According to Art Laffer, a tax rate of 0% would raise 0
dollars in revenue, and a tax rate of 100% would also raise 0 dollars in revenue.
The optimal tax rate would be somewhere between 0% and 100%, and there
is a wide range of opinion between Liberals and Conservatives about where that
maximum revenue point would be.
But we aren’t at the mercy of opinion, because we have data.
Last night I posted a rough graph derived from 1940 to 2011
income tax data. Tonight I’d like to
fine tune that data a bit to give a clearer (and most surprising) view.
The original graph only used time periods of 5 year, 10
year, 20 year, and 30 year increments, and did not accurately average each
specific tax percentage rate.
For the corrected graph I’ve taken ALL time periods, from 1
year, 2 year average, all the way to 72 year average rates and returns. All of the values are equivalent to 2005
dollars, and divided by the U.S. population for that year to give per capita
revenues in equal weighted currency.
That gave me 2,628 percentage rate and per capita return
rows.
Next, I rounded each percentage fraction to its nearest full
percent (i.e. 29.9% and 30.1% would both be 30%).
Next, I averaged all per capita return values for each full
percent between 28% and 94%. (There is no income tax data outside of those
percentages for the 1940 to 2011 time period).
Finally, I divided each percentile’s return rate by the
maximum potential return, which was located at 35%. So, the return for 35% is 1. The return for 44% is 0.8581.
I did the same thing for the idealized capital gains curve
created for my 11/17/2012 post:
The two curves are now on the same scale:
The blue line is the historical revenue curve for Income Taxes.
The red line is the idealized revenue curve for Capital
Gains.
The blue line was calculated from 72 years of data
(1940-2011) – maximum income tax rates for each year; total Federal revenues
for each year, divided by total U.S. population for each year.
The red line was calculated from 62 years of the S&P
index (full details are on the 11/17/2012 post).
Both lines show maximum revenue at a 35% tax rate – but that
should NOT be true if Art Laffer were correct.
Look more closely at the right side of that curve. The idealized red curve shows capital gains
revenue even if government taxed 100% of your capital gains. According to Art Laffer, the government
should get 0 dollars in revenue at a 100% tax rate, but the idealized line
assumes no change in investor behavior and terminates with 48.54% of the
revenue that would have been generated at a 35% rate. That is, if a 35% rate would raise $10,000 in
revenue, a 100% rate would STILL get $4,854 in revenue.
Of course, that’s absurd, right?
Well, no – look at the blue line. The blue line shows ACTUAL government
revenues between 28% and 94% top income tax rates. The curves have the same slope!
This is astonishing to me.
The Laffer Curve seemed to be intuitive, but it turns out to be
wrong. People will still work even as
the tax rate approaches 100%, and in fact this is what we have seen in
communist groups such as the old Soviet Union, or even a social commune like an
Israeli Kibbutz. There are various
reasons to work: boredom, dissatisfaction with environment, peer pressure,
government mandates to work-or-else, etc.
So, it turns out that Conservatives are wrong: tax rates do
NOT directly influence individual behavior.
And yet the revenues go down anyway…
This is where the Liberals are wrong: tax rates DO affect
total economic activity.
The reason is rather mundane: people are still willing to work, but they run out of things to work with.
We don’t get taxed once, but in incremental layers. When I buy a car or groceries, that’s in
AFTER TAX money. My car dealer and
grocery store clerk take MY after tax money and then have to pay tax on what
THEY get, and then THEY buy things with whatever is left over after their
taxes.
The higher the tax rates, the less layers of activity there
are before everyone runs out of money. I
may be able to buy a car and groceries, but my grocer may not have enough left to
buy a car himself. So, the grocer will
STILL work (as the Liberals say), but he won’t have enough left over to pay for
anything (as the Conservatives say). The
limit isn’t necessarily in terms of human labor, but instead in raw
materials. Communist countries produced
cars, made out of what scanty materials they could buy, and so the cars were
practically worthless. A farmer may be
willing to sow, if there were any seed left to buy.
The metal and the seed ended up in the non-Communist
countries that could pay more. Even
though a person MIGHT work even if he weren’t paid, he’ll still sell to the
highest bidder – which is the buyer who hasn’t already lost his money to taxes.
Take the money away, then, and economic activity slows down,
in SPITE of individual behavior. People
work harder and harder to buy less and less, until there is nothing left to
buy.
In any case, according to this curve, the recent tax hike
from 35% to 43.8% should create a 14% per capita DROP in Federal revenue.
Never trust a lawyer with math.
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