to Virginia or a few miles north to Pennsylvania,” Syrylo said. “So there are millionaires who are no longer going to be filing Maryland tax returns.”

With President Obama proposing higher tax rates for the entire nation, perhaps this is a good time to remind people about the three-part video series on the Laffer Curve that I narrated. If you have not yet had a chance to watch them, the videos are embedded here for your viewing pleasure: