Talking about Art Laffer and his curve Jonathan Chait says this:
This is not merely a technical objection. It exposes a conceptual flaw underlying Laffer’s entire premise. People are not, in fact, utility-maximizing robots. They choose to work for reasons other than maximizing their incomes on the margin: habit, pride of craft, and so on.
Utility maximising does not mean revenue maximising. That’s why we use the different word, utility, because it does not mean revenue. Things like habit – because change is annoying and thus detracts from utility -, pride of craft – because boosts to the ego increase utility – and so on and on are parts of utility, the thing we claim is maximised.
People are utility maximising because the original observation and definition is that utility is the thing people maximise. Also, that utility ain’t the same as revenue.
The really bizzre thing is him saying:
“I would personally prefer not to pay a 100 percent income tax, but under such circumstances, I would not cease working.”
Well, you may not choose to stop working, but after a few days with zero income – the government having taken all your money – you will have starved to death and you would have ceased to be working, so in the end it’s identical.
The other reading is that he is declaring his willingness to enter slavery.
I expect the Intelligencer to have a conversation with him that starts “since you’re happy to work for nothing …”
I suspect $0 is very close to the rate he’s already paid. And if they’re paying much more than that, they need to find a more descriptive name for their writings.
This Chait fellow certainly has his finger on the pulse of the workers. I work on the production line in a cheese packing factory and I can honestly say that neither I nor any of my fellows would cease working if the state took all our earnings.
My brother feels the same way about his job gutting pigs at the abattoir. It’s a vocation, see.
“Laffer, schlaffer” is what we say at the end of a double shift permanently on our feet.
Looking at that definition of utility, I’d argue that desire to avoid a flogging is included. So I’d say it works even under slavery.
This is silly. It’s possibly true that someone who truly loves their work will keep doing it no matter how much they are taxed. But that’s expending their own labor and they are also the exception. A lot of doctors truly love their work but they might also like golf or fishing and many will spend more time at their hobbies if taxed too heavily. What Chiat particularly is not considering is will someone expend capital or take risks to work more when taxed so heavily? Will a successful restaurant owner who truly loves cooking and serving customers open a… Read more »
Many in baseball say, “I’d play this game for free,” and some seem to give their current club a “home-town discount.” Nevertheless, annual salary negotiations are about something. So Laffer could still be right; even in a labor-of-love, some would withdraw their merchandise from the market if taxes got too confiscatory and clubs didn’t compensate; tax take would decline. If baseball opens this year, clubs are proposing that players pro-rate their agreed salaries; the NY Post reports that players expect a few stars not to agree to this and withhold their services. It’s also been reported that clubs in Texas… Read more »
That would explain why the Rangers and the Mariners are always such playoff powerhouses. It would also explain why the Astros wouldn’t need to cheat to wina series.
I think there is an important distinction between profit and tax. People may well work for no (financial) profit, but that is not the same as them working with 100% tax. The factor most influential in willingness to work for no money is creativity. Many writers, artists, singers etc would do what they normally get paid for even if they were not paid. After an artist dies it is quite common to find they have left behind many works which they did for their own pleasure rather than for money. And Avicii, for example, did a tour (House for Hunger)… Read more »
I think the periodic example of someone giving a free concert or perhaps working for $1 per year is actually pretty rare. it does happen, but realistically, a signer might give a free concert and even lose money putting on that show, but will they give a free tour?
The Laffer curve is nonsense, and economists occasionally point out that real life data fail to match its predictions, but I have not seen any proper theoretical refutation. Mathematically it’s wrong, but superficially plausible. It looks like you have zero at two ends of a curve and non-zero at least one place in between, so there must be a maximum somewhere. This would be a consequence of Rolle’s Theorem, but unfortunately for the Laffer curve that requires mathematical properties which are not true for tax. Firstly, it requires the curve to be differentiable everywhere, and there is no proof that… Read more »
Of course the Laffer curve is nonsense: https://www.theguardian.com/society/2019/jun/24/nhs-consultants-turning-down-work-avoid-huge-pension-tax-bills (apols for linking to the Grauniad).
To ridicule using numbers does not make you a mathematician. This sophistry/dissembly is the same as telling us what CO2 does in a test tube therefore we know future climate. No, there is no reason why tax revenue as a function of tax rate has to be continuous and differentiable. The same “human psychology” tells us that there are points of diminishing returns, and no one does any work at a tax rate of 100%, though you may find and celebrate anomalies. There isn’t an exact point at which the world’s minds go on strike. There is an approximate point… Read more »
You say “There is an approximate point at which raising tax rates is counterproductive”. What is it? (And cite some sources)
Here’re Peter Diamond and Emmanuel Saez trying to calculate the peak of the Laffer Curve for taxes upon income in the United States: https://www.aeaweb.org/articles?id=10.1257/jep.25.4.165 The rate is different for different taxes, in different societies. But consider. No one has sales taxes about around a 10 to 12% rate. But VATs regularly rise to 25%. Why? One argument being that the difference in how the taxes are collected means that it is possible to charge higher rates. Or, as we might put it, the peak of the curve for a sales tax is at a lower rate than that for a… Read more »
James Hannam’s book “What Everyone Needs to Know about Tax: An Introduction to the UK Tax System” is an excellent book and his ‘Third Rule of tax’ covers Tim’s point about VAT – it is invisible, added into the price so you don’t see it, whereas Sales’ tax, in my experience, is clearly shown as a separate item after the price of the item so you can see how much tax you are paying.
Yes, although that’s not the only point. Sales tax is, by definition, charged once and once only at the retail point. VAT is charged in increments along the production chain. That’s actually the definitional difference between the taxes. An effect of this is that each purchase in the production chain wants to make sure that his supplier is properly VAT registered, so that he can reclaim that VAT paid out on supplies. You’ve got the production chain supporting the levying of the tax. With a sales tax, at that one point, there’s too much temptation to evade it when it… Read more »
VAT is often clearly shown on receipts, but why would it make any difference anyway? If I’m buying something it makes no difference how the price is made up. It’s all my money that I’m handing over.
An interesting paper, but highly flawed. Typical eceonomists, however. They say “One way to judge how seriously to take such numbers is to consider whether elements left out in the derivation push for a significantly different answer.” when the far more important way to judge numbers coming out of a model is to compare them to observations in the real world. Yes, higher rates of VAT are possible than sales taxes. This is because enforcement is distributed rather than centralised (a bit like capitalism itself). A transactions tax is a very peculiar thing. For goods and services it would be… Read more »
What a load of garbage. You admit there’s a curve then claim that it isn’t a curve by Begging the Question and asserting it can’t be. And in all of it you spectacularly miss the point. I don’t think anyone claims the curve can be computed mathematically. But it tells us something very useful about human behaviour in response to tax rates that is shown by experience and experiment to be true. The claim it tells us nothing is laughably false.
You clearly have not read what I wrote. I said that it was a curve but not a function. People certainly do claim that it can be computed mathematically, and do so for mid ranges where they are trying to show that some particular tax rate is better than another. They also assume it is smooth and continuous. It tells us nothing because it starts from the position that 0% tax and 100% tax raise no revenue, and that somewhere in between there is revenue, and then goes on to tell us nothing more than we have just started with.… Read more »
It’s not a function, so it can’t be true?
Are circles real?
The Laffer Curve is idealised. Like every real life concept. Is my income imaginary because it cannot be exactly calculated? Is my height a false concept, given that it varies across the day by half an inch?
Sometimes it pays to not to be too clever.
It can be real, but it may lack mathematical properties that a function would have – like a maximum. To give a concrete example, suppose the tax rate is 40% and increases to 80%. This will make many people set up and use tax avoidance schemes. If the tax rate goes back to 40% some of those schemes will persist as the overhead of setting them up has already been paid. But this means that the total tax raised is now less than it was originally. So the revenue cannot be determined by the tax rate even in principle, and… Read more »
Of course tax rates aren’t continuous – I can’t see anyone introducing a tax rate of e^pi. But the fundamental truth remains that (trivially) a tax rate of zero collects zero; a tiny rate raises a tiny amount of tax; 100% tax rate raises (near enough zero. The function isn’t continuous, but it is still the case that a small change in the tax rate results in a comparatively small change in revenue, so the approximation is close enough for Laffer’s observation to be valid, as has been evidenced in the real world many times.
I always thought the Laffer Curve told us about choices at marginal rates? As the UK has seen with consultants, they have been choosing en masse not to work weekends when they suffer 100-110% tax. They keep doing their regular work, but decide not to do more for nothing. Same with skills – why get better at your work if you gain nothing from that? And so on.
It’s a lot more complicated than that. They’re not facing >=100% tax, but it’s still a big problem. A highly paid doctor gets a big salary, and part of that is a contribution to a pension. Since contributions to pensions are tax free (because the pension will be taxed when it is paid – it’s just moving the money and tax into the future), that means that the doctor gets a chunk of salary to spend which has been properly taxed. Then there’s the deadly complication: there is a limit to how much you can contribute to a pension tax… Read more »
I keep expecting one day that the argument will be made that even if people do alter their behavior in response to tax rates that doesn’t mean it should be tolerated. Verified time cards could be submitted with income tax returns. If someone appears to be slacking off rather than earning more, why should that let them off the hook for the taxes on what they could have earned? Coming soon to a Guardian editorial near you.