Tuesday, March 27, 2012

Higher Taxes = Tax Avoidance = Lower Revenues

From Robert Frank's "Wealth Report" in the WSJ:

"Britain's recent experiment with hiking taxes on the rich may have some lessons for the U.S.

To dig itself out of recession, Britain hiked its income-tax rate to 50% for those making more than £150,000 ($240,000). Proponents said the tax was needed to bring fairness to an economy, in which the rich were getting richer and not contributing enough to the cause. Critics said the tax would chase out the job creators.

As it turned out, the real impact was in tax avoidance.  According to the Chancellor of the Exchequer’s budget announced today, the income-tax hike caused “massive distortions” that cost the government. A study found that £16 billion of income was deliberately shifted into the previous tax year. As a result, the tax raised only £1 billion – a third of the £3 billion amount forecast."

MP: There are several basic economic lessons here including:

a) If you tax something, you get less of it, b) taxes and regulations are always distortionary because people can change their behavior to avoid them, i.e. raising tax rates raises tax avoidance, c) incentives matter (as do disincentives), and d) the Laffer Curve accurately predicts the inverse relationship between tax rates and tax revenues at high marginal tax rates.  

Thanks to Peter Parlapiano for the tip. 

19 Comments:

At 3/27/2012 9:04 AM, Blogger morganovich said...

we saw this same thing in the US when clinton hiked taxes on top earners.

income tax receipts remained mired at very low levels. it did not generate new federal revenue. what it did do was help keep real income growth negative.

it was the CUT in cap gains taxes in 1997 (rammed through by congress over presidential objections) that caused tax income to rise to record levels.

this makes the proposed jump in the top tax rates look pointless and the jump in cap gains rates look outright harmful. 15% going to 24% is a massive increase and will have profound effects on investment. a 60% hike in tax burden is no joke.

it will cause very real capital flight.

 
At 3/27/2012 11:18 AM, Blogger Buddy R Pacifico said...

" the Laffer Curve accurately predicts the inverse relationship between tax rates and tax revenues at high marginal tax rates."

Who invented the Laffer Curve?

Economic philosphers over the centuries from Ibn Khaldun, a 14th century Muslim philosopher, to John Maynard Keynes.

From Ibn Khaldun: " "It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments."

Source: Arthur Laffer, a very nice man who had great patience in explaining the curve to myself.

 
At 3/27/2012 12:03 PM, Blogger juandos said...

Milton Friedman - The Free Lunch Myth

 
At 3/27/2012 12:16 PM, Blogger Benjamin Cole said...

Yes, taxes should be lower. But don't tax you, don't tax me, tax that man behind that tree.

If you want lower income and capital gains taxes, you have to cut agency spending.


Below is list of largest federal agencies financed by income and capital gains taxes. Where should we cut?



Remember, Paul Ryan says the top three agencies are sacrosanct.

Defense 3,200,000
Veterans Affairs 240,000 

Homeland Security 200,000
Treasury 162,119 

Justice 124,870 

USDA 100,000 

DOT 100,000
Health and Human Services 62,999 

Interior 57,232 

Commerce 41,711 

NASA 19,198 

EPA 18,879
State 18,000 

Labor 16,818 

Energy 14,000 

GSA 14,000

 
At 3/27/2012 12:20 PM, Blogger misterjosh said...

I think we'd be stupid to raise taxes, but are we really at the inverse relationship part of the Laffer curve? Moving income into the prior year is only going to work for so long.

I think diminished revenues can be more easily explained by the fact that wealthy people's incomes are more volatile than poor peoples' and we're still in a recession.

There's also the fact that no tax ever brings in as much as predicted, just like no medical spending ever costs as little as predicted.

 
At 3/27/2012 12:26 PM, Blogger misterjosh said...

Benjamin, you've been the same broken record for 2 years now. For one thing, I'm as big a fan of cutting defense, corporate welfare, and rural subsidies as you are, but why stop there?

For another thing, why break out "income and capital gains taxes"? All taxes go into the same bucket & all spending comes out of the same bucket. Anybody who tells you different is pulling a fast one.

 
At 3/27/2012 1:42 PM, Blogger kmg said...

The top marginal tax rate that gets the most revenue is in the low 20s (21-24%).

This was known in the Middle Ages, even.

And this has to include Federal, State, Local, Medicare, etc. Many people in NY and CA pay 47% or more.

A top marginal tax rate in the low 20s is optimal for revenue. Any more, and people both work less and find ways to avoid taxes.

 
At 3/27/2012 2:44 PM, Blogger Hydra said...

Higher Taxes = Tax Avoidance = Lower Revenues


the tax raised only £1 billion – a third of the £3 billion amount forecast."

=================================

Huh?

That is still a billion more, not less revenue.

 
At 3/27/2012 2:47 PM, Blogger Hydra said...

when clinton hiked taxes on top earners....... it did not generate new federal revenue.


=================================ReReally? None?

I don't think so, but even if you are corret, the Brits raised a billion.

The conclusion to be drawn is that our situatons are different, not that they are the same.

 
At 3/27/2012 2:50 PM, Blogger Hydra said...

"Remember, Paul Ryan says the top three agencies are sacrosanct."

===============================

Shoot, let's cut justice then, since there is so little of it anyway. with the money we save, we can all buy a couple of more guns.

 
At 3/27/2012 2:58 PM, Blogger Hydra said...

A top marginal tax rate in the low 20s is optimal for revenue. Any more, and people both work less and find ways to avoid taxes.

==================================

I happen to agree with you, that it is in that range, but some economists thing it is as high as 60%, and a few think it is really high, like 90%.

After all, you still have to eat.

I don't think your statement is a surety, as given.




" the Laffer Curve accurately predicts the inverse relationship between tax rates and tax revenues at high marginal tax rates."

Yes, but it is famously lacking in any sort of scale on the curve. There is no way of telling what amounts to high marginal rates, and no agreement on how to go about calculating it, although many examples are extant.

Some people think high marginal tax rates are as low as 8%.

 
At 3/27/2012 3:02 PM, Blogger VangelV said...

Remember, Paul Ryan says the top three agencies are sacrosanct....

Paul Ryan is not very different than Obama. Spending goes up and cuts are some time in the future. That does not seem to be a very credible approach for the GOP.

 
At 3/27/2012 3:24 PM, Blogger morganovich said...

"Yes, but it is famously lacking in any sort of scale on the curve. There is no way of telling what amounts to high marginal rates, and no agreement on how to go about calculating it, although many examples are extant."

that's not entirely true. you look at what happens around changes.

in 1993, we hiked the top marginal rate and it had basically no effect. it did slow the economy though. we had years of negative real income growth.

the cap gains cut in 1997 caused income tax as a % of gdp to spike and gdp to grow faster and real income growth to turn positive.

that gives you a sense of the shape of that part of the curve.

like an curve (demand, supply, etc) the laffer curve can never be fully quantified. we have to use what we have, just like apple uses past experience to guess what the demand curve for an ipad looks like and how many more they will sell if they drop the price $50.

this argument that a curve is meaningless unless you can fully quantify it seems surprisingly popular, but it it's a flawed notion.

you never know a whole curve. but you can know things about parts of it. we know that when cap gains were lat around 24%, it did real harm and that dropping them upped growth and income tax as a % of gdp.

we saw similar jumps in the early 80's when reagan cut them.

it's not unreasonable to assume that reversing that will have the opposite effect.

it's also quite reasonable to assume that if hiking the top marginal tax rate did nothing last time, making the same hike again is likely to do the same.

those looking to up tax revenues in the US need to realize that the problem is not top rates, but bottom ones.

in the 80's 15% of americans. that number is now 49-51% depending on who you ask.

that's the problem. 1/3 of americans stopped paying taxes.

that makes it virtually impossible to rein in spending as well as if half the voters know they are not paying, hey, free beer! let's go!

half the voters with no skin in the game is a disaster. it starves the government of revenues and ups desire for spending, which is a terrible combo.

 
At 3/27/2012 4:25 PM, Blogger kmg said...

Also remember that women are naturally collectivist, and 70-80% of government spending is a transfer from men to women.

So a society where women get to vote, can only experience expanding government.

Expecting women to support small government is like expecting government employees to support small government.

This is where conservatives fail, as all their low-tax, small government rhetoric gets abandoned when the prospect of groveling to a woman by caving to her demands for more government spending presents itself.

 
At 3/27/2012 4:36 PM, Blogger AtlantaDude said...

While I instictively want to believe it, is there any proof that lower marginal tax rates correlate with higher growth. Anecdotally, we got growth in the early 80s and mid 90s after tax rate cuts, but as the graph linked below shows, there does not seem to be much statistical correlation between toptax rates and growth. I think part of the problem is growth (CHANGES in GDP) may be impacted by CHANGES in marginal rates, moreso than the absolute levels. Of course, economists have trouble modeling transitory responses to transitory inputs, because they don't fit into neat, closed-loop differential equations. Nevertheless, that does not seem to justify the conventional wisdom that steady state lower rates bring a lasting period of higher growth.

http://news.yahoo.com/blogs/signal/does-28-top-marginal-tax-rate-mean-175706337.html

 
At 3/28/2012 10:31 AM, Blogger morganovich said...

"Also remember that women are naturally collectivist, and 70-80% of government spending is a transfer from men to women."

what color is the sky on your world?

i'd love to see you try and back that up.

last i checked, we are spending 3.6 tn.

716 bn is defense. that's 20% right there.

so 100% of the rest is a transfer to women?

224 bn (6%) is interest.

another 22% in social security. maybe 60% of that goes to women, but the rest doesn't.

your numbers here look so wildly wrong that i cannot even imagine how you go to them.

 
At 3/28/2012 7:24 PM, Blogger Methinks said...

Yeah, kmg! You tell it like it is, bro.

The world would be so much better off without those pesky women who are all exactly alike.

Or so you imagine since imagination is all you can rely on when it comes to women.

 
At 3/28/2012 7:33 PM, Blogger Ron H. said...

AtlantaDude: "While I instictively want to believe it, is there any proof that lower marginal tax rates correlate with higher growth."

Well, without even using any numbers, I just ask myself if I believe income in the hands of government is used more productively than income in the hands of the private sector, and I have my answer.

 
At 3/28/2012 7:44 PM, Blogger Ron H. said...

"Higher Taxes = Tax Avoidance = Lower Revenues

"the tax raised only £1 billion – a third of the £3 billion amount forecast.

=================================

Huh?

That is still a billion more, not less revenue.
"

Just for your benefit:

"Higher Taxes = Tax Avoidance = Lower - than expected - Revenues"

 

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