Yet Again, Tax Cuts Do Not Pay for Themselves

The Wall Street Journal says Kevin Hassett has discovered the Laffer curve, but I think these data might say something else. Here's the picture from the editorial where they are making their usual plea for more tax cuts:

The blue line is supposed to be the Laffer curve, but this is far from compelling. Since it looks like all that's been done here is to draw a line through an outlier, Norway (an outlier that in other contexts we are told to ignore because it is an outlier, e.g. see below), and since this is clearly not the best fitting line to these data, here's another possibility:

I haven't actually run the regression, but it looks clear to me that revenues rise with tax rates, and the fit also looks better than in the first graph. Toss out Norway, and the fit looks even better (and to quote The Economist blog on this point, "Throwing out Norway...").

I know how much supply-siders want to find a Laffer curve, they've become frustrated going this long without success. But if they really think one exists they'll need to keep looking because they haven't found it yet. [Update: Max has estimates.][Update: Response(s) to a post at The Economist's blog,  Free Exchange.]

Comments

[Tim Worstall]

The Laffer Curve doesn't exist? Good grief! Come along now, it exists all right, it's the shape and where we are on it that's at issue. A 100% tax rate will, in time, raise no revenue as people simply do not engage in that behaviour. A 0% one similarly, no revenue. As a 1% one will raise some, we have a curve there.
Worth also noting that "supply side" economics does not rest upon the Laffer Curve, nor on solely lowering marginal tax rates. It's, as the name suggegsts, about reform of the supply side of the economy. Opening up AT&T's old monopoly of long distance phone calls was supply side, more so perhaps than any tax changes.

[Cyrille]

"A 100% tax rate will, in time, raise no revenue as people simply do not engage in that behaviour."

You know, that'd be a very hard point to make. I strongly doubt that there is ABSOLUTELY no other reason than direct revenue to engage in an activity. Look how bitterly the elections to a non-paid position can be fought...

And just because you'd tax at 100% would not mean that you would not give anything. If what you get is somehow indexed on performance then there is clear incentive to do something.
It is not even certain by logical reasoning that 100% tax rate cannot be the one yielding the highest revenue. As for actually finding a Laffer curve by econometrics... I'm yet to see one indeed.

[bakho]

Laffer (Laugher?) curves are truthiness peddled to the public to support tax cuts for the wealthy.

Why is corporate income tax used in the above graphs? I thought Laffer curves supposedly apply more to individuals? Do the Laffer arguments about working harder under lower taxes (is this correct?) also apply to corporations?

[ken melvin]

They should look more closely at pancakes, sandwiches, tree leaves, ..., and things like that for images of the curve.

[oops]

is there a point at which taxes decrease revenue? seems like the 100% and 0% is a no brainer but is there enough data out there to determine where the inflection point would be?

[robertdfeinman]

I've debunked the Laffer curve before:
There is no Laffer Curve

Just to cite one of the assumptions - tax receipts go to zero at 100% tax rate since no one would work. During WWII there were lots of "dollar a year men" who worked for nothing. Their motivation was patriotism or helping the war effort. Similarly there is much volunteerism in society. People expend efforts for many reasons, but the libertarians frame everything in terms of money and can't see how there is any motivation outside of acquiring more of it.

So even the axioms that the two endpoints are at zero is not true.

[jjj]

i have always felt that takes revenues would grow at a rate near infinity if only we could reduce the rate to zero!!
1

[lonesome moderate]

From robertdfeinman:

During WWII there were lots of "dollar a year men" who worked for nothing. Their motivation was patriotism or helping the war effort.

Patriotism was hardly the only thing that motivated these people. The dollar a year men were for the most part established corporate executives, and many if not most of them took advantage of their government positions to protect the interests of the corporations that paid them. Harry Truman believed that they were not putting the country first, and through his Senate committe eventually had most of them replaced with career civil servants.

Of course, this has little or nothing to do with the Laffer Curve.

[robertdfeinman]

Well I spent my entire career working for non-profits when I could have gone out and made more money elsewhere. The same is true of many people in academia.

There are other motivations in life besides money. Perhaps James Galbraith would like to discuss the motivations of his father who put public service ahead of strictly monetary goals.

The Laffer curve is based upon unfounded assumptions about human nature as well as having no documentary evidence to show that it exists.

The Libertarian idea that one should maximize everything for one's own benefit is not only vile and amoral it isn't even true to human nature.

[James Killus]

Just a technical note: the point for Luxembourg is also something of a special case, since Luxembourg is similar to Delaware in being home to a lot of corporations for reasons (such as financial regulation) other than taxation.

I suspect that corporate regulation, plus the actual efficiency of taxation (the US has all sorts of corporate tax loopholes) may account for a substantial amount of the variance in the numbers as well.

But the fact that the WSJ is once again doing its best to lower the level of intellectual discourse in economics should surprise no one.

[oops]

robertdfeinman- your personal experience has nothing do do with the realtionship between tax rate and tax revenue. it is a question of if there is an inflection point or if there is enough data to guess at an inflection point between 0 and 100%.

0%- anarchy
100%- marxism?

[theo]

Did Kevin Hassett draw that curve using Microsoft Paint?

Even if you had extraordinarily strong a priori reasons to fit a convex down curve from that exact family (what are they, log parabolas?), you would NEVER get the curve shown as a least mean squares fit. Especially if you used robust regression, as you almost certainly should for a dataset with such outliers.

I would say that Hassett has embarrassed himself, but he works for AEI, so he's clearly incapable of embarrassment.

[Robert]

What I think Mark is posing is the following two part hypothesis:
If the Laffer curve exists, then 1. it should be the same for all countries and 2. graphing tax revenues verses corporate income tax rate is the correct way to model the Laffer curve. I assume that the vertical axis is income tax revenue derived from corporate income tax as a percentage of GDP.

I think that he has conclusively shown that this hypothesis is false.

says...

Of course there is a Laffer Curve. But it looks like this.

[Robert]

When thinking about the Laffer curve in the context of the corporate income tax rate as opposed to the individual income tax rate, I think that we also need to consider risk. So not only might the Laffer curve for corporate income taxes differ by country, it might also differ by perceived riskiness of the corporate endeavor and for a particular risk level, it might vary over time.

So, like the instantiation of the first stable single cell organism (notice the careful avoidance of charged terms like evolution or creation), the Laffer curve may be a "truth" that cannot be duplicated in the lab or empirically observed in nature.

[Arne (not anne)]

I suspect that the number of people willing (and able) to continue working when all of their revenue is taxed away would represent an outlier in some data set, so I tend to believe that there is a Laffer curve and that 100% would be where I should find one end of it. As such that fact that the curve drawn heads to zero at 33% is yet another reason to dismiss it.

[Arne (not anne)]

I suspect that the number of people willing (and able) to continue working when all of their revenue is taxed away would represent an outlier in some data set, so I tend to believe that there is a Laffer curve and that 100% would be where I should find one end of it. As such that fact that the curve drawn heads to zero at 33% is yet another reason to dismiss it.

[Cyrille]

Many people would be able to work with all their direct revenue taxed away -those taxes would go somewhere, and to a great extent (with a 100% rate) they would be redistributed...

[billy]

"A 100% tax rate will, in time, raise no revenue as people simply do not engage in that behaviour."

This a ridiculous assertion. A 100% tax rate would imply all benefits and needs are provided by the tax collector. The money simply cannot be taxed and put into the ground (well, maybe it can be, because the laffer/gold bug nuts dream of burying gold into the ground). It would only mean that control over spending is now with the tax collector.

There are thousands of monasteries. kibbutz, etc are living proof of 100% tax and redistribution. People do work at 100% taxation, and there would be non-zero revenue

[anne]

http://delong.typepad.com/sdj/2007/07/most-dishonest-.html

July 13, 2007

Most Dishonest Wall Street Journal Editorial Ever
Edited by Brad DeLong

Yes, it's the Wall Street Journal editorial page reporting more American Enterprise Institute-quality research from Kevin Hassett. This is the most mendacious ever.

Mark Thoma is on the case....

[I remember Paul Krugman noting Kevin Hassett was young and thinking the young can learn. No; never in this case.]

[anne]

http://www.washingtonmonthly.com/archives/individual/2007_07/011682.php

"The Wall Street Journal editorial page is really getting desperate. Even for them. In an editorial today they present data on corporate tax rates around the world and, like those people who find an outline of the Virgin...."

Ah, I should have known, I should have seen, I must practice seeing and knowing, me, being a woman of belief.

[Robert]

"A 100% tax rate would imply all benefits and needs are provided by the tax collector."

Need to be careful about the individual verses the corporate argument. An individual can live in a 100% taxed world. The notion of a corporation as an entity that can raise capital and invest it in a profit making endeavor that will return a revenue stream to the investors ceases to exist. That is true unless dividends paid out are treated as a corporate expense (instead of being taxed twice). In this latter case, the notion of a "growth" company ceases to exist and everyone who invests in corporations would by definition become a value investor.

Since I detect a slight anti-for-profit-corporate bias in this list, I suspect that the impact of 100% taxation of corporate profits might be minimized in the mind of most of the participants.

[Yancey Ward]

From Billy,

A 100% tax rate would imply all benefits and needs are provided by the tax collector. The money simply cannot be taxed and put into the ground (well, maybe it can be, because the laffer/gold bug nuts dream of burying gold into the ground). It would only mean that control over spending is now with the tax collector.

There are thousands of monasteries. kibbutz, etc are living proof of 100% tax and redistribution. People do work at 100% taxation, and there would be non-zero revenue

Yes, it is true that some people do work at 100% tax rates. However, a 100% tax rate is not analogous to a monastery or a kibbutz. The proper name for your scenario described in the first paragraph of the quote is slavery.

[Dave]

Does the Laffer curve why rich people are never willing to do any real work. Perhaps the CEO only works two hours a day because he only gets to keep 65% of his $40 million salary. Perhaps the janitor works so much harder because his marginal tax rate allows him to keep 90% of his $300 per-week paycheck.

Clearly what America needs is to put the CEO back to work by allowing him to keep 80% of his stock bonus, and then encourage the janitor to take some time off by cutting his take-home down to 80% of his salary. According to the Laffer curve, this would generate more income for the country.

I have decided that if someone offers me $1.5 billion for my secret salmon grilling technique, I am going to haggle them down to $1 billion so that I will save money on taxes. This will be good news for the country because it means I will work harder.

[Yancey Ward]

Mark Thoma,

Though the graph by Hassett is pretty ridiculous, your attempt to graph the relationship as linear is just as silly. Though, maybe that was your point?

[Steve]

Has anyone wondered how the US has a higher headline corporate tax rate than Australia (35% vs 30%) but tax collections are almost 3 times as high in Australia (6% of GDP vs 2% of GDP)? Loopholes - more like 6 lane expressways :-)

[billy]

Yes, it is true that some people do work at 100% tax rates. However, a 100% tax rate is not analogous to a monastery or a kibbutz. The proper name for your scenario described in the first paragraph of the quote is slavery

Yeah, right. The slaves could elect their masters and order the masters on how to spend their own earnings.

When the taxpayers get to decide how the money is spent, and gets to pick who spends it, the analogy to slavery is really bust. The kibbutz is really perfect.

The real point though is rhetorical - revenues do not go to zero under 100% taxation. That may be a moot point, but when 0-revenue-with-100%-tax is used an extreme to illuminate the Laffer principle, debunking the extreme kind of make the principle itself questionable.

[anne]

What Mark Thoma did was what any scientist would do in finding and graphing regression direction from a data set. The data fit is a statistical relation, and though I enjoy silly not silly at all.

[robertdfeinman]

Yancey Ward:
Unless there is some a priori reason to assume a non-linear relationship in data points, using a least-squares or best-fit linear graph is appropriate.

Given a finite set of data points it is possible to construct a curve that will go through all of them as closely as desired. This curve would have very little error, but would obscure the overall relationship (if any) and be very poor for predicting where new data points would occur.

Mark Thoma's analysis is appropriate given the data provided.

[Bruce Bartlett]

I had exactly the same thought as theo (above) the instant I saw that graph. There's no way that line fit those data. It had to be drawn by hand.

[Yancey Ward]

Billy,

Even a democratically elected government that controls all spending doesn't make it not slavery. You would have to have 100% agreement to make it so. If even one person disagreed with such control, that person would be a slave.

[Robert]

Anecdote follows. The Chinese currently have a reputation for industriousness. I had an acquaintance who spent several weeks in China in the early 80s (he had spent two years in Korea as well). His impression of the Chinese compared to the Koreans was that they were lazy.

I wonder if the incentives provided by the what was effectively a 100% corporate tax rate (no private corporations) of then compared to the current incentives has any impact on the recently observed behavior of China to lift hundreds of millions of people out of poverty. I wonder of the revenue available to the Chinese government now compared to then might provide some insight in how we might think about the Laffer curve.

[billy]

Even a democratically elected government that controls all spending doesn't make it not slavery. You would have to have 100% agreement to make it so. If even one person disagreed with such control, that person would be a slave.

Sure. I disagree with the Iraq war, corporate welfare and tax breaks and religious charity being funded by the govt.

I want my freedom from this slavery.

Yeah, right.

[Yancey Ward]

Robert,

Uh, no. A simple eyeball analysis of Thoma's graph shows it's predictive power to be completely wrong (of the seven countries with the highest tax rates, six fall well below the line Thoma drew). Does an eyeball analysis count as an a priori reason? I think so. Let me put it another way, what is the a priori reason to think the relationship should be linear? Because it is easier to draw a straight line than a curve?

[Yancey Ward]

Billy,

You will find this difficult to believe, but I want my freedom from those as well. So, what was your point, again? You seem to now agree with me.

[Ed Drone]

If you follow that curve, as the WSJ has it, a small increase in tax rate, to say, 40%, would result in negative tax revenue! You'd think the corporatists would be all over that! Increase the tax rate to 50% and the government would start handing them money!

Figures don't lie, as they say....

Ed

[Kiva Oraibi]

It's like the Kenya song tells us, "Forget Norway!"

[billy]

You will find this difficult to believe, but I want my freedom from those as well. So, what was your point, again? You seem to now agree with me

You sure miss the points.

First,
100% tax means zero revenue? - Not true.

Then you dance around it. There may be revenue, but it is slavery.

100% tax is slavery? - Not in a democracy.

Then you redefine slavery as not getting your way in a democracy.

Democratic disagreement is now slavery?.

[Celo]

A Laffer curve for Corporations? But what are they "choosing" to do if not maximize profits? Surely corporations don't enjoy leisure time? Either they operate to maximize profits or they shut down. I can't imagine a board of directors who will give permission for its executives and employees to work at 65% of capacity because they don't want to generate too much revenue.

More appropriate to look at the impact on the company's investment. But there again, the choice is between investment in increasing the profits from its operations, or investing in another instrument. Overall, the investment will not dissipate into thin air. It won't go on vacation.

[anne]

http://matthewyglesias.theatlantic.com/archives/2007/07/worst_editorial_ever.php

July 13, 2007

Worst Editorial Ever?
Eited by Matthew Yglesias

Via Brad DeLong, Marc Thoma finds a winner. The culprits, naturally, are at The Wall Street Journal editorial page, specifically Kevin Hassett.

That doesn't even remotely resemble a best fit curve. They've drawn the line straight-through an outlier. And look how steep it is at the right hand side. They're asking us to believe that the marginal impact of increasing corporate income tax rates above the Norwegian level is not only negative, but massively negative in a way that none of the non-Norway data bears out. It's an insult to everyone's intelligence. At this point, one needs to think that letting Rupert Murdoch destroy the WSJ news pages might be better for the world than letting the WSJ news pages' credibility continue to provide a "halo effect" to the editorial page.

[Robert]

There seems to be a belief represented in some of the comments that if the tax on corporate profits were raised to 100%, that for-profit corporations would continue to be formed or that existing for-profit corporations would continue to generate profit instead of extracting all revenue as expense. Am I misreading the comments?

[anne]

Norway, by the way, is using its oil and gas resources with remarkable forward looking skill, providing for ample saving against future resource limits. I have long been impressed, and, oh, what a terrific investment market Norway has been.

[Kenneth Fair]

Is the left side of that graph tax revenue as a percent of GDP, or *corporate* tax revenue as a percent of GDP? Because if it's the former, the graph is even more meaningless than it already is.

[Yancey Ward]

Billy,

No, I did not miss your point about 0% revenue, and I was not the one who claimed that in the first place. I only pointed out that where you work but have no personal income and no control how your work product is used leaves you as a slave. If 51% of the population institutes a 100% tax on everyone, then, yes, those 49% that did not agree to it are now 100% slaves- and it does not matter if some of their income is used to support them since plantation owners also fed and housed their slaves. Dance around that all you wish, but it would not change this fact.

[Robert]

Case in point: "It is not even certain by logical reasoning that 100% tax rate cannot be the one yielding the highest revenue. "

I’ve already discussed for-profit corporations. I hope that we agree that a 100% tax on profits would destroy the meaning of for-profit corporation.

In the case of individuals and our income tax system, that means that everything over, say, the standard deduction goes to the government. We have to live on whatever the standard deduction leaves us. In order to induce people to earn more than that standard deduction we would have to create a work environment that was pleasant enough (university professor?) or triggered our altruistic nature (teacher, social worker, policeman, soldier, missionary). I struggle to understand why any of the less pleasant jobs would have willing participation over and above the minimum required to make that standard deduction. Notice that all of the examples of jobs that I provided where people might work harder than that are all financed by those earning more than the standard deduction.

Further, everyone would have to meet all of their expenses by the revenue that fits under then standard deduction.

Well maybe we can itemize. The argument gets a little more complex, but it reductio-ad-absurdum point remains. One cannot construct a capitalist society with a 100% tax rate. Are we back to arguing who is better off – north or South Korea?

[Robert]

So, after a fascinating detour into a world view where a 100% tax rate will create steady state positive revenue, we are back to a curve where the vertical axis is revenue and the horizontal axis is tax rate, that logic dictates that 0% and 100% tax rates yield 0 revenue and empirical evidence has demonstrated that intermediate points are greater than 0.

So the ongoing debate continues to be what is the shape of that curve.

[billy]

I only pointed out that where you work but have no personal income and no control how your work product is used leaves you as a slave...Dance around that all you wish, but it would not change this fact.

I think we've already debunked that slavery argument.

If you don't like taxes, argue so. Instead of creating a cock and bull story about Laffer.

Robert,

Leave the bogeyman of 100% taxation alone. It is only of importance in that the 100%tax-zero-revenue claim is wrong, and as far as that helps in discrediting Laffer, it is good.

The Laffer nuts are a bunch of crooks - who simply could not make any other arguments to reduce taxes and govt, that could be sold to the public. Hence they jumped on low taxes more revenue as a means to hoodwink the public.

[tockeyhockey]

slaves worked for a 100% tax rate for thousands of years in the world.

and for those who quickly dismiss the point, there are still slaves today -- people who work, for instance, in farms where they are guaranteed to owe more to their landlords every year than their crop sales would be able to pay. this is a state of affairs still very much prevalent in coffee producing areas of south america.

so in essence, these people are "taxed" at 110%. they work all year and have less than zero at the end. yet they still work.

can some milt friedman type please hammer this case into their rigid little theory for me?

[James Killus]

I believe that we have now passed the rational discussion point and entered the zone where joshing is required. Therefore, I shamelessly promote and quote myself:

True, there are some people now who do, in fact, advocate a strong military and low income tax rates, but they are advocates of Supply-Side Economics. You know, morons.

[Robert]

"Leave the bogeyman of 100% taxation alone. Hence they jumped on low taxes more revenue as a means to hoodwink the public. "

Agreed that our further tax cuts are not justified by the evidence presented. I think that we can tax more efficiently if we eliminated one of the taxes on dividends. (Probably the individual tax since the corporate tax is at the high end of what individuals pay.) I think that would induce corporations to pay out more and that payout will have a more positive impact on the economy than share pay backs and corporate takeovers (and thus generate more tax revenue).

The other side of the argument is that higher corporate and individual taxes will linearly generate more revenue. We “know” that this is not true (at least, we “know” this until someone takes apart my prior post:-) ). Looking at the international data, we know that we are already at the high end for corporate tax rate and probably cannot go much higher. So the I think the discussion revolves around what is the “right” marginal income tax rate for higher income individuals.

[Robert]

"The other side of the argument is that higher corporate and individual taxes will linearly generate more revenue. "

Sheesh, having a discussion with myself. Where you anne when I need some help?

I make this point that is because that is how CBO scores the effect of tax changes (I think still true since nobody knows the shape of the curve). So we increase taxes and everything looks fine in the short term so we increase them again then in a few decades we look around and wonder why the economy is so bad.

As the UK and Western Europe re-invent themselves, I would think that there is an increasing body of data relating tax policy to economic growth. I admit that it is hard to isolate because they made other changes as well.

[Bloix]

1) Norway is unlike every other country on the chart because it has a 50% surtax on its oil and gas industry. This tax is levied on companies that cannot go elsewhere and that remain profitable even at this very high tax rate. So the Norwegian experience is not comparable and should not be included on the chart.

[John Jay]

The fact that revenues have fallen (and only risen slowly, over time, at rate lower than inflation + population growth) prove that Reagan-Bush tax cuts are on the WRONG end of the Laffer curve. That is, reducing US tax rates have moved us to increasing reduction in US Federal Revenue.

In fact, the Laffer concept suggests that if our goal were to maximize Federal Revenue (which it should not be; our goal should be to align revenue with expenses, no more, no less), then taxes should be raised.

[worker]

I think Philadelphia experienced the other side of the Laffer curve in the late 1980's when their municipal level "wage tax" at around 5% with the Wilson Goode administration coming back for more every year. Have you read Robert Inman's work on the subject.

How many Mayors does it take to destroy a major city?
1, if he's Goode!

[a]

Bull. Run the regression. The curve peaks at about 30%.

[ferd]

I recall a social experiment a few years back where the researchers went to various countires and "lost" wallets loaded with, like, $50, and waited to see if the wallet and money was returned. Norway, if I recall, was one of the few places in the world where every "lost" wallet was returned.

So, maybe Norway is a place with unusually honest corporate accounting practices, even at tax rates of 29%. And maybe, as tax rates rise, managers of average honesty exert extra efforts to avoid or evade taxes. With Norway honest accounting applied everywhere, is it possible that the laffer curve might even go u-shaped?

says...

http://maxspeak.org/mt/archives/003184.html

July 13, 2007

UP AND DOWN THE LAFFER CURVE
By Max Sawicky

This (the chart) is the dumbest thing I've ever seen, and I've seen a lot. Check out that curve; it's a gotdam roller coaster! (Original WSJ editorial here.)

For fun I did a regression line for similar data (same year, same countries). I threw out those annoying communist outliers at the top (Luxembourg and Norway) -- countries with high tax rates and revenues. (By the way, when you include them without forcing a zero intercept, there is no significant relationship between the corporate tax rate (combined, central and sub-central govs) and corp rev/GDP. Very slight negative relationship. Throw out the two outliers and the same non-result (insignificant positive relationship).

[anne]

Sorry, but my name did not take on the above post from Max Sawicky. Mark Thoma, of course, is completely right.

[svvandal]

The above chart cannot be used to dismiss the Laffer Curve because the sample does not include observations across the range of plausible tax rates. You could however argue about whether or not a curve exists when the minimum tax rate is zero and the maximum is 35.

For me, the mere fact that virtually no countries have a corporate tax rate >50% is proof enough that the Laffer Curve exists. Why tax a company at 70%, when 35% will generate greater tax revenue??? The chart is 'living proof'.

[demisod]

"For me, the mere fact that virtually no countries have a corporate tax rate >50% is proof enough that the Laffer Curve exists. Why tax a company at 70%, when 35% will generate greater tax revenue??? The chart is 'living proof'."

But that assumes that maximizing government revenue is the driving force behind setting tax rates. One could argue that the power of wealthy interests to influence policy to favor them is equally important.

[Mean Mister Mustard]

This post's comments are awesome. They show almost nothing about the Laffer Curve, but they show a bunch about contemporary conservatism. What exactly does it show? That it is a big JOKE! There was a time when conservatives had, in addition to things like Laffer curves, good ideas. Those times are long over.

[Miracle Max]

For the record, his numerous sins notwithstanding, I don't think it's been established that Kevin Hassett drew the infamous curve on that graph. It's in the WSJ editorial, not in anything that he has done that I have seen. The data points in the graph are unexceptionable. I couldn't reproduce them exactly, but my own diagram doesn't look all that different.

[Ian Clarke]

The curve you criticize is a deliberate and cynical manipulation of the data, so you respond with your own deliberate and cynical manipulation of the data.

Regardless of where the points actually lay, if you insist on drawing a line, and you require that the line goes through 0,0 - then it is inevitable that the line will indicate a positive correlation between corporate tax rate and government revenue.

The curve fitting you criticize is indeed flawed and manipulative, but so is your line-fitting, because by insisting on a line, you make a positive correlation inevitable regardless of the actual data.

I think it is pretty obvious that government revenue will decrease above a certain tax rate, because after a point taxation will remove the incentives for doing business, and businesses will therefore move. The interesting question is where this point is, and neither the curve you criticize, nor your own line-fitting, answer this question.

[Mark Thoma]

Thanks Max.

And yes, I agree that what is needed is a formal, multivariate, model based analysis, not some line sketched on a chart showing a bivariate correlation (when that is attempted, i.e. when this is done correctly, there's no evidence that we are, or have ever been, on the right-side of the peak you describe). That was the point, the graph in the editorial shows absolutely nothing (and they should have known that), and the alternative story is just as plausible, more so perhaps, if you are going to simply eyeball your favorite curve. It's just not how we do this. I've been making this point over and over, this is just a small part of a continuing conversation on this topic.

[reino]

The Laffer Curve exists, but it has nothing to do with this graph.

To get a Laffer Curve, the y-axis must represent a dollar amount, not a percentage. (It could be a percentage of a constant value, but not a percentage of each country's wealth.)

The x-axis of the graph shown represents the tax rate. The y-axis also represents the tax rate. That is not how you get a Laffer Curve. The theory behind The Laffer Curve is that increasing the tax rate can lead to a decrease in revenue because it will lead to economic decline (or at least slowed economic growth). The basic idea behind it is solid, though there is no agreement in terms of actual numbers in actual situations.

Economic growth has no impact on any of the numbers graphed. Without economic growth, there is no logic behind The Laffer Curve. Therefore, the graph has nothing to do with The Laffer Curve.

If the corporate tax rate was 100%, the corporations would stop or at least slow down. That probably would cause tax revenues to go down. However, it would not cause tax revenue as a percent of GDP to go down.

Take a waitress who always gets 15% tips. If her restaurant suddenly doubles its prices, the number of customers will go down significantly, and she probably will earn less money in the end even though each tip will be larger. However, she will still get 15% of the bill--that part does not change.

The only reason that the graph above is not a perfect line like Thoma's is that different countries have different collection rates and different ways of sharing tax burdens between corporations and individuals. Because those quantities have little to do with tax rates, there is no pattern at all in the data. The lines/curves drawn by Thoma and Hassett are equally valid because neither one has any validity. The only thing that makes Thoma better than Hassett is that he admits that he just made it up as opposed to claiming that it rationalizes lowering the tax burden on wealthy corporations.

[Robert]

Corporate rates:
http://www.irs.gov/pub/irs-soi/02corate.pdf
capped out at 52% in the late 60s. Perhaps there is room to the left, but I doubt it.

Individual rates:
http://www.irs.gov/pub/irs-soi/histaba.pdf
capped out at 92% in the mid 50s. There is still room to the left of that? Kennedy and the Great Society democrats thought otherwise.

[german_reader]

A typical case of contemporary GAGA-economics you find so often today. This graph says in reality nothing unequivocal about the relation between tax rates and tax revenues. You don't know which country has which tax exceptions. You don't know how large the shares of corporations in the single economies are.

The United States are the country of "big business", corporations. Many other countries have more traditional economies based on small companies owned by a single person, who may pay personal taxes, but no corporate taxes.

The high profits of US-companies are the pride of american capitalism. Therefore revenues from corporate taxes in the United States should be in tendency higher than in other countries with more traditional economies, based on fewer or less profitable corporations, simply because their importance for the economy and their share of taxable income is larger than in most other countries.

A possible conclusion from this graph could be, that lower "nominal" tax rates with few or no exceptions can result in higher tax revenues than high "nominal" tax rates with many exceptions. Or to turn it the other way around higher "real", "effective" tax rates can create higher tax revenues than lower "effective" tax rates.

Serious research would need much more detailed comparisons of tax policies, tax systems, economic structures or general government economic policies. Hard work for "true" economists ( Haven't seen many around today ).

One way to do this would be to compare national profits ( measured on a common basis ), "nominal" tax rates and tax revenues to find out "real" tax rates and the effectivity of the different tax systems. What works best? High tax rates, high tax rates with many exceptions or low tax rates. And what has better consequences for a economy or society as a whole: High real tax rates or low real tax rates? As said complex work for passionate people.

[MJS]

Clearly, with a sample so small, representing a snapshot of one year, and with a likely very large number of confounding and hidden variables that have not been accounted for in this simple chart, teasing out a Laffer Curve relationship is, well, (forgive me) laughable.

But, assuming the underlying data points are accurate -- and notwithstanding the arbitrary Laffer Curve imposed by WSJ on the data, and also stipulating that the sample limitations and ignored variable examinations described above make any conclusions based on the data suspect -- I do see one interesting relationship based on a superficial glance:

The five highest revenues/GDP come from countries within a relatively narrow range of corporate tax rates - about 22% to 32%. I am looking only at the five highest because these five all have standard deviations significantly larger the 6th highest revenue/GDP data point, including and after which begins a clustering of 21 of the data points around the mean, median, and mode of the overall revenue/GDP sample. In other words, their higher revenue earnings are all fairly significant.

This range of about 10 percentage points represents the exact median of the tax rates, as 8 countries have less than 22% rates, while 8 have higher than 32% rates.

So, if the null hypothesis is that "The rate of taxation has no statistically significant correlation to the highest revenues/GDP countries," then based on this data it would appear there is a need for an alternative hypothesis.

Now, the truism that that correlation does not equal causation does apply. Still, that truism does not negate the need for an alternative hypothesis.

Point? While the imposition by WSJ of such a clear Laffer Curve relationship on the data is hardly rigorous, the data from the chart does nothing to disprove the Laffer Curve. Further, based on the above analysis, the data may even lend support to the conclusion the WSJ chart-maker inferred from the data, even if the graphic representation of that inference was manifested by a curve that did not significantly demonstrate a fit to the data.

As an aside, some might rebut by noting that the five lowest Revenue/GDP countries include one country in the "optimal" 22%-32% tax rate range. Further, two of the five lowest are in the under-22% tax rate group, while the remaining two are in the over-32% tax rate group. This merely demonstrates that, from the data, no statistically significant correlation exists between the lowest Revenue/GDP countries and their tax rates. It also demonstrates that it is (of course) possible for lower Revenue countries to still be in the "optimal" range - a possible explanation would be that, shockingly, tax rates are not the only factor determinative of a country's revenue. Nevertheless, this non-correlation does not disprove that, based only on this data, there is a significant correlation between the highest Revenue/GDP countries and their tax rates.

[anne]

http://delong.typepad.com/sdj/2007/07/most-dishonest-.html

July 13, 2007

Most Dishonest Wall Street Journal Editorial Ever

What's interesting to me is that the US has a relatively high statuatory rate yet a low rev/GDP ratio. That implies a low effective rate (liability as share of income).

The reason is that so much corporate income escapes taxation. There are loopholes like the one which let the Blackstone group actually collect $200 mil from the IRS after their $4.8b IPO (see today's NYT story by David Cay Johnston). There's devilish transfer pricing schemes, and there's the ~$20b gap between book profits and IRS profits.

I think we need another '86 reform moment: broaden the base, lower the rate, simplify, stop treating everything so differently (tax equity and debt financing at the same rates), etc...

-- Jared Bernstein

[anne]

Jared Bernstein's reference....

http://www.nytimes.com/2007/07/13/business/13tax.html

July 13, 2007

Tax Loopholes Sweeten a Deal for Blackstone
By DAVID CAY JOHNSTON

The Blackstone Group, the big buyout firm, has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public.

Although they will initially pay $553 million in taxes, the partners will get that back, and about $200 million more, from the government over the long term.

The plan, laid out in the fine print of Blackstone’s financial documents, comes as Congress debates how much managers at private equity firms like Blackstone and hedge funds should pay in taxes on their compensation.

Lee Sheppard, a tax lawyer who critiques deals for Tax Notes magazine and has studied the Blackstone arrangement, said it was a reminder of the disconnect between the tax debate in Congress and how the tax system actually operates at the highest levels of the economy.

“These guys have figured out how to turn paying taxes into an annuity,” Ms. Sheppard said. “What people don’t realize is that the private equity managers, the investment bankers, all the financial intermediaries, are in control of their own taxation and so the debate in Washington about what tax rate to pay misses the big picture.”

The debate in Congress is about whether most of the compensation that fund managers earn should be taxed at the 35 percent rate that applies to other highly paid Americans, or at the 15 percent rate for capital gains.

Questions in Congress about possibly raising taxes on such compensation were prompted in part by publicity about the rich rewards for people who run these firms. Stephen A. Schwarzman, the co-founder of the Blackstone Group, made nearly $400 million last year, for example.

The Blackstone partners’ tax deal, however, is for the sale of part of their stake in the management firm, which is why their profits were taxed at the usual 15 percent tax rate for capital gains. Over all, the company raised $4.75 billion in the initial public offering, but the benefits of the tax structure involve just $3.7 billion of that.

Other private equity firms and hedge funds that have gone public, or plan to, make use of similar techniques, their documents show....

[anne]

Also, by the way, in this absurd dishonest presentation and analysis by the Wall Street Journal and Kevin Hassett, the United Arab Emirates is an administrative entity and levies no taxes and collects no tax revenue and should not have been included by Hassett and the WSJ.

[ilsm]

Sorry for being late to this game.

The WSJ goodness of fit from the data is perfect and the standard type of logic used to justify the need for your $600B a year war machine.

[Robert]

Keep in mind reino's comment:

He said that the Laffer hypothesis does not focus on % of GDP as the vertical. Part of the story is that the correct tax rate maximizes growth thereby increasing GDP. So the tax rate that maximizes return as a percentage of GDP might not be the rate that maximizes revenue.

[anne]

Ilsm:

"The WSJ goodness of fit from the data is perfect and the standard type of logic used to justify the need for your $600B a year war machine."

Not quite, not quite; the military budget agree to for the coming year is $624 billion which includes neither $14 billion for the nuclear arsenal nor any of what will be well above $150 billion for Iraq and Afghanistan. The $624 billion for the military is really going to be almost $800 billion.

[Markus]

My work is not-for-profit. At least our division. We run at a continuous loss. My interest in having the company succeed has to do with me still getting a paycheck, not about having the company post huge profits.

[Deborah]

I live in BC. Our news papers this week boasted that tax cuts work because we had a record win fall in a revenue surplus this past year, and it was significant.

But, here's the real truth. BC's economy was strong in the past because of our commodity based economy. It died a painful death as mines were closed due to poor commodity prices through the 80s.

Commodity prices have been exceptionally strong and the commodity sector has been booming beyond people's wildest expectations.

Through this boom unmatched in our economic history our provincial debt has increased by $13 billion dollars, from $20 to $33 billion dollars. I am a teacher and I know our wage increases are far below inflation through these boom years. Relative funding for something as important as education has grossly declined through these boom years. Indeed, if you were to contrast our wages to Ontario you would find that BC teachers have a 17% higher workload and a %17 smaller pay cheque, and we have the highest housing costs in Canada. It is enormously scary to see that massive increase in debt and to know we are have stressed important services pretty close to a breaking point. It makes me sick to think "what happens in a recession?"

They take credit for their policies for being responsible for our booming economy. $1 copper prices to $3.50 copper has nothing to do with it, it is about their tax cuts. We ought all shudder in our sleep at their inability to assess what has happened beyond their living in box the size of an atom with walls that expand the universe.

So, this year we will see $1.3 billion paying down debt, debt that there was zero excuse to allow to increase in the first place making us $12 billion further in debt in a booming world economy unprecedented in history.

[robertdfeinman]

Just to cut to the chase:
Will all those who believe in the Laffer curve please supply some examples? They need to be based upon actual data and have real values for both axes.

Thanks, we'll wait...

[anne]

Deborah, that was a finely considered analytical comment indeed. Please post more, but especially more on BC and Canada.

[anne]

There is by the way every reason to think commodity demand will hold for quite a while, which is why I have been noticing from Australia to Finland and Norway and Canada and South Africa folr several years. Brazil would long ago have been in recession as currency value climbed, but for commodity demand.

[anne]

Brazil is an important historical indicator, and shows just how strong the international economy and international investment markets have been for more than 5 years. I find this the strongest international growth period in at least 50 years. India and China have changed the international development dynamic in a way probably not experienced since the spurt in America after 1875; which is another reason not to discount how much international support China and India can count on.

[anne]

I have long been amused at investment analysis that is obviously driven by conservative ideology, and seemingly designed to be comically self-defeating.

[Robert]

"Will all those who believe in the Laffer curve please supply some examples? They need to be based upon actual data and have real values for both axes."

http://en.wikipedia.org/wiki/Laffer_curve

Will all of those who belief that single cell organisms can be created by some natural process, please supply some examples? They need to be based upon actual data.
http://en.wikipedia.org/wiki/Origin_of_life

Will all of those who belief that the observed change in global temperatures over the last 100 years please supply some examples? They need to be based upon actual data and have real values for both axes."

http://en.wikipedia.org/wiki/Attribution_of_recent_climate_change

Some things are just hard to isolate and observe.

[Robert]

Correction - I should not post when I am going out the door.

"Will all those who believe in the Laffer curve please supply some examples? They need to be based upon actual data and have real values for both axes."

http://en.wikipedia.org/wiki/Laffer_curve

Will all of those who believe that single cell organisms can be created by some natural process, please supply some examples? They need to be based upon actual data.
http://en.wikipedia.org/wiki/Origin_of_life

Will all of those who believe that the observed change in global temperatures over the last 100 years are due to CO2 accumulation please supply some examples? They need to be based upon actual data and have real values for both axes."

http://en.wikipedia.org/wiki/Attribution_of_recent_climate_change

Some things are just hard to isolate and observe.

Dr. Thoma's comment was "...there's no evidence that we are, or have ever been, on the right-side of the peak you describe....". Similarly, there's no evidence that we are on the left-side of the peak.

My comment was that with a maximum marginal personal income tax rate ranging from 7 to 92 percent, we have likely captured the peak of the individual income tax Laffer curve. With the maximum corporate rate ranging from 1 to 52 percent there may possibly be some room to the left of 52%. However, if we go there, I suspect that, in a few decades, we will ask ourselves why the economy is so bad.

Part of the problem with raising corporate taxes is that, with free trade, we have tax rate competition impacting us in a way that we did not in years past. If you search on "European corporate tax rates" you'll see a number of links on tax rate competition.

[Reality Man]

Robert, is that the best you can do? The Chewbacca defense? Do you know the difference between a scientific theory, like evolution, and the Laffer Curve? The debate on evolution in terms of public policy is whether or not it can be honestly discussed (not loaded with Christianist/young Earth bullshit) in classrooms. The debate on the Laffer curve is whether or not our corporate tax rates, which effects the economy, and thus voting behavior, how American's view the outside world and relate to the outside world, etc. as a whole, are going to be in line with reality. The Laffer curve is not only debated by conservatives when they pass corporate tax cuts, it is enforced as if it is a proven fact. No one is enforcing evolution via public policy to make gorillas walk upright.

[BJ Feng]

What about the record revenues the government has taken in since the Bush tax cuts were enacted? I suspect that won't be enough evidence for the naysayers, in fact, I suspect no amount of evidence can be presented that will get them to change their minds.

Speaking of evolution, has evolution ever been directly witnessed? No, but it makes logical sense and there is indirect evidence that points to evolution as a sound theory. Same with the Laffer Curve. The unexpected record revenues since the Bush tax cuts fits the theory perfectly.

[Robert]

Reality Man,

Did you read any of the Wikipedia links. The existence of the Laffer curve is not in question. The general outline of the origin of life is not in question. The correlation between CO2 and global temperature is more tenuous but seems to have achieved scientific consensus status.

Taking the last, can you construct a graph with Y-O-Y temperature on one axis and Y-O-Y CO2 change on the other and find a correlation?

The point I was making was that denying the existence of generally accepted truths may be fun in a blog's comments but is not a useful contribution to the discourse.

So the discussion more appropriately centers around what role should the Laffer curve play in public policy. How do we trade-off a tax policy that encourages maximum GDP growth verses a tax policy that generates maximum revenue to the government? Are they the same tax policies? Should we go for maximum GDP growth even if tax revenue is somewhat lower? Should we increase near term tax revenue even if there is a negative GDP impact? Is there a steady state Laffer curve point for a given tax type? Or is there a feedback between tax policy and the theoretical Laffer curve maximum that means we can never hit it because of the way individuals and corporations will adapt behavior to current policy - thus changing tax policy "just because" may increase relative revenue for a time until a steady state sets in then the maximum has moved a little? Is maximum revenue/GDP growth a reasonable goal for government tax policy?

All sorts of fun policy discussions to be had around the Laffer curve once one is willing to acknowledge that it exists.

There may be other reasons to reject the incorporation of the Laffer curve into the public discourse and going back to 92% and 52% tax rates on individuals and corporations. Achieving mediocre returns to capital, stifling entrepreneurship, generally soaking the rich and deploying a larger proportion of a reduced GDP into transfer payments may achieve a desirable social outcome. Given my antipathy toward how current policy marginalizes millions of less able American workers, I am certainly open to a discussion on tax (and immigration) policy that increases the relative income of the lower two quintiles. If such is the case, then the discussion should be about slowing the growth of GDP via tax policy rather than denying the existence of the Laffer curve.

The experience of countries (including the USA) with high government control of GDP indicate that the GDP outcome is less than desirable. But maybe the argument can be made that other factors, not tax policy, were the root cause of the poor GDP outcome. Yet another discussion.

Bottom line:
1. The existence of the Laffer curve has achieved a scientific consensus.
2. That a top marginal individual income tax rate of 70% is to the right of the peak has achieved a political consensus here and around the world.
3. That a corporate tax rate of 35% is likely to the right or very near the top. International factors play a bigger role in making this determination.
4. Using tax policy to support GDP growth has achieved a political consensus here and around the world.

[Werner]

Hardly anyone pointed out that the presumably "nominal" tax rates on the bottom scale are pretty meaningless. While, for example, the UK tax system has relatively few exemptions, the German system has quite a few so that the "effective" tax rate in Germany is probably even lower. Many entries will probably shift to the left when using effective rates.

Even the left-hand scale leaves many questions unanswered. A country's tax policy may favour other forms of taxes so that the percentage of GDP needs adjustment.

The silly point then is that the curve was drawn on raw incomparable data.

[Lafayette]

C: Many people would be able to work with all their direct revenue taxed away -those taxes would go somewhere, and to a great extent (with a 100% rate) they would be redistributed...

Have you ever heard the "Laffer Curve" seriously considered by any reputable European economist? Have you ever seen it referred to as part of economic policy and a defense of cutting taxes in Europe? Is it often mentioned here in the debate on tax alternatives?

I haven't. Then shouldn't we assume that it is the aberration of a vivid imagination and its usage is restricted to right-wing American politics that needs to defend the indefensible with a bit of seemingly plausible rubbish?

There are lies, damn lies and Laffer Curves.

[Matt]

Good point on the upward regression. However, even if you ignore Norway as an outlier, there's still a clear downward trend in the clump in the 25-35% rate range. If the data used is correct, then there must be some reduction in revenue with increased tax rates, even if it's not as much as some people claim.

[Lafayette]

Matt: If the data used is correct, then there must be some reduction in revenue with increased tax rates, even if it's not as much as some people claim.

Explain then why you think that a series of countries that display (the behaviour you think they show) would mean that a reduction in taxes in any one country would behave accordingly.

You would have to assume that all countries are economically identical or similar (particularly in the nature of taxes imposed) and they are not.

[Lafayette]

Also note that Norway is exceptional in that the tax collected is almost singularly concentrated upon exported brute petroleum intended for its National Retirement Fund.

[anne]

http://matthewyglesias.theatlantic.com/archives/2007/08/laffer_curve_revisited.php

August 2, 2007

Laffer Curve Revisited
By Matthew Yglesias

You may recall The Wall Street Journal's July 13 editorial which proved that the Laffer Curve is real if you restrict your attention to corporate tax rates, mis-code Norway, and draw your line wrong. Thanks to Kevin Hassett's efforts to spell this argument out in more detail, Brendan Nyhan was able to look at the exact same data and draw the line correctly:

[Reference]

If you exclude Norway, who's oil tax revenue shouldn't really be lumped in with corporate income taxes in general (it's more like a royalty), things look even less like the WSJ version of reality.

[Notice Mark Thoma's curve drawn just as Mark Thoma drew the curve and as any scientist would have estimated the curve.]

[anne]

Mark Thoma was of course right, as was Brad DeLong, but rightness does not preclude being willfully blind and continually distorting. Again, please someone stop using the United Arab Emirates which does not function as a governing body only an administrative designation.

Mark Thoma done good.

[anne]

Next time, Mark Thoma, even if you care to include Norway, not the UAE and your line works. Without Norway, which should be excluded, though I love Norway, and the line is perfect. Of course, at a 100% corporate tax, who knows :)