01/20/2013 States of Confusion

Cognitive dissonance is what happens when we compartmentalize contradictions.

 

There’s one more curve to throw into the mix: the Krugman curve.  Paul Krugman has never claimed it, but I’m officially nominating him right now…

The Laffer curve is the maximum progressive Federal tax rate.

The Krugman curve is the maximum progressive academic tax rate.

In theory the Krugman curve would be identical to the Laffer curve.  Economic studies are nearly unanimous in placing the peak of the Laffer curve between 65% to 70% maximum progressive tax rates, which is the same as 35% average tax rates.

My own calculations placed the idealized capital gains maximum at 35%, which would create a maximum revenue point on progressive tax rates at 65%.  That is, capital gains are flat rates, so a 35% average is the same as a 5% to 65% progressive tax.

So then, Paul Krugman and I agree with virtually all mathematical studies of the Laffer curve: a progressive tax rate should peak at 65% (which is an average of 35%).

And yet… my historical graph of actual per capita revenues shows a peak when the maximum tax rates are at 35% -- not 65%.

When I first produced that graph I had to scratch my head, because the graph for maximum progressive IRS revenues was identical to the curve of where average revenues should be.

It was perfect.

It was also perfectly wrong.

And there are exactly 50 reasons for it to be wrong: Alabama, Alaska, Arkansas…..

Right, the Federal government only gets part of our taxes.  The states get another part.  That 35% average or 65% maximum is for all taxes put together – not just the IRS.  When you plot the actual IRS revenues, then, you can only plot the Federal government’s share.

The Laffer curve is what’s left of the Krugman curve after reality takes a bite out of it.

Add all State and Local taxes together, and they’ve cut that 65% maximum down to the 35% maximum we see from actual Federal revenues:

Art Laffer himself never gives an actual number for the peak, because it is impossible to do so unless you also know what other taxes are forcing the curve to contract.

A European VAT tax at 20% would cause the Laffer curve to peak at a 25% max / 15% average.

The State and Local taxes are also close to 20%, but many of them can be deducted from your Federal taxes, leaving us with the 35% max / 20% average for the historical IRS revenues.

Occasionally you’ll see an economist laugh at Conservatives who point to the true peak at 35%, because the math very clearly shows it SHOULD be at 65%.  And, unfortunately, Liberals tend to stick with the Krugman curve as well.

Krugman and the Liberals would be 100% correct – if there were only one tax in the entire country.

So, their math is perfect.

And it is also perfectly wrong.

So, that’s the back story: in the absence of all other taxes, the average tax rate would be 35%; but the presence of other taxes turns that 35% average into a 35% maximum.

So what are all those other taxes?  On the state level, here are some categories from the United States census bureau:

(Source http://www.census.gov/govs/statetax/historical_data.html )

Property Tax (T01)

Tot Sales & Gr Rec Tax

Total Gen Sales Tax (T09)

Total Select Sales Tax

Alcoholic Beverage Tax (T10)

Amusement Tax (T11)

Insurance Premium Tax (T12)

Motor Fuels Tax (T13)

Parimutuels Tax (T14)

Public Utility Tax (T15)

Tobacco Tax (T16)

Other Select Sales Tax (T19)

Total License Taxes

Alcoholic Beverage Lic (T20)

Amusement License (T21)

Corporation License (T22)

Hunt and Fish License (T23)

Motor Veh & Oper Lic

Motor Vehicle License (T24)

Motor Veh Oper License (T25)

Public Utility License (T27)

Occup and Bus Lic NEC (T28)

Other License Taxes (T29)

Total Income Taxes

Individual Income Tax (T40)

Corp Net Income Tax (T41)

Total Other Taxes

Death and Gift Tax (T50)

Docum and Stock Tr Tax (T51)

Severance Tax (T53)

Taxes NEC (T99)

Yeah, some of those overlap, but who can keep track?

Tim