WSJ: Arthur Laffer - Tax Hikes and the 2011 Economic Collapse

[Bikerdude]

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Originally Posted by Gone4Good Hmmm, so if tax rates are so deterministic to economic growth then the 2000 tax cuts must have led to years of above average growth . . . oh wait, they didn't? Never mind.

Never mind the "dotcom bubble burst" and "911". Alas, so hard to prove a negative.

[ejman]

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Originally Posted by BTravlin You are right in that those who work for an hourly wage or a fixed monthly salary will likely see only small changes because most of these tax changes affect the wealthy and they do have the knowledge and means to finesse their taxable income to some degree. It seems as if most of the recent tax increases are directed at the wealthy. I wonder how much more they are going to swallow before they pull up stakes and move elsewhere with their money?

Where would they move? The US (even if we were to go back to pre Bush rates) has lower tax rates than most other industrialized nations. I'm sure there are third world countries with lower tax rates but then you may get into quality of life and cultural issues. Its one thing to go on vacation quite another to move lock stock and barrel to another country ( I know, I've done it).

Since the US taxes income of US nationals wherever they happen to live I guess one way out is to renounce US citizenship. Some people do it but most probably would not unless things really got out of kilter. Back in the 50's I believe the top tax rate was northward of 90% and maybe there was a stampede out of the country then but I don't think so. I think what happened instead is that wealthy people got really really creative on how to avoid taxes - Just as they have always done, probably since at least Roman times.

[jdw_fire]

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Originally Posted by BTravlin It seems as if most of the recent tax increases are directed at the wealthy. I wonder how much more they are going to swallow before they pull up stakes and move elsewhere with their money?

well to get out from under the US income taxes by moving they would also have to give up US citizenship, do you really think there would be alot of people who would do that?

[FinanceDude]

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Originally Posted by Gone4Good If you look at a graph of revenue as a % of GDP (it's too late for me to create and post it, maybe tomorrow) I think you get a pretty good answer. What I see looking at that chart is that the very large Reagan tax cuts didn't reduce revenue that much. That argues for us being to the right of the kink in the Laffer Curve at that time. The Clinton tax increases raised revenue quite a bit, which argues for us being at the left of the curve. And the Bush tax cuts reduced revenue a bunch (tax revenues at the real-estate bubble peak were still about 200bp lower than the prior peak, if memory serves). That also argues for us being to the left of the kink.

Laffler doesn't seem to think so......but then again he is a world renowned economist.........

[FinanceDude]

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Originally Posted by Bikerdude Never mind the "dotcom bubble burst" and "911". Alas, so hard to prove a negative.

Quite being logical..........

[IndependentlyPoor]

Let's see, Laffer looks at selected GDP and tax data and argues that Reagan's tax cut caused the economy to take off like a rocket. Barry Ritholtz cries foul and point to confounding economic events. Gone4Good looks at different time points in the same data and argues that we are to the left of the Laffer sweetspot and BikerDude cries foul and points to confounding economic events.

I think I see a pattern here.

[DblDoc]

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Originally Posted by IndependentlyPoor Let's see, Laffer looks at selected GDP and tax data and argues that Reagan's tax cut caused the economy to take off like a rocket. Barry Ritholtz cries foul and point to confounding economic events. Gone4Good looks at different time points in the same data and argues that we are to the left of the Laffer sweetspot and BikerDude cries foul and points to confounding economic events. I think I see a pattern here.

Sniff...Sniff... Me thinks I smell some politics..

DD

[kyounge1956]

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Originally Posted by Gone4Good If you look at a graph of revenue as a % of GDP (it's too late for me to create and post it, maybe tomorrow) I think you get a pretty good answer. What I see looking at that chart is that the very large Reagan tax cuts didn't reduce revenue that much. That argues for us being to the right of the kink in the Laffer Curve at that time.

I think a slight decrease argues for a position very close to the top of the curve, but I'm not sure it's possible to say which side of the high point we were on prior to the Reagan tax cuts. I think we were either slightly to the right, and the tax cuts overshot the high point, or slightly to the left and moved away from the high point. A big tax cut producing only a small change in revenue (either up or down) suggests to me a position on the curve where it is closest to being horizontal, and possibly that the actual curve is a different shape—much flatter on top than the diagram.

Quote:

The Clinton tax increases raised revenue quite a bit, which argues for us being at the left of the curve. And the Bush tax cuts reduced revenue a bunch (tax revenues at the real-estate bubble peak were still about 200bp lower than the prior peak, if memory serves). That also argues for us being to the left of the kink.

agreed both times

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Originally Posted by FinanceDude Laffler doesn't seem to think so......but then again he is a world renowned economist.........

ISTM Laffer is talking about something different in the article. The diagram shows how changes in tax rate affect government revenue; the article talks about how changes in tax rate affect the growth of GDP. Though I am sure there is some relation between the two, I would not necessarily expect them to move precisely in tandem. Maybe what's really needed is a three dimensional curve.

[swampwiz]

I might be sounding like a couple of Germans - named Marx & Engels - but macroeconomically speaking, I don't see a problem. I've always believed that if the earning of income (here I mean earn as in the FICA & IRS sense, as opposed to unearned - i.e., by actually working instead of living off the labors of others via investment of capital) were at such a high level as to make the marginal increase in effort be not worth it to the worker, then that job must be such a highly desired job that folks with a less lucrative job doing something similar (albeit perhaps at a lower level) would be lining up to take that job. Or alternatively, if a small business owner felt that his net after tax income (and here let's say that income would be the net after opportunity cost of any investment he would have in the business) would be so small as to not make it worth it, he would similarly sell it to someone who would want to make it work (perhaps someone who would have to get a bank loan, in which a large part of the net cash flow would have to service, thereby making the net income lower, making the taxes lower, etc.), or some bigger entity which would hire a manager to take the place of the business owner. In all cases, the business stays as a working concern, someone holds the investment of the capital, some manager runs the business.

The same could be said of highly paid professions. I seriously doubt that folks would simply stop lining up to go to medical or law school just because of confiscatory tax rates at the top end. It would be laughable to think that someone would decide not to go to medical school because he might make so much money that that marginal tax rate would be super high.

And as for folks who claim that they would just up and invest their money elsewhere, hey go for it. As American citizens, the IRS will get your income. And if you decide to run away and go live and invest in some 3rd country, just try and run a small business in a place like that. OK, how about China? Fine, screw up in some way, and a you get a bullet in the back of the head! You will come back and understand that even though the taxes may be high, it is in your best business and lifestyle interest to be in the USA (or at least for legal purposes.)

Besides, if the wealthy get too out of line from the peasantry, there are solutions - e.g., France 1789, Russia 1917 ...

[clifp]

I tend to agree mostly with Ziggy I don't think that mostly small change in taxes rates will have much impact on behavior. Although all of the changes cumulatively very well may have me dramatically alter my portfolio and quite possible do the same for self-employed, and semi-retired people.

Capital gains 15%- 20% I still have losses from 2008 so this will have little impact on me initially and even when I have to pay it is still less than a wage earner pays.
Dividends treated as ordinary income. This will effectively double my income tax from 15%-28% and possible 31% some year.
Raising top tax rates, no impact unless I get really lucky

A subsidy for people buying their own insurance and making less than 400% of the Federal poverty level. This provides a big incentive to lower your "income" to qualify for the subsidy.

Currently, my portfolio yields 4% (40% in tax sheltered) and consists of lots of dividend stocks, MLPs along with bonds, and CDs. If the tax cuts expired and dividends are treated as ordinary income. I will probably sell most all of my individual stocks in my taxable portfolio and invest the money in slice and dice index portfolio the dividend yield for an index funds is roughly 2%. This will reduce my income to a level where I can get a subsidy for what I figured will 2 out of 3 years. Every other or every third year I'll sell stock to rebalance and replenish my cash reserves. In those years I won't be eligible for a subsidy so I'll buy a bronze instead of a silver medical insurance.

I suspect that as Laffer suggests that cumulative changes will actually cause people who have flexibility to postpone when they recognize income may adopt this strategy. I think it is almost certain that companies that have recently embraced paying out a large portion of their profits in dividends will re-examine the policy.

[clifp]

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Originally Posted by IndependentlyPoor I am going to try to toe the non-political line here, but it might be impossible when talking about tax policy. I have been thinking about the financial industry and their huge compensations lately. It seems to me that the lure of hundred-million dollar bonuses is just too much for the character of many (if not most) folks to resist. The heads-I-win (hugely) tails-you lose effect seems to drive folks into irrational, immoral, and illegal actions. This is one place where the disincentives that Ziggy pointed out might be just the thing we need. Removing the temptations for malfeasance that gazillion dollar bonuses present by taxing them at, say 80%, would probably discourage financial gurus from taking crazy risks to make such huge amounts of money. The trick would be to set the threshold for the top rate very high. I dunno, $50MM maybe. This sort of thing has precedent. The top rate in 1937 was 79%, but look at the threshold for that rate. It was $5MM then, or more than $75MM in today's dollars. There. My best shot at presenting a potentially controversial policy notion in a non-political fashion.

Why I can understand the appeal of this idea I think there is very little chance that more than handful of people would pay the 80% s rate and certainly no banker would. I also think it would have any even smaller chance of doing what you hope, in discouraging excessive risk taking.

I started work right before the Reagan tax cuts. Many of the engineers in my open office were quite senior. The top 3 conversations at the office were stocks, tax shelters, and sports, and I am pretty sure that sports was distant third.

Here are the top tax rates from 1980/81 49%,55%, 63%,68%, 70%. Take a guess at corresponding income levels were for a single filer. Then go to the bottom of my message, for the answer.

Pretty amazing huh, since virtually everybody in my office other than myself was in marginal tax rate well over 50% when including CA income tax, the entire department was obsessed about avoiding paying taxes. People were investing in horse farms, ranches, oil wells, natural gas wells, low income rental properties you name it. Each investment employed a CPA, a general partner, a lawyer and a sales force. None of them every made a profit (and I am not sure they ever produced a barrel of oil, a racehorse or a steak)

When income tax rates get too high (and I argue anything over 50% is to high) people will go to extraordinary lengths to avoid paying taxes. Countries like Greece and Turkey are classic examples of this.

Finally, you are crazy if you think a company like Goldman Sachs would pay its executive 50 or 100 million bonuses if they are taxed at 80%. Instead they will pay them much lower salaries, but they will also give them alternative forms of compensation. Like 5 million options on Equity Participation units for the Goldman Sachs Solar Energy Green American fund. Now the Goldman Lawyers and accounts will argue that options are only worth $1 each. But some how all perfectly legal in a few years the options will turn in $5 million in cash and $50 million in tax credits. At which point they will receive $50 million bonus but not owe taxes on it.

Now I am obviously speculating here what GS will do, but I know that nobody is making investment in any alternative energy without tax credits.

In fact tomorrow morning Nords and I are attending a seminar in on investing in renewable energy. Is it put by a Hawaii or Silicon Valley entrepreneur talking about Hawaii's wonderful physical and economic (highest energy cost in the country) for renewable energy? Nope it is put by the top CPA and legal firm in the state talking about the tax angles. An 80% tax rate would be great for bankers, accountants, and lawyers, but that is about it.

GS and Wall St. bankers may have the morality of serial killer or a politician, but they are also extremely adept at playing the system. If the system changes they adapt, and they likelihood that Congress can write a set of tax laws that will cost them 1/2 their salaries is very slim.











80/81 Tax rates 49% 34,100, 55% 41,500, 63% 55,300, 68% 88,100, 70% 108,300.

[shotgunner]

The responses are interesting. Politics as it affects the tax code is a Fire and Money issue. It seems to me that the sunsetting of the Bush tax cuts will have an effect on early retirees and ER wannabee's. Many of us who are LBYM live on a relatively small income stream and most likely will be affected by the loss of the 10% income tax rate and many us will most likely pay more in Cap Gains taxes. I have enjoyed the 0% rate myself. I personally benefitted from doing a 1035 exchange moving moneys out of a 403b which I believe will now incur a tax hit after 1/1. Finally, the estate tax comes back. Now that may not be our problem per se but many us here do hope to leave more rather than less to our children. Additionally I believe the estate tax was forcing the liquidation of small business upon the owners death to pay taxes and especially hard hit was family farms.

I don't know about economic collapse, trigger for a double dip recession or whether federal revenues will go up or down. I do think it will affect ER's in a negative way to some extent and those who want to be ER'd.

[Gone4Good]

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Originally Posted by FinanceDude Laffler doesn't seem to think so......but then again he is a world renowned economist.........

Who are you going to believe, him or your lyin eyes?

Explanatory Edit: Obviously tax revenues are impacted by economic cycles. But look peak to economic peak and trough to trough. We took in 240bp less in revenue as a % of GDP (~$350B) at the peak of the housing bubble than we did at the peak of the dot-com bubble (even though the housing bubble was larger). And look at the troughs. Unemployment peaked in the '81 recession a touch higher than the current one, and yet revenue was a whopping 480 bp higher then versus now (BTW, if we were taking in that level of revenue now, the Federal deficit would be cut by more than half and be a much more manageable 4.5% of 2010 GDP, all else being equal).

[Gone4Good]

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Originally Posted by DblDoc Sniff...Sniff... Me thinks I smell some politics.. DD

Except I'm arguing that both the Reagan tax cuts and the Clinton tax increases worked as advertised. It's only recently that we've run off the rails (could it be because when Reagan cut taxes top rates were 70% which is quite different from cutting them when rates are about half that level? There is danger in extrapolating linearly along a curve . . . in this case, Laffer's Curve)

[BTravlin]

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Originally Posted by ejman Where would they move? The US (even if we were to go back to pre Bush rates) has lower tax rates than most other industrialized nations. I'm sure there are third world countries with lower tax rates but then you may get into quality of life and cultural issues. Its one thing to go on vacation quite another to move lock stock and barrel to another country ( I know, I've done it).

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Originally Posted by jdw_fire well to get out from under the US income taxes by moving they would also have to give up US citizenship, do you really think there would be alot of people who would do that?

There are two types of wealthy: the merely wealthy and the uber wealthy. The merely wealthy will double up on tax avoidance plans. The uber wealthy can find sanctuaries where they are welcome and have the means to enjoy quality of life just about anywhere they desire.

[Gone4Good]

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Originally Posted by kyounge1956 A big tax cut producing only a small change in revenue (either up or down) suggests to me a position on the curve where it is closest to being horizontal

Not necessarily. A large cut that moves you from Point B to Point A is revenue neutral, according to the graph. I think that's what we did in the 80's. That would also explain the big swings in revenue from both the Clinton increases and the Bush cuts (whereas a move along a horizontal line would produce little change in revenues). Judging from the impact recent tax changes have had on receipts, it seems we're on a very steep, upward sloping point on the curve. That means we should have little economic cannibalization of tax increases from current levels.

[fritz]

Ever wonder if articles like these are published just to sell advertising space, and increase readership

Kind of like taking something simple and turning it into rocket surgery. Nothing like being gobsmacked with incorrectly attributed statements in a screed. Have to admit – it makes for good cannon fodder. Just goes to show that even though things may be eloquently written – doesn't mean that they are anywhere near correct, or make any sense.

As I see it – referenced article(s) pretty much only confirms that when the government attempts to tinker with accepted standardized methods (tax rates) – it invariably has unintended consequences, as people attempt to manipulate the system to skirt (if only temporarily) the upcoming changes.

One would also have to be blind to not see that somebody (everybody) will have to pay for the flights of fancy in the financial industry that resulted in the government having to pump money into the system to prevent total collapse. The bill for the emergency repair of our economy (a big one) is coming due, and we'll have to pay it in the form of higher taxes/inflation. Of course we could have put this tab on the specific doers of the deeds, but they have more clout in Washington, so we get the bill....

[REWahoo]

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Originally Posted by fritz Kind of like taking something simple and turning it into rocket surgery.

[fritz]

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Originally Posted by REWahoo

Kind of like taking something simple and turning it into rocket surgery.


I was having a little fun with the nitwittydom article(s), and attempting to impersonate Mrs. Malaprop. Barney Fife would have called me "factitious"

Rocket "surgery" is actually stated by Laffer in the article. "Gobsmacked" and "creed" are from Ritholz. Thank God I have WordWeb installed on my computer and can quickly and easily understand what the carefully interjected words mean. Always makes me think the author is trying to pump up their literary knowledge. Texans refer to this type of pulling the wool over your eyes as "Big Hat - No Cattle" (from the Millionaire Next Door).

[REWahoo]

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Originally Posted by fritz Texans refer to this type of pulling the wool over your eyes as "Big Hat - No Cattle" (from the Millionaire Next Door).

That's not the only way we refer to it...