Laffer Curve

10 Key excerpts on "Laffer Curve"

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  eBook - ePub

  The End of Prosperity

  How Higher Taxes Will Doom the Economy--If We Let It Happen

  • Arthur B. Laffer, Stephen Moore, Peter Tanous(Authors)
  • 2008(Publication Date)
  • Threshold Editions

    (Publisher)

  What explains this conundrum? Well, to start, the real-world effect of a tax increase is to take away some of the incentive to work— as George Harrison, Mick Jagger, and Hollywood actor Ronald Reagan discovered. Why should workers or entrepreneurs break their backs if the government is going to take half or more of what they make? Moreover, higher taxes cause high income earners to hire expensive accountants and lawyers to find tax shelters and other means to reduce their tax burden. And high rates can also induce people to move from high-tax places to low-tax places. Conversely, lower tax rates have the reverse effect: a greater incentive to both workers and entrepreneurs to create wealth (and a smaller incentive to engage in tax sheltering). This wealth creation process provides more jobs and more profits, which in turn often spins off more tax revenues than expected—just as Henry George explained the process at the beginning of the chapter.

  Here’s what the Laffer Curve looks like (Figure 2-1 ):

  Figure 2-1: The Laffer Curve

  The central insight of the Laffer Curve is that there are always two tax rates that produce zero revenue. This is obvious when one thinks about it. It is clear that 0 percent taxes produces zero revenues. No surprise there! But there is another tax rate that produces zero revenues, and that’s a tax rate of 100 percent. If the government takes everything you earn you don’t work. (Actually, people would work to sustain themselves, but they would not report the income to the tax collector and thus the government would get nothing.)

  Another insight of the Laffer Curve, as shown in the figure, is that between these two extremes of 0 percent and 100 percent rates of tax, there are two tax rates that will collect the same amount of revenue: a high tax rate on a small tax base and a low tax rate on a large tax base.

  The Laffer Curve doesn’t say whether a tax cut will raise or lower revenues. Revenue responses to a tax rate change will depend upon the tax system in place, the time period being considered, the ease of moving into underground activities, and the prevalence of legal loopholes. As you follow the shape of the curve, notice that when you get most of the way up the line on the left, tax revenues start to go down. The theory is simply saying that at these higher tax rates (in the “prohibitive range”), there is a disincentive to make more money, which will result in lower revenues from taxes. In the end, it’s really all about incentives to work, invest, take risks, and earn money.

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  The Economics of Voting

  Studies of self-interest, bargaining, duty and rights

  • Dan Usher(Author)
  • 2015(Publication Date)
  • Taylor & Francis

    (Publisher)

  t *.

  These are not the only conceivable shapes of the Laffer Curve. Both curves in Figure 4.1 are humped, with no tax revenue at tax rates of 0 per cent and 100 per cent and with a revenue-maximizing tax rate of less than 100 per cent. It is at least conceivable that the Laffer Curve is uniformly upward-sloping, either concave as in Figure 4.2(a) or convex as in Figure 4.2(b) . It turns out that all three shapes are possible.

  Figure 4.1 Two possible shapes of the Laffer Curve.

  Figure 4.2 Two other shapes for the Laffer Curve.

  From the supply curve of taxable income to the revenue-maximizing tax rate

  Taxation is impeded by the taxpayer’s incentive to reduce his tax bill, contracting his observable tax base through outright tax evasion, by working less or by other means. Contraction of the tax base is expensive, for, if that were not so, nobody would pay tax at all. Since taxpayers naturally choose the least expensive way of concealing any given share of the tax base, the marginal cost of contracting the tax base must increase with the proportion of tax base already concealed.

  Imagine a supply curve of taxable income as illustrated in Figure 4.3 with taxable income as perceived by the tax collector, y , on the vertical axis and the ‘price’ of taxable income, (1 − t ), on the horizontal axis. The price of taxable income is like a market price in response to which taxable income is supplied by adjusting the amount of actual income concealed from the tax collector, by changing the supply of labour or by some other means. Regardless of why declared income is affected by the tax rate, Figure 4.3 shows an increase Δt in the tax rate reducing the supply price of taxable income from (1 − t ) to (1 − t − Δt ) and causing taxable income to change from y to y − Δy

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  Taxes Have Consequences

  An Income Tax History of the United States

  • Arthur B. Laffer, Jeanne Cairns Sinquefield, Brian Domitrovic(Authors)
  • 2022(Publication Date)
  • Post Hill Press

    (Publisher)

  Chapter 3 Beyond Piketty: The Laffer Curve Is Alive and Well

  W

  hen tax rates on the rich are raised, revenues per dollar of tax base increase. Equally true is that higher tax rates reduce the incentive of income earners to report taxable income. This shrinks the tax base. In principle, these two effects oppose each other. Therefore, the effect of higher tax rates on total tax revenues is indeterminate. The question, it would appear, is an empi

  rical one.

  In this chapter, we inquire after this empirical question. We ask: What have been the results of taxing the income of the top 1 percent at the various tax rates that have been in place since 1913? We find that in general, tax revenues from the top 1 percent have risen when that group has been taxed at lower rates and fallen when that group has been taxed at hig

  her rates.

  The theoretical relationship between tax rates and tax revenues is what is expressed in the Laffer Curve. As the curve, pictured below, has it, tax rates at both zero and 100 percent collect no revenue (in the latter case, because people decline to engage in taxable activity whose results are confiscated). In between the zero and 100 percent tax rates is a bulbous curve with a maximum point. Tax rates beyond the maximum point put the curve in the “prohibitive” range. Any increase in the tax rate brings a decline in tax revenue. Tax rates before the maximum point are in the “normal” range. Any decrease in the tax rate brings a decline in revenue. Our empirical research presented here shows that tax rates on top income reporters in the United States have largely been in the prohibitive range for the entire history of the income tax. We therefore believe that by having lower tax rates, the United States could both enjoy a greater general prosperity and collect more tax revenues from high-income

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  Political Economy

  • Daniel Usher(Author)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  definition, Δ R is equal to 0. These curves capture the essential features of table 4.1, but they are relevant to any and every tax system where the tax base shrinks because tax payers can divert effort from more taxed to less taxed activities. The hive-shaped relation between tax revenue and tax rate, commonly referred to as the Laffer Curve, is characteristic of all taxation: the taxation of cheese in this example, excise taxation, income taxation, tariffs, and so on. No tax-setter – not a monopoly, not a predatory government, and certainly not a government with the interests of the citizens in mind – would deliberately raise taxes beyond the point where the tax revenue is as large as possible. It has sometimes been alleged that countries have occasionally placed themselves on the wrong side of the Laffer Curve by mistake. Particular taxes may be on the wrong side of the Laffer Curve when some public purpose is served by reducing consumption of the taxed good. The tax on tobacco may be on the wrong side of the Laffer Curve to deter smoking, as discussed in the next chapter. 136 PUTTING DEMAND AND SUPPLY CURVES TO WORK Elasticity as a measure of the steepness of demand and supply curves It is immediately evident from the inspection of figure 4.2 that the steeper the demand and supply curves, the smaller is the deadweight loss as a proportion of the tax revenue. Thus, for choosing among taxes or for estimating the full cost per additional dollar of public expenditure, it would seem helpful to have at hand a standard measure of the steepness of curves. One’s first thought on the matter is that steepness could be measured by the slope, by the change in price per unit change in quantity, or, equivalently, by the change in quantity per unit change in price. Suppose the price of bread is fixed at one dollar per loaf, so that the price of cheese, defined in the first instance as “loaves per pound”, can be reformulated as $ per pound.

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  Handbook of Public Sector Economics

  • Donijo Robbins(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  The new tax responsiveness literature (NTR) looks beyond labor supply effects to include the effect of taxation on total reported taxable income. This literature has argued that it is the responsiveness of taxable income to marginal tax rates, not hours worked, that policy makers should think about when calculating revenue and deadweight losses for determining the optimal size of government, optimal tax rates, and tax reform (Goolsbee, 2000b; Saez, 2001; Burtless and Haveman, 1990). As Goolsbee (2000b) noted:

  Concerns about inefficiency have led some to condemn the tax increases of the 1990s and praise the cuts of the 1980s. Concerns about rising inequality have led others to do the reverse. At the center of the debate is the amount of deadweight loss created by a progressive tax code. The responsiveness of taxable income to marginal rates is exactly what determines that cost and, in principle, is a strictly empirical matter (pg. 353).

  * Named after economist Arthur B. Laffer, the so-called Laffer Curve reflects the tax rate–tax revenue relationship determined by the elasticity of labor with respect to the net wage. For any change in the tax rate, there is a corresponding percentage change in the net wage. Whether tax revenues rise or fall is determined by whether changes in hours worked offset the change in the tax rate.

  The NTR literature is based on the idea that tax cuts, even if they do not increase the number of hours worked, may still increase revenue if they induce people to switch income out of nontaxable forms. For example, Goolsbee (2000b) looked at how marginal tax rates affect reported taxable income rather than hours worked. Goolsbee found that even though the short-run elasticity of taxable income with respect to the net-of-tax share was greater than one, suggesting that the responsiveness of taxpayers to changes in marginal tax rates is substantial, especially among high-income individuals, these changes were due to temporary shifting of taxable income. This also suggests that the deadweight loss of progressivity may be more modest than previously thought.

  Similarly, Slemrod (1996) offered another informative study of the causal connection between the increased incomes of high-income families and the tax changes in the 1980s (i.e., reduction of the top rate of individual income tax from 50 to 28%). His conclusions suggest that increases in reportable income represent shifting of income (i.e., from corporate tax base to the individual income tax) and not income creation from additional labor supply.

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  Fiscal Policy after the Financial Crisis

  • Alberto Alesina, Francesco Giavazzi, Alberto Alesina, Francesco Giavazzi(Authors)
  • 2013(Publication Date)
  • University of Chicago Press

    (Publisher)

  6 How Do Laffer Curves Differ across Countries?

  Mathias Trabandt and Harald Uhlig*

  6.1   Introduction

  We seek to understand how Laffer Curves differ across countries in the United States and the EU-14. This provides insight into the limits of taxation. As an application, we analyze the consequences of recent increases in government spending and their fiscal consequences as well as the consequences for the permanent sustainability of current debt levels, when interest rates are permanently high, for example, due to default fears.

  We build on the analysis in Trabandt and Uhlig (2011). There, we have characterized Laffer Curves for labor and capital taxation for the United States, the EU-14, and individual European countries. In the analysis, a neoclassical growth model featuring constant Frisch elasticity (CFE) preferences are introduced and analyzed: we use the same preferences here. The results there suggest that the United States could increase tax revenues considerably more than the EU-14, and that conversely the degree of self-financing of tax cuts is much larger in the EU-14 than in the United States. While we have calculated results for individual European countries, the focus there was directed toward a comparison of the United States and the aggregate EU-14 economy.

  This chapter provides a more in-depth analysis of the cross-country comparison. Furthermore, we modify the analysis in two important dimensions. The model in Trabandt and Uhlig (2011) overstates total tax revenues to GDP compared to the data: in particular, labor tax revenues to GDP are too high. We introduce monopolistic competition to solve this: capital income now consists of rental rates to capital as well as pure profits, decreasing the share of labor income in the economy. With this change alone, the model now overpredicts the capital income tax revenue. We furthermore assume that only a fraction of pure profit income is actually reported to the tax authorities and therefore taxed. With these two changes, the fit to the data improves compared to the original version (see figure 6.2

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  Margaret Thatcher and Ronald Reagan

  A Very Political Special Relationship

  • J. Cooper(Author)
  • 2012(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Kemp-Roth emerged from these economic debates and articulated in legislative terms the arguments of supply-side economists. Supply-siders argued that non-inflationary eco- nomic growth would follow increased incentives to work, investment and saving. The most effective way to implement this was a reduction of indi- viduals’ marginal tax rates. The central academic economists of supply-side Origins and First Term Cuts 77 theory were Arthur Laffer and Robert Mundell, particularly Laffer, author of the eponymous Laffer Curve. In short, the Laffer Curve demonstrated that tax cuts could be self-financing. The argument was that government revenue was zero if tax rates were at either 100 per cent or zero per cent. Subsequently, tax rates had to be set at their optimum for government reve- nue and as incentives for individuals. In the mid-1970s, Laffer and Mundell met Jude Wanniski, an editorialist for the Wall Street Journal, and the Journal’s Editor-in-Chief, Robert Batley. Following this meeting, the Journal became the leading supporter of supply-side economics in the American press, and Wanniski even produced a supply-side book in 1978 (The Way the World Works). It was Wanniski who introduced Laffer to Kemp. 16 It is important to emphasise that Reagan was not an advocate of supply- side policies until after the 1976 presidential campaign, although he had always opposed deficits and strongly advocated balanced budgets. When interviewed for this study, Laffer recalled that when he was in New Hampshire during Reagan’s unsuccessful 1976 presidential campaign, Reagan had defended his tax-cutting agenda against concerns that it would lead to a deficit by stating that he would eliminate waste, abuse and fraud, and reduce spending. Four years later, Reagan answered the same concerns in New Hampshire by confidently stating that lower taxation would create more economic growth and, in short, there would not be a deficit.

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  Handbook of Public Economics

  • Martin Feldstein, A.J. Auerbach(Authors)
  • 1985(Publication Date)
  • North Holland

    (Publisher)

  Even the “Laffer Curve”, popular for a time among non- economists, might more appropriately be called the “Dupuit curve”: * I am grateful to Angus Deaton, Avinash Dixit, Liam Ebrill, Jerry Hausman, Mervyn King, Randy Mariger. Jack Mintz, Harvey Rosen, Efraim Sadka, Jon Skinner, Nick Stern and Lars Svensson for comments on an earlier draft. ’ Dupuit (1844). ’See. for example, Diewert (1981). Handbook of Public Economics, vol. I, edited by A.J. Auerbach and M. Feldstein 0 1985, Elsevier Science Publishers B. V. (North-Holland) 62 Alan J. Auerbach “If a tax is gradually increased from zero up to a point where it becomes prohibitive, its yield is at first nil, then increases by small stages until it reaches a maximum, after which it gradually declines until it becomes zero again. It follows that when the state requires to raise a given sum by means of taxation, there are always two rates of tax which would fulfill the requirement, one above and one below that which would yield the maximum. There may be a very great difference between the amounts of utility lost through these taxes which yield the same re~enue.”~ The purpose of this chapter is to present the chronological development of the concept of excess burden and the related study of optimal tax theory. A main objective is to uncover the interrelationships among various apparently distinct results, so as to bring out the basic structure of the entire problem. 1.1. Outline of the chapter Any discussion of welfare economics inevitably begins with the problem of welfare measurement, which in the present context involves a treatment of Marshall’s consumers’ surplus and its relationship to Hicks’ (1942) notions of compensating and equivalent variations. These are discussed in Section 2, where special attention is paid to the distinction between the measurement of the welfare effects of price changes and the distortionary impact of tax changes.

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  Destined for Failure

  American Prosperity in the Age of Bailouts

  • Nicolás Sánchez, Christopher F. Kopp Jr., Francis Sanzari, Nicolas Sanchez(Authors)
  • 2010(Publication Date)
  • Praeger

    (Publisher)

  While lower-income earners under the current structure of taxation may not be at this level, research in the field indicates that those earners in top tax tiers may actually have been beyond this maximum in recent years. 15 Additionally, the Laffer Curve illustrates a point vital to this chapter: Incentives matter. The U.S. tax structure has significant effects on economic incentives. In the efforts to raise revenue for the government, it is imperative to consider the incentives and disincentives posed by various structures and levels of taxation. The liabilities presented thus far are substantiated by public opinion about the nation’s tax code. According to a 2007 survey published by the Tax Foundation, 83 percent of the population believed that the tax policy is “very complex or somewhat complex.” 16 Furthermore, “seventy-eight percent [of those surveyed] believe the federal tax system needs ‘major changes’ or ‘a complete overhaul.’ ” 17 While the public may not be able to enumerate the specific pitfalls that impose undue costs on the economy, the general consensus recognizes the existence of the liabilities we present. With this evidence in mind, we must search for an acceptable approach toward reform. VIABLE ALTERNATIVES We turn now to potential measures to mitigate this incredible structural liability within the U.S. economy. Just as the inherent problems with the structure of taxation are not new topics, neither are attempts at reform. In fact, over the years politicians, economists, and a variety of other sour- ces have put forth numerous potential reforms that might address some or all of the liabilities identified within this chapter. While it is impossible to consider every proposed reform, we now strive to identify the most viable and potentially successful alternatives.

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  Rediscovering Social Economics

  Beyond the Neoclassical Paradigm

  • Roger D. Johnson(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Even though Arthur Laffer did not provide empirical evidence that existing tax rates were above this theoretical T*, it was not too difficult to convince the general public that their own individual taxes were too high. This was then translated into the argument that the existing progressive income tax structure was imposing too high a burden on the top income earning individuals who were imputed to be the prime drivers of economic growth. The backward/inverted ‘S’ model of labor, in contrast, suggests these high wages and possible shortages can occur if the individuals oper- ating at the top end of the labor market have the ability to restrain entry by Tax rate Tax Revenue T* $* Fig. 10.3 The Laffer Curve (Arthur B. Laffer “Supply Side Economics.” Financials Analysts Journal. 37, no. 5 (1981): 29–43.) 138 R.D. JOHNSON others into their market segment. 5 Critics of Reagan’s and Thatcher’s economic policies caricatured them as ‘trickle down’ economics. Advocates of the Neoclassical perspective often attempt to dampen concern for the bottom end by appealing to the perception that the stan- dard equilibrium labor market model applies equally to the top and the bottom so the rising tide metaphor also reflected what happened when the tide fell. Looking back to the ‘headless stickman’ model of Fig. 10.1, it may be that the upward and downward movements of W U and W L are synchro- nized, but there is also growing evidence that the spread between them is increasing. As a result, the bottom end may become increasingly mired in an equilibrium situation with higher levels of involuntary unemployment— assuming such a thing exists. The possibility of stagnant or continuously falling wages and persistent involuntary unemployment at points below W 0 has, for good reason, attracted more passion and concern than the problem of a potential labor shortage at the top since it obviously raises fears about the ability of lower income individuals to meet their basic needs.

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