Home > Solution-Problem, Unintended Consequences > A defense of Art Laffer, and tax policy news from Britain

A defense of Art Laffer, and tax policy news from Britain

Art Laffer, among the original “supply side” economists, comes in for a lot of criticism on the left.  From what I can tell, it is mainly due to his association with Ronald Reagan, who is treated simplistically by both left and right.

But one thing cannot be disputed about Art Laffer: he was on to something.  Note the most common mischaracterization of his famous “Laffer Curve.” According to the common conception, Laffer’s point was that lowering taxes will “pay for itself.”  This is patently ridiculous, both as a statement of Laffer’s point and as a statement of reality.

Now, there very well could be cases where lowering taxes would “pay for itself,” and speaking of Ronald Reagan, the ol’ Gipper found that tax revenues actually soared when he made dramatic, across-the-board cuts (from a top marginal rate of 70.1% to 28.4%).

But what Laffer was actually saying  needed no practical application to make logical sense.  His point was that there is an efficiency point at which revenue will be maximized.  Raise taxes and you may well end up with more money, but you will likely do so with less efficiency. This all depends on where your particular tax rate is on the Laffer Curve.

For example, much of the wealth of the richest people in the country is held in equity form – in other words, aside from immediate cash needs, these people control when and how they realize their wealth.  In the case of a person with millions and even billions in corporate equity, there is nothing to be gained by selling out in a high-tax environment.

Take this to the extreme, and it is very easy to see that people with any capacity for tax deferral and/or avoidance will take the opportunity.  It is, in fact, very easy to posit a tax rate hike at which revenue will be ultimately reduced.  In the past couple of decades, we have not seen that kind of rate hike (or reduction) in this country, as going from top marginal rates of 35% to 39.6% will move the efficiency needle, but not overwhelmingly.

That is where Britain steps in.  Even though Laffer’s ultimate point makes theoretical sense without practical application, Britain’s recent experience seems like pretty overwhelming evidence.  According to the Telegraph, Britain, which recently raised its top rates from 40% to 50%, has seen an overall drop in revenue:

The Treasury received £10.35 billion in income tax payments from those paying by self-assessment last month, a drop of £509 million compared with January 2011. Most other taxes produced higher revenues over the same period.

Senior sources said that the first official figures indicated that there had been “manoeuvring” by well-off Britons to avoid the new higher rate. The figures will add to pressure on the Coalition to drop the levy amid fears it is forcing entrepreneurs to relocate abroad.

Revenues from the tax hike were supposed to raise £1 billion more.  In actual fact, they raised £509 million less.  It is difficult to know what the “tipping point” is, but I think it is fair to say that it is less than 50%.

Again, Art Laffer was on to something.

See more links at the TaxProfBlog here.

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