Two Sides of the Laffer

Happy New Year readers.   2013!

I still owe everyone some commentary on Steig’s 3rd (or is it the 4th) victory lap.   I have spent several hours on the new Antarctic doom paper, hopefully I will have some time shortly to write on that.  In the meantime, we are awaiting some movement on the “fiscal cliff” and as usual, I have a few thoughts on that.

My first thought is that the “deep spending cuts”, is that they don’t even touch the overspending by the Federal government, yet we are told that these cuts are disastrous.   I do agree that they are cut from the wrong areas, i.e. defense instead of EPA, but disastrous is not how I would describe any cuts at this point.   We desperately need to reduce spending, so I’m ready for whatever we can get.   The defense spending will be reinstated at the first opportunity anyway.

My second thought leaves me more confused.   Democrats are pretending concern about the middle class paying too much tax, yet this is exactly what they have so often demanded.  Raising taxes is the only way under the worldview of the anti-industrial left to logically balance the budget.  Cutting spending is simply not an option.  Keynesian economics is literally driven by the ignorant view that theft from business and spending of money by government, drives business.  So they must spend or the economy will die and they will have less money to spend.   Of course, like so much of life, they are partially right.  The US government has so ingrained itself into business at this point, that they are in control of massive percentages of the workforce and the economy.

And this brings me to the Laffer curve.

The Laffer curve is basic economic theory representing a tax vs revenue curve, which represents how much revenue is gained at different tax levels.   Wikipedia has a typically extreme leftist view of the subject here and like taxation, the public understanding of the subject is a huge irritation to me.  If you tax personal income at 100 percent – or greater – then there is no incentive to make income and the government receives zero tax.   If you tax at zero percent, the government gets zero tax so somewhere in-between, the government makes more than zero.   The left will have you believe that you can maximize income at about 70% tax rate, which is just dumb, but that is what they think.  Often, the argument the “blogging left” makes for higher tax is based on revenue as a percentage of GDP, but capitalism doesn’t exist to maximize a percentage of dollars sold,  it exists to maximize total dollars earned.  Because taxes retard the gross economy, maximizing a percentage of GDP is not related to the Laffer curve.

Politicians of all types are fond of saying, X tax will create additional revenue to pay for Y program.  This language has then been regularly repeated by the ever-compliant and rarely understanding media.  On the left, both the media and the politicians firmly believe that increasing tax on the wealthy will bring them more money,  and in the short run, they will be correct.

This is where it all falls apart.

The same Democrat politicians and extreme left media are today making the claim that raising tax on the middle class, would be economic disaster and less government income would be had.

So on which side of the Laffer curve are we?   We cannot be on both.  Either more tax is more revenue with a decent economy and more ability for government investment, or more tax is less revenue and a terrible economy.   It cannot be both.   Yet the Democrats freely admit that taxing the middle class will ruin the economy.  These same leftists often point out the increasing separation in wealth between the rich and poor to justify the taxes, rarely noting the indirect economic pressures that their re-distributive policies create on the poor.  The reality is that a good economy has guaranteed for nearly a century that America’s poor, are some of the wealthiest poor people in the world.   It isn’t about the wealth of the rich, or it shouldn’t be, it should be about the wealth of the rich and the poor, and despite the propaganda, that is what capitalism has done best.  Provide money for the people, from rich to poor.

The Laffer curve is a funny thing.  If you want to maximize tax revenue, you need to find the balance of where business is competitive and making a strong profit, and government is taking just enough green blood out, such that the gross economy isn’t dragged below the optimized limit.   Currenlty, many countries are taxing businesses at under 20%, yet the near-bankrupt Europe is far higher.   China is right at 20%  by this table, but the laws are also written to allow many deductions.   US business competes with these countries today.  Business is war, and business in these countries are what we are at war with.    Looking deeper into the table, the US is listed as taxing business at  40%, yet the reality is far worse.   We are faced with many taxes, such that the true rate is north of 50% already –  keeping in mind that we haven’t yet experienced the next 5% tax increase in the next few hours, and another percent for the affordable health care act.

This all fits together when you realize that when other countries tax business at a lower rate than the US or Europe, they are shifting the maximum income which can be gained through tax to a lower percentage level.    If we tax the US more, and other countries tax less, their competitiveness is increased, and ours is reduced.   Laffer teaches that less tax revenue for the government is a guaranteed result of a tax hike after some optimized yet unknown percentage rate, and international competition in general means that the magic point at which less government revenue is realized, is guaranteed to have shifted to a lower percentage.

Now this whole subject is way to complicated for most people, and most won’t spend more than a minute or two even thinking about it, it is key to understanding what they are voting for.  Unfortunately, it literally hurts their stupid little uneducated brains, but they are not the readers of this blog.

Many economists have spent time trying to calculate the peak government revenue point (shape of the Laffer curve), but the subject is as elusive as moisture and condensation in a climate model.  My impression is that the widely differing results are more based on author belief than in true accuracy.   Still, it is my opinion that you can look at the successes of other countries and spot which tax levels are working, and which are not.   Unfortunately, there is a great deal of noise in the data created by individual political and resource situations that allows plenty of obfuscatory argument for any direction you want to go so there are no solid answers.    A low tax in a country like Somalia, cannot correct the insane government situation which destabilizes any business viability.   A high tax on a country like Saudi Arabia, is equally confused by the massive oil reserves, they have a 20% rate though.

So, since I have declared a true calculation all but impossible, I will tell you my belief of where we sit on the curve.   If the US government cut taxes on business income in half, halved the capital gains tax, reduced some of the stupid employment laws and the unreasonable environmental controls, slash the IRS code and filing requirements, we would see a massive influx of international business looking for a politically stable ground to put their headquarters.  We could double the size of America’s economy in very short order, putting nearly everyone who wanted a job to work.  Such a move would take the world by complete surprise and again, companies would compete for workers and America’s poor would stay near the top of the world in wealth.   There would be a huge influx of cash from the rest of the world that over twenty years could eliminate our National Debt- except that politicians would have their hands in the cookie jar.  More than that, it would again allow America the economic power to lead the world toward the freedom and health that they all deserve.  If it were done suddenly, there would absolutely be a huge drop in revenue in the first few years though, just as a huge tax hike creates more revenue in the short term, yet could kill the economy in a decade.

Even if you disagree, the thinking person should not forget that more tax does not necessarily equate to more revenue.

May you live in interesting times….  2013!

19 thoughts on “Two Sides of the Laffer

    1. Uh. Not untouched. Just taxed at current rates. Which as Jeff points out are probably sub-optimum – at least for high earners.

    2. My regular point here has been that we employ a lot of people below 250,000 and they just got touched.

      All of our money comes from the same corporate bucket. Assuming that the house passes this bill, what we have to look forward to is more spending and about $2.5/employee/hr of new healthcare and tax costs. Since a fair number of our employees are working as assemblers, that 2.5/hr of extra load on the business is far from zero.

      The Wikipedia article is heavily biased, and like all left-wing articles, completely fails to recognize the effect of regulation on the optimal tax rate. I am expecting an excellent spring though, perhaps extending for several years. I wonder what the lag time will be before people slowly begin to experience the fruits of tax and spend.

      1. The Obama care taxes will be felt fairly quickly in my view. The entire nation of business owners have been postponing all the new Obamacare regulations. They have no idea how this monstrosity will be implemented, but it is already affecting hiring. The full affects of Obamacare will be economically terrible.

      1. Re: Matthew W (Jan 1 12:22), Yes, Cali has been stupid long enough for the results to show. The lags have all been used up, there. It is now febrile. Two of the rare exceptions are both due to the innovative competence of one man, though: Musk’s SpaceX and TeslaMotors are putting out un-parallelled products that literally have no competitors on a cost-benefit basis for their customers. The rationales espoused by Elon Musk are boilerplate liberal “save the world-ism”, but the means and tools he has created fortunately transcend that.

  1. The reason it can’t be computed is that the computation requires counter factuals whether you want to increase or decrease taxes. I prefer the biological constraint of mimicry: when the mimics’ population gets above 44%to 46% of the total of both, predators will start consuming both. We should look at politicains and taxes as the same. The total tax bill, including fees, should be 46% maximum.

    The part that is missing and was not discussed in the wiki is spending effeciency by the individual governments under consideration. Computing just the main economic effects misses the reason that the curves are sloped different from the ideal. Denmark has high taxes yet, at present, is properous. The other part is that often facilities once built do not reach shutdown price for decades, such that attributing the actual cost only occurs when the tax becomes so onerous, or the facilty so depreciated that business leaves otherwise profitable locations. Because of the lag between at present and the future of tax or repeal, and that ineffeciencies are hidden, unmeasured most likely, there should be at least a 20% offset, as has been determined empirically by businesses. When one considers a cost with large uncertanties, a 20% excess budget is necessary to prevent waste of investment. With Laffer at 50%, we get the 40% for long term such as taxes. If government actually measured and computed these costs we get back to the 10% rule, and 45%.

    Looks like 45% is the maximum. Though the analysis is somewhat tongue in cheek, the real problem is that we cannot and government has an incentive not to measure. As one economist stated that we would continue to have economic problems until politicians understood that one cannot break the laws of economics just as one cannot break the law of gravity. One can see this particularly in the Keynesian and Neo-Keynesian as used by the politicians: it requires taxes increase when times are good, not just to pay off the debt, but to save for the next downturn. I doubt you will see Keynesian theoretical problems discussed with such clarity as the Laffer on wiki. Yep, it is not there. The supposed ineffeciencies of the public economy are there but not the government’s.

    You are right Jeff, biased economic wiki. Note that if you buy the inefficiencies argument, it would show that the ideal Laffer curve would be 0 at about 90%, not 100%. Also, this assumes one can actual measure hidden taxes and fees, one I do not necessarily buy.

    1. Re: johnfpittman (Jan 1 08:52), The “inefficiencies” are (wide) variations and “slop” in the means and approaches taken by various actors to address the market(s). This is exactly the space where development and innovation occurs. It would not occur to or be permitted by an “ideal” government management. Stagnation and obsolescence would be the inevitable result.

  2. Personally, I think that we are close to an optimum point on the curve (concerning taxes). I don’t think that up a little here or down a little there would make a big difference with respect to revenue to the feds.

    As you mentioned, there is an almost unlimited amount of laws and regulations that could go away very quickly that would help the economy and our personal lives in ways that changing the tax laws couldn’t (leaving out any type of large change in the tax laws).

    The EPA had its time and place and did an incredible job of cleaning up pollution in America. But like the typical bureaucracy, it needed to expand itself and find other stuff to do and got totally of its original purpose and mission (having been hijacked by career leftist environmental kooks) . Slash a few thousand pages of EPA regulations and the economy will have a much better chance of getting better.

    Not EPA, but here’s an Illinois example of overreach:

    “Energy-efficient homebuilding is about to take a big step forward in Illinois, but consumers will pay now to save on future utility bills.
    A new statewide building energy code that takes effect Jan. 1 strives to make homes more comfortable and residential energy bills less costly by making the building’s “envelope” tighter. The adoption of a substantial amount of the International Energy Conservation Code for homes puts Illinois at the forefront of such efforts among states.”

    Is it really the role of the government to force me to be more energy efficient???

    1. No matter what the tenth amandment says, the federal government will use the “General Welfare” and “Commerce” clauses to intrude into your life. For example, you can’t install 1″ water pipes in your home. These kinds of restrictions are “for our own good” as Nanny knows best. It is quite possible that football will be deemed unsafe in its present form.

      Where will it end? It may be time to read Goerge Orwell’s books again.

  3. If our leaders would look at what has happened in other countries they might be less inclined to implement ideas that have failed dismally elsewhere. We learned nothing from the Japanese mortage and banking bubble twenty odd years ago. We learned nothing from the harm done to the Spanish economy by subsidizing “Renewables”.

    My countrymen (UK) recently raised “Taxes on the Rich”. If the idea was to increase government income it did not work:

    The truth is that everyone knew it would not work but they did it anyway in the name of “Fairness”. Does that sound familiar? In this context “Fairness” means the “Politics of Envy”.

    1. As an American Conservative, “If our leaders would look at what has happened in other countries”, is the real pisser of all this.
      We can see what horribly mismanaged government monetary policy did to Japan
      We can see what government run health care did to England
      We can see the dismal results of “green energy” in Germany and Spain
      At home, it’s blindingly obvious that Fannie and Freddie (ie federal policy) caused the American mortgage crisis
      and yet we go full speed ahead into the abyss.

  4. The first and foremost key to economic success is predictability. If business is to thrive – at any point of a taxation rate – it must be able to predicate what the costs will be (taxes included).

    We are in a situation right now when there is nothing but uncertainty about future total costs.

    Tax rates: nobody has any idea what the cost of an employee is going to be in 2014. The rules and regulations are still being written for Obamacare. This also is why temporary tax cuts – the temporary reduction in Social Security withholding for instance failed.

    Regulatory costs: Financial sector – Dodd-Frank will have a significant impact on the cost of capital and again the rules have not been written (in violation of the law itself). Energy, Agriculture – what will the EPA get away with? Healthcare (see above).

    As far as tax rates go, the second key is the optimization on the elusive Laffer curve.

  5. Obamacare taxes just kicked in. The payroll “Tax” was not extended. Taxes on everyone paying taxes just went up (just more on those making more than $400k). The aborted recovery that has been non-occurring for 3.5 years will continue to non-occur.

  6. Hiya Jeff (and all…)

    If I can focus first on the debt argument here, I must say I am not at all worried by American levels of public debt.

    Our debt has been higher in the past as a percentage of GDP, which is the only sane metric to use. The people who are lending us money are in line to do so. They have more confidence in our ability and intention to pay than maybe you do. They like us so much they’re willing to lend us money at effectively zero interest.

    If America were a ‘household’, its debt would be considered very manageable–a bit more than 100% of annual income. Anybody reading this who has a mortgage may well hold a much higher percentage of debt.

    What worries me is that our obligations are set to grow dramatically, to help seniors stay out of poverty and get some sort of medical care. That is why I am not overly upset at taxes returning to levels last seen during the Clinton administration, when we managed to grow the economy quite well, even with taxes at a respectable level.

    We’ve had much higher debt in the past and done just fine. We’ve had much higher taxes in the past and done just fine. We have problems ahead that we need to prepare for–but we can and we will.

    Happy New Year!

    1. Thomas – when the debt was higher, there was a terminus in sight (either our demise or that of our enemy). Today there is none. When we spent for WWII, when it was over, so was the spending. There is nothing in the spending today that will be over. And that is what worries me. There is no end in sight. The debt itself (as of today) is not the problem. What it represents is.

  7. The problem is that when no one will lend you money any more, it happens suddenly, as in Greece. At the same time, the cost to borrow skyrockets.
    One of the hidden costs of regulations is the things that don’t happen. Chicago (per se) has had no Walmart stores because they can’t get a permit. Many start-ups are discouraged because it is so hard to jump through all the hoops. You can’t open a hole-in-the-wall deli anymore, because you can’t pass all the inspections. You must be already rich to start a business, which cuts out the poor from having a way to get started. For hundreds of years in America you could start out for no money by getting land for free, starting all kinds of low-entry businesses with no or minimal permits, but now you need permission to start a cab company and food trucks are regulated out of existence. Why do you need 1000hrs or more of courses to cut hair? Why a degree to give a massage? Why a degree to offer interior design advice? Bill Gates did not need a degree to become a billionaire. Politicians don’t need a degree, just votes. Why do the poor more likely need a degree/certificate/permit than the rich?

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