Where’s the High Point on the Laffer Curve? And Where Are We?


Anti-taxers love to haul out the legendary napkin-inscribed Laffer curve to demonstrate that lower taxes would yield more government revenue. But this ploy only works because they assume that we’re at or past the high point — that higher taxes would move us down the right slope. (Note the cross-marks-the-spot in the image here?)

But where are we really, relative to that high point? James Kwak gives us an answer, based on a great recent paper by Christina and David Romer (emphasis, interjections, mine):

…an [income] elasticity of 0.19 [from the Romer paper] implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.

This is obviously not to say that we should be taxing at that level — only that Laffer-curve arguments are ridiculous because we’re nowhere near the high point.

Kwak adds another key insight about the paper:

Second, remember that this is a study of the super-rich: not the top 1%, but the top 0.05%. These are the people whom one would expect to have the highest income elasticity, precisely because they don’t need the marginal dollar. Elasticities tend to be lower for ordinary people because they need to cover their expenses.

So we’re even father from the peak than suggested by the .19 elasticity.

Takeaway:

when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes.

Hat tip Karl Smith and Mark Thoma.

Cross-posted at Asymptosis.

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