Top End of the Laffer Curve

Megan McArdle:

I know I keep pounding the point that at American levels of taxation, the Laffer curve promise of higher revenue on lower rates doesn\’t apply. Well, at 55%, it\’s plausible to believe that it *does* apply. There is a limit to how much you can raise taxes on the rich.

There\’s an interesting if underappreciated point here I think. There\’s two ways in which raising tax will reduce revenues. Or, sorry, possibly could, if we engineer things to move to the right of the peak of the Laffer Curve.

1) All of the usual stuff: if the marginal tax rate is 55% or 75%, then people will simply substitute leisure. Or instead of making high risk high return investments in equity, make low risk ones (tax free municipals look pretty good at high rates of income taxation, like, say, the 98% the UK had on investment income). In short, people will stop doing productive stuff.

2) People will bugger off and do their productive stuff somewhere else. Why pay 60% in the UK when you can pay 13% in Russia or 0% in Monaco?

OK, those are actually both pretty obvious, at least from the European view. But 2) rarely comes up in US discussions of such things. Because, you see, under US tax law, you don\’t get out of paying Uncle Sam (you do get out of State taxes, but not federal) by moving to another country. Unlike most, in fact I think all, other countries in the world, you\’re taxed as a US citizen, not upon where is your residence. So as this ability of US citizens to decamp to Switzerland to avoid the taxes doesn\’t exist (except by giving up citizenship and believe me, the US makes this more difficult than any other country as well) the American debate about the peak of the Laffer Curve concentrates solely on 1).

Whereas, from what I can see, the European one concentrates on 2).

Which leads me on to a favourite annoying little point of mine. There\’s no such thing as "The Laffer Curve". There are a series of them. Depends upon the person, the tax and other bits and bobs associated with the situation. Sure, we can aggregate the population\’s responses to the level of any given tax: but if we forget, in the case of income taxes, those two different ways in which the take can fall, then we\’re going to end up with our presumed peak of the curve in the wrong places.

Now if we make the (gobsmackingly, awfully, wrong, but it\’s to clarify) assumption that the reactions to 1) are the same worldwide we are then left considering only 2). How easy is it for the high earners to flee the tax jurisdication?

For those in the UK, very simple indeed. For those in the US, near impossible. Which leads us to the fact that the peak of the Laffer Curve in the UK is shifted leftwards from the one in the US. Another way of saying the same thing is that the revenue maximising tax rate in the US is higher than it is in the UK.

Of course, I would argue that this means the UK rate should be lowered but I\’m aware that there\’s thems who would argue differently.



8 thoughts on “Top End of the Laffer Curve”

  1. Two comments.

    (1) I imagine it would take a very large financial incentive for most UK people to move to Russia — I wouldn’t want to live in a country run by criminals. Nor can I imagine hordes of people moving to Monaco (no room).

    (2) would it not be sensible for the UK (and other European countries) to do something to prevent the USA from grabbing income tax from US citizens resident in Europe? For a start, it’s a blatantly unfair practise.

  2. Philip Hunt,
    WRT your point number 2, US citizens resident in Europe still pay their European taxes anyway, so there isn’t much in it for European governments, anyway.

    [Funnily enough, it is probably harder for an American to come and work legally in the UK and Europe than it is for someone from, say, sub-Saharan Africa, for instance. It doesn’t seem like Europe wants to attract Americans if you go by residency and immigration rules.]

    And Americans abroad don’t start getting taxed on their income until it is above $80,000 (or $160,000 for a couple), so changing that rule isn’t going to get much democratic traction in the US.

    Tax treaties make any social security and income taxes and the like recognised as reciprocal up until that point.

  3. Just by way of interest SA has the same tax em wherever they are system.

    Oh, I didn’t know that. The Japies I worked with in Kuwait didn’t pay any tax, so I guess it is easier to just bugger off and keep your salary secret from the SA government than the US government.

  4. I imagine it would take a very large financial incentive for most UK people to move to Russia — I wouldn’t want to live in a country run by criminals.

    Ah, it’s not that bad. It is often damned good fun, actually. I have to say the financial incentive for me was pretty strong though.

  5. Zzzzzzzzzzzzzzzzzzzzzzzzzzzzzz……………….



  6. Philip Hunt & James G:

    Also note that you can offset taxes that you are required to pay to the government of the country in which you live against your US tax bill.

    So basically, your US citizen living in the UK pays his UK tax just like a UK citizen, but then might owe some more money to Uncle Sam.

    (You can only offset direct personal taxation, so a foreign country which wanted to make itself more attractive to US citizens should, it seems, lower its sales taxes / VAT and raise taxes on income.)

  7. To understand just how unfair the US tax system is for those living outside of the country, one has to take a quick look at the differences in tax systems. A German resident US citizen pays 19% VAT on everything purchased and this sum is not considered in the tax paid at the end of the year and there is not such system in America. Many of the taxes paid in Europe are not on income and do not exist in the US. (VAT, Television tax, energy tax etc etc) Which leads to an interesting point for the Europhile Brits: When they fill their tank in Germany they are already directly paying taxes to prop up the failed German pension system. A little taste of the future, or what?

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