US Tax Rates Are Too High, Well Over The Laffer Curve Peak

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We’ll all recall how so many are calling for much higher income tax rates on higher earners. Because inequality, of course. There are even political campaigns – lookin’ at you Lizzie Warren – based on all the wonderful things that can be bought with the extra revenue to be received. One problem with all of this being that if the tax rates are above the Laffer Curve peak then there is no extra revenue. Rather, higher rates reduce the revenue coming in. If you actually desire more revenue to do more good things then you’ve got to lower those tax rates.

Of course, some will argue that Laffer was wrong, that there is no such tax rate. Then we can turn to those who know what they’re talking about, where the question is, well what is that rate? Just to avoid too much shouting we can take this piece of research by Peter Diamond and Emmanuel Saez as being our best guess at what that rate is. It’ll differ given the structure of the underlying society etc but this is about the best guide we’ve got. Or about the best we’ve got that hasn’t been written by those who are already anathema because they believe in freedom and or liberty or anything strange like that.

It is often stated that the rate discovered here is 75 to 80%. This is not so – that could be the rate if only we entirely and wholly changed the taxation system in a mass of highly undesirable ways. If we remain with roughly what we’ve got in structure and intent then the peak of the Laffer Curve is 54%. That is not income tax, that is taxes upon income. That means we add together all Federal and State taxes upon income, including “employer paid” portions of Social Security, Medicaid, special amounts for this and that and so on and on. Anyone even vaguely familiar with the US taxation system will not that top earners are, already in many states, paying this or more.

There is something else though. The Laffer Curve is not about taxes upon high earners. It is about taxes upon income. It’s true that there will be slight differences in what the peak rate on lower incomes should be, or what the peak of the curve is there. The income effect will be higher than the substitution at lower incomes than it is at higher. We don;t know how much so let’s just stick with what we’ve got – 54%.

At which point:

The U.S. has a plethora of federal and state tax and benefit programs, each with its own work incentives and disincentives. This paper uses the Fiscal Analyzer (TFA) to assess how these policies, in unison, impact work incentives. TFA is a life-cycle, consumption-smoothing program that incorporates household borrowing constraints and all major federal and state fiscal policies. We use TFA in conjunction with the 2016 Federal Reserve Survey of Consumer Finances to calculate Americans’ remaining lifetime marginal net tax rates. Our findings are striking. One in four low-wage workers face marginal net tax rates above 70 percent, effectively locking them into poverty.

This includes the withdrawal of welfare benefits as income rises – as it should – and so is compatible with the Universal Credit idea that the peak tax and withdrawal rate should be 60%. Or is it 66%?

As we can see that rate is hugely above the Laffer Curve peak. It should, therefore, be lower.

It’s possible to extend the taper. Withdraw benefits at slower rates as income rises. This is, however, hugely, vastlylily, expensive. So it’s not going to happen to any significant degree and if it does then it will be financed by reducing the overall amount of benefit being paid. Which would mean taking money off the truly low income in order to soften the blow to the marginally low income – not the way we want to be doing things.

The only other way to do this is to reduce the taxation of the income of those low income folks. This has been done, a bit, by the Trump tax reforms and the much larger personal deduction. A further bite could be taken by FICA taxation only applying to the income above the personal deduction, not from dollar $1 of income as now. In fact that would be the simplest manner of at least beginning to get to grips with this problem. FICA only starts at $12,000 a year or so. Or even, if all are to be sensible, starting income tax and FICA only at the poverty line, currently $14,000 or so a year for a single adult.

US tax rates simply are too high and the best manner of reforming them is to increase the amount that the poor can earn tax free. We’re already at the Laffer Curve peak for many of the poor and near all the rich. Thus this will mean our enjoying less government which would be such a pity – or, the analysis could even be correct and we’ll enjoy more by getting tax rates below that Laffer Peak.

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Michael van der Riet
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Michael van der Riet

Or, naturally, by optimizing the tax rate, more tax will be collected and there will be even more government, huzzah.

TD
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TD

Is it the goal of people who advocate for higher taxes to actually collect higher taxes or is their real goal to lower wealth and living standards?

Jim
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Jim

Their aim is to inflict as much pain as possible on people they don’t like. The economics of it doesn’t even come close to their motivation – its entirely spite. The modern Left are after all the heirs to a philosophy that murdered its opponents by the tens of millions, so we should expect nothing else.

Esteban
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Esteban

There is an argument that some income taxes should apply from the first dollar earned. When I got my first paycheck at around age 15 I was shocked to find that somebody named FICA took about 7% of my $25 check. That was the first tiny seed of the reality about free government-provided stuff.

If you don’t tax anything at all until North of $14,000 (higher if you have dependents, etc.) you make it a lot easier for people to support high tax rates because they only apply to other people.

Addolff
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Addolff

Absolutely. I know it is verboten here, but start tax from £1 income and the people who talk about ‘free’ stuff and ‘we have to increase funding for (insert your favourite money pit here)” will now have skin in the game.

Spike
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Spike

I don’t think many Americans are beyond the peak of the Laffer Curve. Top regular income tax is 37%. Add FICA (National Insurance); employer plus employee share is about 13%. But most of it cuts out at income levels well before the highest income-tax rates kick in. States add income tax, sometimes into double digits, but states are famously in competition with one another, especially now that it’s harder to get some of the state tax back off the federal tax. The withdrawal of benefits as low-earners start earning more does create a very high marginal tax for them.

Snarkus
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Snarkus

Oz has lifted tax free threshold for years to lift burden on low income. Perhaps a look at deductions only available to asset rich might be more equitable. Direct money taxes dont affect the very wealthy or less wealthy and scam minded who fund the bodies that fund political parties to avoid public donation knowledge