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

[shotgunner]

I was wondering if anyone had read this article and what you thought. I am hoping he is wrong but he makes a good case.

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

[BTravlin]

I don't know that the tax increases will cause a collapse or double dip but tax revenues will be much lower than they would have been otherwise and they will be a drag on GDP. I have already taken a good chunk of retained earnings out my company now to avoid the higher capital gains tax rate coming into effect next year. I'm sure other people are making similar moves to avoid the higher taxes.

[W2R]

Interesting article. It seems to me that the end of the Bush tax cuts will have to have some marked effect on the economy and more important (to me), on our lives as retirees and prospective retirees. It won't be long before we will see for ourselves whether there is any effect on the economy, and what that will be.

In preparation for the end of the tax cuts, I ever-so-cleverly lowered my income by retiring.

[IndependentlyPoor]

There is always a contrary view
Art Laffer: Make Up Your Own Facts Here | The Big Picture

[ziggy29]

This thread sort of dances on the edge of political (and not in the politics forum), so I'll try to walk the tightrope: I think hard-core supply siders may overestimate the impact of moderately higher tax rates from relatively low levels. Having said that, I think those on the other side -- his harshest critics who think it's all a bunch of hooey -- are in denial that tax rates impact taxable economic activity, and possibly significantly.

If I already made enough money to live on for the year and I got to keep 75 cents of every dollar -- and a tax hike made that 72 cents instead (as would happen with the 25% bracket reverting to 28%), that would likely not stop me from working and amassing more wealth. But if you let me keep only 50 cents, there's a good chance it's no longer worth it to me to work longer and pay more taxes on higher income. And jack the tax up to 70% -- let me keep 30 cents on the dollar as it was before the Reagan tax rate cuts -- and there's no way I keep w*rking unless I absolutely loved what I was doing and would do it for free (because I almost would be).

Tax rates matter. Maybe not as much as Laffer thinks if we're only tinkering around the edges, but a lot more than people who think our deficits are nothing that massive tax increases can't fix are willing to consider.

I guarantee you that if we enter an era where we have higher taxes and more means-tested entitlements, it *will* impact when I pull the plug and become a tax consumer rather than a tax payer. It matters. How much it matters depends on how extreme the change in policy becomes. It also matters because many businesses and consumers may make suboptimal economic decisions as a "CYA" against potential future changes to tax law. It would sure be nice if we could operate more from a standpoint of tax certainty and know that tax law changes wouldn't make today's good decisions bad ones a decade hence.

[Rustic23]

I did not see any major flaws in his reasoning. Will it happen to the extent he says, Who Knows? However, I suspect many people will be like BTravlin and will be making plans to take income this year and not next.

[Gumby]

Quote:

Originally Posted by ziggy29 If I already made enough money to live on for the year and I got to keep 75 cents of every dollar -- and a tax hike made that 72 cents instead (as would happen with the 25% bracket reverting to 28%), that would likely not stop me from working and amassing more wealth. But if you let me keep only 50 cents, there's a good chance it's no longer worth it to me to work longer and pay more taxes on higher income. And jack the tax up to 70% -- let me keep 30 cents on the dollar as it was before the Reagan tax rate cuts -- and there's no way I keep w*rking unless I absolutely loved what I was doing and would do it for free (because I almost would be).

Maybe, but this reasoning ignores the fact that most people work at jobs involving a fixed number of hours for a fixed salary. Regardless of tax rates, they will continue to work those hours for that amount of pay. The labor market response, as they say in economic terms, is inelastic to tax rate changes.

[ziggy29]

Quote:

Originally Posted by Gumby Maybe, but this reasoning ignores the fact that most people work at jobs involving a fixed number of hours for a fixed salary. Regardless of tax rates, they will continue to work those hours for that amount of pay. The labor market response, as they say in economic terms, is inelastic to tax rate changes.

Well, it goes back to what we've sometimes said before about the potential for future higher taxes and means-tested entitlements -- as long as we cheapskate obsessive savers LBYM types who can FIRE way before most folks are a tiny enough minority, we won't move the needle when we realize that continuing to w*rk is a sucker's game economically. But if more people join our ranks it could become problematic if too many people reach FI to the point where they don't *have* to work for what few crumbs Uncle Sam may leave.

[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.

[FIREd]

I don't think the economy will collapse because of them, but tax hikes may have an impact, IMO. DW and I are taking steps to lessen the blow. We are moving future income forward (stock options, bonuses) and rearranging our portfolio in advance of the tax changes. Our taxable investment income should drop to almost nothing in 2011 (I was happily paying 15% tax on qualified dividends until now but, since that rate is going to 39.6% for us, I am moving the money into tax-free munis). I wouldn't be surprised if 2010 represented our peak income year. I expect our total taxable income to drop about 40% next year and stay at those lower levels until we retire. Then, of course, our income will go even lower. Our spending will have to be cut too in response to the lower net income (I am targeting a 10-15% cut in spending for 2011). It is a necessary step to keep our FIRE plan on track.

[BTravlin]

Quote:

Originally Posted by Gumby Maybe, but this reasoning ignores the fact that most people work at jobs involving a fixed number of hours for a fixed salary. Regardless of tax rates, they will continue to work those hours for that amount of pay. The labor market response, as they say in economic terms, is inelastic to tax rate changes.

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?

[soupcxan]

A single person working a single job for a fixed salary is unlikely to change much in response to tax rate changes. It's a much different story for a two income household where one person's income is balanced against time with children, child care expenses, etc. In that situation, it's much easier for marginal tax increases to push someone out of the labor market. So instead of gaining 2% as you go from from 33% to 35% tax revenues, you lose 33% tax revenue on that income because stay-at-home-parent labor is not taxable (yet).

[ziggy29]

Quote:

Originally Posted by soupcxan So instead of gaining 2% as you go from from 33% to 35% tax revenues, you lose 33% tax revenue on that income because stay-at-home-parent labor is not taxable (yet).

The question here would become, how many people could (and would) call it quits because of this change in that tax bracket? If the answer is very, very few, the increase in rate may more than overcome the small number of people deciding not to feed the beast.

Alluding to a previous remark I made, I don't think many people will take their toys and go home because of an increase in marginal rates from 25% to 28% or from 33% to 35%. (And if it does, they were already extremely "on the fence" about calling it quits.) But there are other things coming which make me wonder. Individuals buying their own health insurance are set to lose 15-18 cents on every dollar they earn from about $50-80K in the form of lost subsidies for health insurance. On top of regular income taxes (and SS/Medicare taxes if it's earned income), that is a huge chunk lost to taxes and lost subsidies. (The lost subsidy isn't technically a tax, but it has the same effect.) A self-employed individual in that income range may have income taxes (state and federal) plus SS/Medicare taxes (both halves) and a loss of health insurance subsidy that may eat 60 cents on the dollar. If you already earned enough money for the year and you knew extra work would let you keep only 40 cents of every dollar and you valued your spare time highly, would you keep doing it?

Don't get me wrong: I think we have no choice but to raise taxes in the face of this alarming debt and deficit. I think to some degree, it will increase revenue faster than it will reduce taxable economic activity. But it's folly, IMO, to think this can all be resolved with tax increases, because the level of tax hikes required to balance the budget and pay down the debt would be huge hits to economic growth.

[MasterBlaster]

The Laffer curve is an idea that serves it's point.

To maximize government tax revenue clearly the points at the ends of the horizontal axis won't generate any income. With 0% tax you get no income. With 100% tax you get nobody willing to work. In between you get variable government income. Depending then on where the curve peaks and its shape there is an ideal tax rate to generate the most income. As taxes move away from that ideal spot revenue falls.

The real question then is... At what taxation level does the curve peak ? The answer is not very clear. The data supports a variety of taxation positions.

The other questions are... Where are we on a Laffer-like curve ? What is it's shape ? and will increased taxation levels from where we are now actually increase government income ?

[ziggy29]

Quote:

Originally Posted by MasterBlaster The real question then is... At what taxation level does the curve peak. The answer is not very clear. The data supports a variety of taxation positions.

There's also a question about the shape of the curve (it's usually portrayed as a graph to a quadratic equation with a negative quadratic coefficient, but is it?), and whether the point of "maximizing revenue" is always the same in all market and economic conditions. But in general it does seem logical that there is some point where tax revenue is maximized under any given set of conditions, especially when you think about the extreme high and low ends of the graph.

[MasterBlaster]

Ziggy:

yeah - Shape and time response of such a curve are more issues. The type taxes levied are also issues. Nonetheless the concept is worth considering, that increased taxation does not linearly produce government income. People change their behavior as their incentives and disincentives change.

[Gumby]

Quote:

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?

It is a fine theory, but I don't think it accurately describes human behavior, even for the wealthy. I have been in the very highest marginal tax bracket. Taxes were the least of my motivations -- my efforts were driven by the demands of my practice. I suspect that other high earners are similar in that they do what they do because that is the life they have chosen, not because their tax bracket is x% or y%. At best, my tax bracket influenced my investment choices (e.g. - I was much more likely to put money in a municipal bond fund).

[stephenandrew]

This is from the Wall Street Journal (5/17/2010). It provides some empirical evidence about tax rates over time, and how they impact the amount collected relative to GDP. It is amazingly stable.

[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.

[Gone4Good]

Quote:

Originally Posted by MasterBlaster Where are we on a Laffer-like curve ?

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.