In debates about tax rates, so often the Laffer Curve gets invoked. Two points on the curve are discussed, the 100% tax rate, and the inflection point. The purpose of the Laffer Curve, as Laffer used it, was to simplify the problem of setting a tax rate. I appreciate the simplification, as I lack any formal education in economics, beyond Economics for Mining Engineers, which never discussed economic theory, merely rates of return and depreciation. On the other side of the simplification coin, it makes people think they understand economics when they may not understand as well as they think they do.
Accordingly, I suggest some simple adjustments to the Laffer Curve. First, rotate it counterclockwise.
For those unfamiliar with the Laffer Curve it plots tax rate against revenue. The origin of the plot is a 0% tax rate with a $0 revenue. In real world examples, this is something like Somalia, which, to my knowledge, only Ayn Rand has ever really considered to be a model for the ideal society. The curve climbs the tax rate (x-axis), and accordingly, the government's revenue increases (y-axis). It is supposedly nonlinear, for reasons I do not entirely understand (could be an issue of scale or to legitimately illustrate an idea). At some point, say a tax rate of 30-70%, the curve reaches an apex, and revenue begins to decline while tax rates continue to climb. This inflection point is the ideal tax rate. When the tax rate hits 100%, the revenue hits $0 again.
The 100%,$0 point is the second most talked about point of the curve (behind the inflection point). The argument goes that if the government takes 100% of your income you have no motivation to work harder, or really, to work at all. The economy as we know it shuts down. People either evade taxes, or barter (e.g. no income) to get what they need. This is the point where I always want to shout, "POPPYCOCK," whenever someone mentions the Laffer Curve.
If the origin is Somalia, then the 100% tax rate is the ideal communist society. I do not think Americans are interested in living at either end of the spectrum, but the point is still important. The Laffer Curve seems to assume that GDP will be affected by tax rates, but government will not be. This is, of course, ridiculous. Somalis demand very little of the government that does not exist there. People who pay low tax rates expect protection (police and military) and infrastructure (roads, power grids, etc.). More taxes means more social services. Next would come education, then healthcare, then housing, then food, and finally comforts. If I commit a bit of Reaganomics heresy, and hold GDP constant (rather than government), the revenue would actually peak at 100% taxation (as a percent of GDP), but government spending would also have to peak to justify the tax rate.
By rotating the Laffer Curve counterclockwise we do introduce a small amount of complexity, but we capture the change in GDP and government. Looking at all the communist states that have failed to outlast, or achieve greatness, it is pretty convincing that a 100% tax rate would be very bad for GDP, but the state's revenue is not $0! The debate over the inflection point can still carry on, but the curve would actually start to reflect reality.
This would take the fun out of it for those who like to argue that Ayn Rand had it correct, and that in the case of human comfort, Somalia is second only to the Garden of Eden. Sooner or later though, you have to eat the apple, and realize that we want to find the inflection point. In this snipe hunt, there are two sides. Avoiding the Keynes-Hayek tug-of-war at the inflection point, the argument, to me, comes down to how people budget, and how those budgets affect the economy.
To begin, I offer how I think the "average" person budgets, or wants to budget. A household makes a given income, and because I am lazy, I will say it $50,000 (I wanted to use $100,000 because it is easier, but the Census has the median household income at $52,762). In this household, we will say about 20% of the income goes to taxes of various kinds, or $10,000. An additional 10% will go into savings, $5000. Insurance easily costs $1000/month (24%). If groceries, gasoline, and other day-to-day expenses cost $1000/month (24%), and rent/mortgage is $900/month (~22%), the budget is totally consumed (yes, this is very simplified).
If that income decreased, savings and (non-government mandated) insurance would probably be the first things to be cut, then incidentals and rent. If the income increases, then the gains are probably the reverse of the cutting order. Incidental costs and rent increase before insurance and savings, to a point. At some point a person is mostly comfortable. Sure, they could move into a mansion or build a Taj Mahal like mausoleum for eternal comfort, but savings is going to start accounting for a greater and greater percentage of income. I doubt, for example, that someone who makes ten times as much as I do has ten cell phones just to illustrate their wealth. I also doubt that on his way to 100 billion dollars Bill Gates blew a trillion dollars at WalMart.
While a personal budget is a bit different than a corporate or government budget (all three take out loans, despite what Paul Ryan will say, just think mortgage), the analogy serves in this case. In Jet Age, Sam Howe Verhovek credits the development of one of the most important jets ever built, the Boeing 707, to a fascinating thing. Sure, the Comet beat the 707 to market, so there was competition. There was also a visionary who saw a market his company could fill. The post-Reaganomics dance card is full in the story except for one thing. The Boeing 707 was developed largely owing to high taxes.
Owing to fear of war profiteering, the tax code made it such that a company's profits had to be reasonably comparable to their pre-war profits. Boeing was a small company that grew tremendously because the market for aircraft grew, but the tax code did not allow for growth. As such, their new profits would be taxed at a painfully high rate. They could avoid these high taxes by investing in research and development. Since R&D is a business expense, they cut corporate profits through reinvestment, or taxable profits anyway. Given a tax rate of 90%, investing $1 million only costs the company $100,000. The government, essentially, pays the remaining $900,000.
Conversely, a corporation that is taxed at a very low rate has little incentive to really invest in developing new products. Certainly they must keep pace with the competition, but take the inverse of Boeing when it built the 707. If a company is taxed at 10%, investing $1 million causes the share holders to lose $900,000, and the government only kicks in $100,000. In this case, a low tax rate encourages companies to not hire more people, to not do research and development, to not donate to charities, but to instead, make the wealthiest share holders wealthier.
I acknowledge that a high tax rate probably does discourage corporations from working overly hard. Boeing thought that the investment in the 707 would pay off, and it did. It catapulted them from obscurity to eventually become one of only two jetliner manufacturers in the world. The worry of profiteering waned, and the high tax rate disappeared. It was a combination of carrot and stick that gave the world jet travel, not just endless carrots.
I propose then that corporate taxes be set fairly low on income that equals some percentage of their expenses. Corporate taxes could even potentially be zero (I question this, but for argument) for profits of up to, say, 20% of expenses (this means you are better investing in your company, then the historical trends of the stock market). After that, the tax rate would sky rocket to 75% or 90%, any logical CEO would make sure to reinvest that money in their company, raising the 20% untaxed profit, and boosting the economy. What if the CEO says, "well heck, my salary can increase by 100% of the profit beyond 20%, I do work pretty hard at this job"? Then we have another issue that is present in this country.
According to this AFLCIO infographic, CEO pay is 380 times their company's average blue collar worker's pay. In 1980 it was 42 times. The 1980s were not exactly the best days of the economy, but neither was 2011. From the same infographic, it seems that when the wealthy get too wealthy by percent of total wealth (e.g. 1929 and 2007) the country is due for imminent disaster. Coupled with this carrot-and-stick tax scheme, executive pay could be limited by percent of total non-executive pay. I doubt that running a really big company is harder than running a middle-sized company, but having never done either, I will accept the anti-tax argument that CEOs deserves high pay. Okay, the bigger one's company's payroll, the bigger one's salary. I cannot even begin to suggest a pay limit, but in all honesty, is any one employee, including the CEO, really worth 380 other people? Is being a CEO really that high risk?
In my mind around $5 million dollars in the bank pretty much allows one to never work again, and live more or less comfortably without worry. If you make just shy of $24 million a year (the average income for the richest 1% of 1% of Americans), if you find yourself out of a job after a year, you are set for life, comfortably. If, on the other hand, you make $50,000/year, you will never achieve that. While I appreciate the effort that the titans of industry give us, I cannot help but think that being a Koch brother, with $25 billion of wealth feels much better than making $7.25 an hour (minimum wage). If the Kochs disagree, I am sure they could find no shortage of people willing to trade.
What does salary have to do with the Laffer Curve? The Laffer Curve is not looking at the tax rates that individuals would pay, but rather the rate at which revenue is collected from the tax base. How the tax code is written to achieve that percentage is not represented. The most simple approach is to put a flat tax on all wealth that is equal to the ideal tax rate on the Laffer Curve. Flat tax rates do not make sense though, and even my modified Laffer Curve does nothing to elucidate the issue.
Unfortunately, for my previously proposed tax rate complicated tax rules seem to cause a lot of problems. For example, most Americans would probably object to eliminating the mortgage interest deduction, but this deduction rewards opulence, and taxes the poor. When politicians argue to eliminate deductions, and broaden the base, I have to set aside my cynicism, and agree. The problem I see with simplifying the tax code, and incorporating elements that legitimately encourage reinvestment in America is that so many people want to cheat their taxes. The idea behind deductions is to encourage various sectors of the economy. When I read tax code, it seems simply evident that the IRS is trying to keep up with people who are trying to game the system. When I come to that conclusion, I groan, knowing my taxes are more complicated because someone else did not want to pay their fair share.
That is the whole debate when it comes to taxes though. How do we agree on what each person's fair share is? I think even Laffer would agree that the curve that bares his name has limited use in the construction of an actual tax system. I do think the tax code could be improved, and I think raising taxes is the best way for this country to get out of the financial situation that lowering taxes has put us in.
In economics and taxes, even a statement like "raise taxes" seems convoluted. While I agree that under certain circumstances lowering the rate while cutting deductions could increase revenue. I might also agree that cutting some taxes may help grow the economy, the argument that cutting taxes increases revenue is silliness that I am getting tired of hearing. I am also tired of people demanding less government, but demanding more government services (VA benefits and over a decade of war are expensive, requiring Americans to pay their taxes, not complain about them).
Accordingly, I offer an additional change to the Laffer Curve. Rather than revenue on the y-axis, use GDP. We know that having no government fails to create meaningful GDP, and we know that 100% taxation limits GDP, though it is probably more than zero. There is still an inflection point of unknown tax rate where taxation maximizes GDP. The government maximizing GDP (or coming close to the maximum) would likely increase revenue. Maximizing GDP would not simply be a result of the tax rate, the tax revenue would have to be used for the benefit of the GDP.
To investigate the revenue-spending situation that best supports the GDP (and hopefully the common good, though that may slightly damage the economy), the modified Laffer Curve must be supplemented with a second curve. The second curve would plot tax rate against the services a government can provide. Presumably, these curves could be constructed such that the ideal combination would fall at the intersection of the two curves. Even without them being that eloquent, they would give people a reference, taxing at a given percent could have a given effect on the GDP, and provide these services. This may help illuminate how much we want taxes to collect.
There will still be those who argue for ever lower taxes. The modified Laffer curve will also not solve the who to tax issue, or how to find the ideal rate. It will though, reflect how economics actually work, and maybe help us remember that Boeing shrunk the world because of high taxes, not low.
Accordingly, I suggest some simple adjustments to the Laffer Curve. First, rotate it counterclockwise.
For those unfamiliar with the Laffer Curve it plots tax rate against revenue. The origin of the plot is a 0% tax rate with a $0 revenue. In real world examples, this is something like Somalia, which, to my knowledge, only Ayn Rand has ever really considered to be a model for the ideal society. The curve climbs the tax rate (x-axis), and accordingly, the government's revenue increases (y-axis). It is supposedly nonlinear, for reasons I do not entirely understand (could be an issue of scale or to legitimately illustrate an idea). At some point, say a tax rate of 30-70%, the curve reaches an apex, and revenue begins to decline while tax rates continue to climb. This inflection point is the ideal tax rate. When the tax rate hits 100%, the revenue hits $0 again.
The 100%,$0 point is the second most talked about point of the curve (behind the inflection point). The argument goes that if the government takes 100% of your income you have no motivation to work harder, or really, to work at all. The economy as we know it shuts down. People either evade taxes, or barter (e.g. no income) to get what they need. This is the point where I always want to shout, "POPPYCOCK," whenever someone mentions the Laffer Curve.
If the origin is Somalia, then the 100% tax rate is the ideal communist society. I do not think Americans are interested in living at either end of the spectrum, but the point is still important. The Laffer Curve seems to assume that GDP will be affected by tax rates, but government will not be. This is, of course, ridiculous. Somalis demand very little of the government that does not exist there. People who pay low tax rates expect protection (police and military) and infrastructure (roads, power grids, etc.). More taxes means more social services. Next would come education, then healthcare, then housing, then food, and finally comforts. If I commit a bit of Reaganomics heresy, and hold GDP constant (rather than government), the revenue would actually peak at 100% taxation (as a percent of GDP), but government spending would also have to peak to justify the tax rate.
By rotating the Laffer Curve counterclockwise we do introduce a small amount of complexity, but we capture the change in GDP and government. Looking at all the communist states that have failed to outlast, or achieve greatness, it is pretty convincing that a 100% tax rate would be very bad for GDP, but the state's revenue is not $0! The debate over the inflection point can still carry on, but the curve would actually start to reflect reality.
This would take the fun out of it for those who like to argue that Ayn Rand had it correct, and that in the case of human comfort, Somalia is second only to the Garden of Eden. Sooner or later though, you have to eat the apple, and realize that we want to find the inflection point. In this snipe hunt, there are two sides. Avoiding the Keynes-Hayek tug-of-war at the inflection point, the argument, to me, comes down to how people budget, and how those budgets affect the economy.
To begin, I offer how I think the "average" person budgets, or wants to budget. A household makes a given income, and because I am lazy, I will say it $50,000 (I wanted to use $100,000 because it is easier, but the Census has the median household income at $52,762). In this household, we will say about 20% of the income goes to taxes of various kinds, or $10,000. An additional 10% will go into savings, $5000. Insurance easily costs $1000/month (24%). If groceries, gasoline, and other day-to-day expenses cost $1000/month (24%), and rent/mortgage is $900/month (~22%), the budget is totally consumed (yes, this is very simplified).
If that income decreased, savings and (non-government mandated) insurance would probably be the first things to be cut, then incidentals and rent. If the income increases, then the gains are probably the reverse of the cutting order. Incidental costs and rent increase before insurance and savings, to a point. At some point a person is mostly comfortable. Sure, they could move into a mansion or build a Taj Mahal like mausoleum for eternal comfort, but savings is going to start accounting for a greater and greater percentage of income. I doubt, for example, that someone who makes ten times as much as I do has ten cell phones just to illustrate their wealth. I also doubt that on his way to 100 billion dollars Bill Gates blew a trillion dollars at WalMart.
While a personal budget is a bit different than a corporate or government budget (all three take out loans, despite what Paul Ryan will say, just think mortgage), the analogy serves in this case. In Jet Age, Sam Howe Verhovek credits the development of one of the most important jets ever built, the Boeing 707, to a fascinating thing. Sure, the Comet beat the 707 to market, so there was competition. There was also a visionary who saw a market his company could fill. The post-Reaganomics dance card is full in the story except for one thing. The Boeing 707 was developed largely owing to high taxes.
Owing to fear of war profiteering, the tax code made it such that a company's profits had to be reasonably comparable to their pre-war profits. Boeing was a small company that grew tremendously because the market for aircraft grew, but the tax code did not allow for growth. As such, their new profits would be taxed at a painfully high rate. They could avoid these high taxes by investing in research and development. Since R&D is a business expense, they cut corporate profits through reinvestment, or taxable profits anyway. Given a tax rate of 90%, investing $1 million only costs the company $100,000. The government, essentially, pays the remaining $900,000.
Conversely, a corporation that is taxed at a very low rate has little incentive to really invest in developing new products. Certainly they must keep pace with the competition, but take the inverse of Boeing when it built the 707. If a company is taxed at 10%, investing $1 million causes the share holders to lose $900,000, and the government only kicks in $100,000. In this case, a low tax rate encourages companies to not hire more people, to not do research and development, to not donate to charities, but to instead, make the wealthiest share holders wealthier.
I acknowledge that a high tax rate probably does discourage corporations from working overly hard. Boeing thought that the investment in the 707 would pay off, and it did. It catapulted them from obscurity to eventually become one of only two jetliner manufacturers in the world. The worry of profiteering waned, and the high tax rate disappeared. It was a combination of carrot and stick that gave the world jet travel, not just endless carrots.
I propose then that corporate taxes be set fairly low on income that equals some percentage of their expenses. Corporate taxes could even potentially be zero (I question this, but for argument) for profits of up to, say, 20% of expenses (this means you are better investing in your company, then the historical trends of the stock market). After that, the tax rate would sky rocket to 75% or 90%, any logical CEO would make sure to reinvest that money in their company, raising the 20% untaxed profit, and boosting the economy. What if the CEO says, "well heck, my salary can increase by 100% of the profit beyond 20%, I do work pretty hard at this job"? Then we have another issue that is present in this country.
According to this AFLCIO infographic, CEO pay is 380 times their company's average blue collar worker's pay. In 1980 it was 42 times. The 1980s were not exactly the best days of the economy, but neither was 2011. From the same infographic, it seems that when the wealthy get too wealthy by percent of total wealth (e.g. 1929 and 2007) the country is due for imminent disaster. Coupled with this carrot-and-stick tax scheme, executive pay could be limited by percent of total non-executive pay. I doubt that running a really big company is harder than running a middle-sized company, but having never done either, I will accept the anti-tax argument that CEOs deserves high pay. Okay, the bigger one's company's payroll, the bigger one's salary. I cannot even begin to suggest a pay limit, but in all honesty, is any one employee, including the CEO, really worth 380 other people? Is being a CEO really that high risk?
In my mind around $5 million dollars in the bank pretty much allows one to never work again, and live more or less comfortably without worry. If you make just shy of $24 million a year (the average income for the richest 1% of 1% of Americans), if you find yourself out of a job after a year, you are set for life, comfortably. If, on the other hand, you make $50,000/year, you will never achieve that. While I appreciate the effort that the titans of industry give us, I cannot help but think that being a Koch brother, with $25 billion of wealth feels much better than making $7.25 an hour (minimum wage). If the Kochs disagree, I am sure they could find no shortage of people willing to trade.
What does salary have to do with the Laffer Curve? The Laffer Curve is not looking at the tax rates that individuals would pay, but rather the rate at which revenue is collected from the tax base. How the tax code is written to achieve that percentage is not represented. The most simple approach is to put a flat tax on all wealth that is equal to the ideal tax rate on the Laffer Curve. Flat tax rates do not make sense though, and even my modified Laffer Curve does nothing to elucidate the issue.
Unfortunately, for my previously proposed tax rate complicated tax rules seem to cause a lot of problems. For example, most Americans would probably object to eliminating the mortgage interest deduction, but this deduction rewards opulence, and taxes the poor. When politicians argue to eliminate deductions, and broaden the base, I have to set aside my cynicism, and agree. The problem I see with simplifying the tax code, and incorporating elements that legitimately encourage reinvestment in America is that so many people want to cheat their taxes. The idea behind deductions is to encourage various sectors of the economy. When I read tax code, it seems simply evident that the IRS is trying to keep up with people who are trying to game the system. When I come to that conclusion, I groan, knowing my taxes are more complicated because someone else did not want to pay their fair share.
That is the whole debate when it comes to taxes though. How do we agree on what each person's fair share is? I think even Laffer would agree that the curve that bares his name has limited use in the construction of an actual tax system. I do think the tax code could be improved, and I think raising taxes is the best way for this country to get out of the financial situation that lowering taxes has put us in.
In economics and taxes, even a statement like "raise taxes" seems convoluted. While I agree that under certain circumstances lowering the rate while cutting deductions could increase revenue. I might also agree that cutting some taxes may help grow the economy, the argument that cutting taxes increases revenue is silliness that I am getting tired of hearing. I am also tired of people demanding less government, but demanding more government services (VA benefits and over a decade of war are expensive, requiring Americans to pay their taxes, not complain about them).
Accordingly, I offer an additional change to the Laffer Curve. Rather than revenue on the y-axis, use GDP. We know that having no government fails to create meaningful GDP, and we know that 100% taxation limits GDP, though it is probably more than zero. There is still an inflection point of unknown tax rate where taxation maximizes GDP. The government maximizing GDP (or coming close to the maximum) would likely increase revenue. Maximizing GDP would not simply be a result of the tax rate, the tax revenue would have to be used for the benefit of the GDP.
To investigate the revenue-spending situation that best supports the GDP (and hopefully the common good, though that may slightly damage the economy), the modified Laffer Curve must be supplemented with a second curve. The second curve would plot tax rate against the services a government can provide. Presumably, these curves could be constructed such that the ideal combination would fall at the intersection of the two curves. Even without them being that eloquent, they would give people a reference, taxing at a given percent could have a given effect on the GDP, and provide these services. This may help illuminate how much we want taxes to collect.
There will still be those who argue for ever lower taxes. The modified Laffer curve will also not solve the who to tax issue, or how to find the ideal rate. It will though, reflect how economics actually work, and maybe help us remember that Boeing shrunk the world because of high taxes, not low.
No comments:
Post a Comment