The Laffer Curve

Let us suppose you are a smart ambitious guy, and have a big idea that you think can change the world, and make a great big pile of money. You run your idea before some angel investors, and they think it is worth a shot. So you, and they, form yourselves into a class C corporation. You are probably pretty well off, and they are probably really well off, so you are paying the maximum tax rate.

Miraculously, your idea turns out to be hot stuff, and the corporation makes a hundred million dollars – which sounds like a lot, but in order to get there, you had to cut the angel investors in for a share, the next round investors in for a share, various highly talented people who joined the company in for a share … But before they get their share, the government wants its share.

Unfortunately the U.S. corporate tax rate is 39.2%. Now you have $60 800 000 in net income. If you are in the state of California, they want 8.84 percent corporate tax. So now you have 51 960 000. OK, this gets split between the various investors, the founding employees, and you, all whom are probably paying at the maximum marginal tax rate. So after it is paid out, the feds want 35%, and California wants 10%, so now that is down to 28 000 000 or so. And then you spend it, and there is sales tax, so now that is down to 26 000 000 or so.

Thus, three dollars for the taxman, one dollar for you.

Of course, should your plan fail, and everyone lose their money, that is your problem, not the government’s.

It is often said that the Bush tax cuts disproved the Laffer curve, since they arguably reduced, rather than increased federal receipts, but that is because they were mostly tax cuts on the poor. They substantially reduced the number of people paying any income tax at all. To the extent that they cut taxes on the rich, they greatly increased receipts from the rich, almost enough to offset the reduced receipts from the poor.

Taxes on the rich in the US are far, far east of the Laffer Maximum.

There is plenty of room for the US government to raise more money by taxing the poor – taxing beer, cigarettes, and petrol. A Pigovian tax on single moms and broken homes would also, like the Pigovian tax on booze, improve behavior, while raising money without harming the economy too much – except of course that any money spent by the government, is, at the margin, spent on damaging and hurtful things, so that while a Pigovian tax on broken homes and fatherless children would improve private behavior, it would worsen government behavior. Giving money to the government is like giving money to a drunken mugger.

But if they want to raise revenue to get money to hand out to crony capitalists, taxing the rich is a dry well. They have to tax the poor. Taxing beer and cigs has reached their Laffer curve limits also.. The last untapped Pigovian sin tax is fatherless children and broken homes. If our rulers don’t want to piss off the feminists by extending sin taxes to new sins, they have to do what Europe does: Tax fuel, food, clothes, and such.

In Europe, all the wells are dry. Europeans are far, far east of the Laffer curve maximum even for taxes on the poor, except that for reasons of feminism, they have not touched the last Pigovian sin tax.

Every time England, Spain, or Greece raise taxes, tax receipts immediately fall, and fall a lot. This rationalized away as Keynesian recession. Supposedly taxes are reducing demand. But for taxes to reduce demand, they would have to raise money, at least at first. Since the tax rises immediately lose money, they are not reducing demand, but reducing supply.

Nonetheless, if we look at the European “austerity” budgets, they are all tax rises today, spending “cuts” tomorrow, the “cuts” being that at some time in the future, expenditures will rise by less than planned, and people who expected to have government jobs and handouts someday in the future will, someday, not have them.

Predictably, the “austerity” tax rises raise tax rates today reducing revenue today, while the “austerity” spending cuts may reduce spending some time, some time, some day, so the European austerity budgets “unexpectedly” fail to reduce the deficits. Seems that most economic headlines these days have the word “unexpected” in them.

If you are going to cut the US deficit, the place to start is massive tax cuts on the rich, and end to handouts to crony capitalists and the poor. All government involvement in the finance sector, green energy, and the rest, is crony capitalist handouts. Social security supplemental is ninety nine percent handouts to the undeserving poor, for example people who say their sexual deviations and alcohol habit prevents them from working, or that they are victims of discrimination on the basis of mental handicap, race, criminal past, and gender, for example people suffering from a mental syndrome that forces them to scream obscenities at bosses, fellow employees, and customers, not to mention all those people with bad backs – but I digress. Back to the Laffer curve.

How far east of the Laffer Maximum is Greece? The proportion of Singaporean residents aged 25 to 64 in employment is 77.1% In Greece, about half that.

With that rate of labor participation, obviously the way for the Greek government to raise more money is to cut handouts and taxes, which is the opposite of what the Greek government is doing.

I notice that whenever these “unexpected” falls in revenue are discussed, people piously proclaim them as evidence for the truth of Keynesianism, which suggests that in Academia blaming revenue falls on the Laffer curve is as dangerous as blaming black dysfunction on a genetic propensity to stupidity and violence. When curiously few people are working, it is obviously the Laffer curve. (At least if we include regulatory burdens such as that employees are fireproof once hired as part of the Laffer curve burden.) But try getting an academic, or anyone whose job is government dependent, to say that.

Now with taxes like that, one might wonder how America functions at all. The answer is quite simple. If your business starts making any money, then you apply the same energy, effort, and ingenuity you spent creating the business to moving all income generating activities outside of the US. If it was not for tax dodging and the export of wealth generating activities, the US would be a third world hell hole.

8 Responses to “The Laffer Curve”

  1. Bill says:

    Of course, should your plan fail, and everyone lose their money, that is your problem, not the government’s.

    It’s not quite that bad. You can write off losses against current and future gains, at least if you’re doing it right. I can’t remember whether and to what extent you can write off current losses against past gains. But, Uncle Sam shares in your losses to some extent.

    Also, you don’t pay profits out of the corporation in the form of pay or dividends if you can avoid it (and you can), so the top tax rates you are citing in Uncle Sam’s second cut are 15%, not 35%, at worst. If you are smart, you don’t ever pay out the profits, and you pass the shares down to your children. At that point, you get a “free” re-basing of the stocks, eliminating (for tax purposes) all capital gains to that point. So, the right tax rate for the second cut may even be zero. The existence of the tax lawyering and estate planning industries strongly suggests that there are lots of ways around paying taxes if you have enough money for there to be any point to the effort. Also, corporations do tax planning as well. Their profits for tax purposes and their profits are often not the same. Finally, state taxes are a function of where you live, and you can choose to live in a place with no income tax or with favorable treatment of capital gains. And I don’t know much about tax avoidance—it’s a big field with lots of techniques.

    To the larger point, you are taking rich to mean venture capitalists. If you take rich to mean Wall St parasite, Fortune 500 CEO or whatever, then the argument is much weaker. These guys are going to rip people off less if we raise their taxes? I doubt it, and, even if it’s true, it’s a good thing not a bad thing for them to rip people off less. Maybe they will decamp for points east or something. That would be excellent. Let them rip off the Chinese.

    • jim says:

      Also, you don’t pay profits out of the corporation in the form of pay or dividends if you can avoid it (and you can),

      You cannot entirely avoid it. Corporations pay out a fair bit of their profits. It is hard to get the money into the hands of shareholders any other way. And if the money is not getting into the hands of shareholders, which in large part it is not, that also reduces incentives.

      The existence of the tax lawyering and estate planning industries strongly suggests that there are lots of ways around paying taxes if you have enough money for there to be any point to the effort.

      Aside from special favors done to crony capitalists, which are not available to most people, the only really effective tax minimization strategy is to move your profit centers to a low tax regime, while keeping your cost centers in the high tax regime.

      state taxes are a function of where you live, and you can choose to live in a place with no income tax or with favorable treatment of capital gains

      Hence the collapse of the California tax base, illustrating the title of this post “The Laffer Curve”.

      If you take rich to mean Wall St parasite, Fortune 500 CEO or whatever, then the argument is much weaker. These guys are going to rip people off less if we raise their taxes? I doubt it, and, even if it’s true, it’s a good thing not a bad thing for them to rip people off less. Maybe they will decamp for points east or something.

      But the parasites cannot decamp, because their wealth comes entirely from crony capitalism, from favors from the government and connections with it – for example, the fed lends certain banks money at zero interest, and they lend it back at finite interest. And they generally have special arrangements in the tax code for them personally, tax breaks very very narrowly specified so that only a single person or a handful of people qualify, so that they pay no taxes.

      • Bill says:

        As a point about California, I believe it. In the intermediate to long run (i.e. on a timescale long enough for businesses to relocate), California is likely deep into decreasing returns to additional taxation. It’s not that hard to start your business up in Utah or Idaho or Taiwan instead of California.

        • jim says:

          A huge exodus is underway from California, causing an ever escalating budget crisis.

          However most of Europe is not only east of the long run Laffer Curve peak, they are well and truly east of the short run peak, even for taxes on the working poor. I am puzzled why they keep raising taxes when it is so obviously and immediately counterproductive. They raise taxes, immediately revenues go down, so they raise them some more.

          I am inclined to blame shear malice and spite. The permanent bureaucracy cannot make themselves richer, so make everyone else poorer.

  2. Alrenous says:

    Oh hell, I’ve been an idiot.

    Official tax rates are ~35% of GDP. But what is GDP? It includes the government paying the money out again. That’s 2/3rds right there.

    So even official statistics confirm that prices are dominated by taxes, often upwards of 70% of any outlay ends up in government hands.

    I was initially skeptical of my 4:1 estimate because it was so high, but every analysis I’ve seen confirms it. This is the first of two I’ve seen confirming it just this week.

      • jim says:

        This analysis is excessively model dependent – despite the apparent science and maths, it is about as good as sticking one’s thumb into the air and saying “looks like …”. Which does not mean it is wrong, it is probably about right, but sticking one’s thumb into the air is probably also about right. In economics, excessively elaborate models reduce accuracy, rather than improve it.

        In Trabandt and Uhlig (2011), we have shown that the consumption tax Laff er curve has no peak

        They have shown something that cannot possibly be true. If your consumption tax was a million percent, one dollar for the shopkeeper, ten thousand dollars for the state, would that produce any revenue?

        It is pretty obvious that Greek consumption taxes are east of their Laffer peak. Every time the Greek government raises the consumption tax, there is an immediate and substantial fall in revenue. Similarly recall the ill fated US consumption tax on luxury yachts.

        That they produce one absurd conclusion casts doubt on all their conclusions. If they underestimate the Laffer effect on consumption taxes, probably underestimate it on all taxes.

  3. […] Jim says that the developed countries are to the right of Laffer curve’s peak, and makes tart remarks […]

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