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The Laffer Curve Applies To The American Welfare State As Well

As far as our best bet goes – this is from the Diamond and Saez paper – the peak of the Laffer Curve in the US economy is some 54% for taxes upon income. It’s higher, up at 75 to 80 % if there are no “allowances.” That ability to dodge tax through renaming income, reclassifying, or even just getting the hell out of Dodge by leaving the country. That means our own such peak is a little lower, as we can get out of the UK tax system just by changing residency, something not available to Americans.

We also know that our combination of tax and welfare systems leaves some with marginal tax rates very much higher than this. Budgets regularly report the numbers, millions above 60%, hundreds of thousands above 80% and even tens of thousands above 100% marginal rates.

It’s long been an assumption – insufficiently examined perhaps – that this isn’t true of the US welfare and taxation states. Hmm, not so fast as this shows:

A better way to assess this would be to figure out the effective marginal tax rates for all upward shifts. So, it’s 79% to go from lowest to second lowest, and then 73% to make the jump from second lowest to the middle quintile, 59% to go one step further, and then 44% to go from the second highest to the highest quintile. Now we’re getting somewhere. Our system as it currently stands punishes everyone for working more, harder, and better. But don’t forget that this is OK: it means we’re all chipping in to help the less fortunate. The thing is, we punish the poor who work more, harder, and better more than we punish the upper middle class who choose to do that. Is it any wonder that there’s a perception that the upper middle class has more strivers?

Yes, this is important. As I’ve said elsewhere recently:

The Laffer Curve is just the interplay of the two. When will enough people go fishing in the face of a tax rise so that revenue falls? The best observations we’ve got say when taxes are in the 50-60 percent level, some people stop working. One famed paper claims the right number is 54 percent for taxes upon incomes, including employer-paid taxes on labor like Medicaid/care supplements and so on. That’s a touch higher than the federal tax system today, a touch lower than that added to certain state taxation systems.

Note what we’ve not said here, that this only applies to rich people. In fact, it applies to all of us. Sure, poorer people are more likely to be influenced by the income effect, but that’s a tendency, nothing like a certainty.

It’s a difficult problem to solve. One way is just to have less government…..for those high marginal tax rates act as disincentives to the poor just as much as to the rich. Actually, more, as there are more poor facing higher rates.

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5 years ago

Let’s be clear, there are rates of taxation well below 60% at which people choose fishing over work plus the greater unpleasantness of remitting to the Parasite Sector. This is magnified when taxation includes a Form 8965 (Obamacare individual mandate) that cannot tell you what your tax is until you research the prices of insurance products you would never buy. Of course it includes the situation where working a bit harder would make you stop qualifying for transfer payments. Why would it not? The Laffer Curve only suggests that there is a level of taxation in which this disincentive overwhelms… Read more »

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