So where is the peak of the Laffer Curve?

An interesting question and one to which we would like to know the answer.

What\’s the top rate we can charge the rich so as to maximise the income we get from charging the rich?

Looks like, for Germany, it\’s around 67%.

Hurrah! says Ritchie and assorted minions. Let\’s whack up the tax rates on the rich then!

Well, no actually, for two different reasons.

The first is that while we\’ve got a 50% top tax rate at present, we\’ve also a 13 or 14% NI rate on those top pay packets. This is the so-called \”employers\’ NI\”, true, but just about everyone, including Ritchie, agrees that the incidence of this tax is on the employee. So, using simple addition (I can\’t be bothered to work it out correctly) we\’re around and about that Laffer Curve peak as it is.

So, higher tax rates on the rich won\’t in fact get more money. And yes, the researchers do say that they think their finding applies to all rich countries, more or less -ish.

And there\’s a second and much more important reason. The model that was used to calculate this result:

The theoretical model used to determine the optimal asymptotic tax rate posits a closed economy without international migration of top earners. As suggested by Simula and Trannoy (2010) among others, taking potential losses of tax base due to migration into account can significantly reduce the level of the optimal top marginal tax rate.

They\’ve used a closed economy in their model. And, do note, we\’ve an open economy: anyone in the EU has an absolute and non-negotiable right to live and work and pay taxes anywhere they like in the EU. Discrimination on the grounds of national origin is verboeten.If someone buggers off to France, Germany, Estonia or wherever, we are not allowed to tax them as if they are still in the UK.

So we\’ve very much got an open economy. Which, as they say, can significantly lower that optimal (ie, Laffer Curve peak) top marginal tax rate.

Which means that, if our current top tax rate is around and about the Laffer Peak for a closed economy, and that peak is lower in an open economy, then our current top tax rate is above the peak for the open economy which we actually inhabit.

QED and lower taxes now please so as to increase revenue collected.

Interestingly, taking possible emigration into consideration, the empirical finding is that the French top marginal rate of 40% is *too high*.

Yes, we\’re well above the Laffer Peak. Lower taxes now please.

19 thoughts on “So where is the peak of the Laffer Curve?”

1. So, let me get this right. Leftist politicians know that if they refuse to let us leave the country, they can take another 20 odd percent of our income without adverse effect on themselves?

The only sensible position is that of the wife of the canon of Worcester Cathedral on another subject – “Descended from the apes! My dear, we will hope it is not true. But if it is, let us pray that it may not become generally known.”

Nominal pay increment £1.00
Employer pays £1.14.
Employee gets £0.50, taxman gets £0.64.
Taxman gets 64/114 = 56%.

Of course, you have to pay VAT on labour in most industries (certainly those employing the rich), so adding that in gets you to:

Employee gets £0.50, taxman gets £0.84.
Taxman gets 84/134 = 62.6%.

3. What the report actually concludes is “Therefore, setting the top marginal tax rate at 67% for yearly incomes in excess of €350,000 (€700,000 for couples) seems to be optimal from the viewpoint of public finances.”

So our top marginal rate is about right, but our threshold is WAY too low. If you are interested in optimising public finances that is.

4. “Of course, you have to pay VAT on labour in most industries (certainly those employing the rich)”

Erm, what?

If a company hires me as a freelancer, they have to pay VAT on my services. But if a company hires me as an employee, I’m pretty sure (for values of ‘pretty sure’ that approach certain) that this isn’t VAT-able in the UK.

The only reason a company hiring a high-income employee would be paying VAT on that person’s labour would be if they were selling their labour as a freelancer to, erm, avoid paying NI.

5. @john b

“If a company hires me as a freelancer, they have to pay VAT on my services.”

Only if you are VAT registered… and if I am VAT registered I can reclaim it

“But if a company hires me as an employee… that this isn’t VAT-able in the UK.”

You are correct it isn’t

6. It’s worth pointing out the reality of the situation here (Germany), for in addition to taxes we have social insurance stuff, all of which is calculated separately and amounts, for most people, to about 20% of gross pay. As the vast bulk of tax revenue comes from people between the median and 2-3x median, tax rates max out somewhere here (about €52,000) and social insurances start to hit their caps (they all max out at different rates – health insurance at about €47,000, pensions much later).

The upshot is, the marginal rate paid on any pay increase once you are already earning a decent salary is between 60% and 70% anyway. And given that you have to earn something to live, it’s probably that marginal rate that counts more than your nominal rate, which might be closer to 45%. Once you max out your social insurance payments, the marginal rate falls to 45%. And ironically the marginal rate on income between €6000 and €7000 a year exceeds 100% (because below that you are basically exempt from all payments to the state).

7. @Noel, you charge VAT on outputs and reclaim it on VATable inputs. This means that NET you are paying VAT only on non-VATable inputs. Sounds paradoxical, I know.

Somebody ALSO pays VAT on your VATable inputs, because down at the end of the chain every input is non-VATable.

It will be paid on labour, corp. profits (i.e. capital return), or imports. Those things are the things which VAT ultimately gets paid on.

8. The point made in #1 is both correct and worrying “Leftist politicians know that if they refuse to let us leave the country, they can take another 20 odd percent of our income without adverse effect on themselves?”

There is a new statutory residence test that is working its way through the system in the UK. While the proposals at the moment are quite dull and not much different from current practice, this would depend how they are implemented by the Gauleiter’s at HMRC.

We could easily get into a situation where those who would wish to leave the UK to find a less harsh tax regime (especially as they move towards retirement) are effectively prevented from doing so or find that much of the income that they would prefer to have taxed at Maltese or Cypriot rates of tax are still taxed at UK rates.

One aspect of this in the new rules is that there are different rules depending upon whether you have come to the UK from somewhere else (e.g. Poland) or were previously resident here.

This all sounds a bit like a long dark slide into the US style “taxation by citizenship”, which leads to the pernicious problem of having to acquire a second citizenship somewhere more free and then renounce your original citizenship just to get free of the tax obligations.

I hate the EU in all its forms, but the one thing that it has allowed is the freedom to escape this particular tax trap.

However, I suspect this is only temporary as the EUSSR moves towards a single political union with a single tax system. Hopefully, either I (or preferrably the EU) will be long dead before that happens.

9. At around the time that Gordon Brown was keeping his supporters happy by soaking the rich, didn’t the Treasury release their own estimate of where the revenue-maximising rate of income tax lay? And wasn’t it at almost exactly 40p?

I think even Vince Cable admits that the 50p rate has to go quite soon before it damages the economy.

10. “I think even Vince Cable admits that the 50p rate has to go quite soon before it damages the economy.”

You’re a bit late for that. There are vast numbers of people who have left the UK (self included) due to the already high taxes that were being squeezed from us (no – I am not a banker).

The primary problem being that the marginal rate of tax is not 40% or 50% but much higher than that when Employees NI is added on top (even more if you also add Employers NI), somewhere above 60%.

No-one in their right mind is going to pay these kinds of tax for the poor services that are available.

We’ve come full circle and now seem to be replaying a variation the stagflation, high taxes, high spending, high debt of the 1970’s. It’s almost as if Harold Wilson were still PM.

The big difference this time is that there are no capital controls (yet) and it is easier than ever for the highly skilled, highly motivated and highly paid to move elsewhere, like Switzerland for example.

The leftists might say “Traitors” and “Good Riddance”, but the country cannot run a high cost welfare state on the back of people earning median wages.

We need to get back to a position where taxes are fair (10-20% range) and if that means cutting back spending (i.e. “The State”) to get back to that then so be it.

It is growth that we need and this is the only way to get it.

11. @Kay Tie, see above.

VAT is not reclaimable on employees. You still have to pay it when you sell their labour or the produce thereof.

Businesses do not pay VAT on costs at all, they pay it on sales and reclaim it on VATable costs.

It is the inability to reclaim VAT on labour which means VAT is paid on labour.

All the VATable costs are VAT free, obviously, because you have reclaimed the VAT.

12. I’m amazed the Laffer curve goes as far up as 2/3rds of your money. Even in a closed economy, lots of people have the option to refuse promotion or simply stop work when they hit higher marginal rates. Where I used to work there was always plenty of offers in low season which coincided with the end of the tax year, so clearly lots of people were exercising their option.
I wonder if national lotteries aren’t just Laffer curves in fancy dress? In the UK the take is 30%, in France it’s 48%. Why the difference if it isn’t the cultural tolerance for tax?

13. So this same aggregate statistics applies to everybody everywhere at all places and times, does it? Communists, conservatives, Ancient Romans, Inuit whale hunters, they’re all maximally productive at 67% tax are they? Hunter gatherers in darkest Africa, if you take 2/3 of their hunted and gathered shit, that’s when they’ll hunt and gather the most is it?

Or is this just another aggregate statistics fantasy, you know, where you pretend to do maths and discover the actual length of a piece of string? One of those? Like what Mr Keynes did?

Honestly, this whole thing looks about as scientific as Breatharianism to me.

14. Ian B, from the post:

“Looks like, for Germany, it’s around 67%.”

There may be some Inuits in Germany, but not so many Romans these days….

15. “They’ve used a closed economy in their model. And, do note, we’ve an open economy: anyone in the EU has an absolute and non-negotiable right to live and work and pay taxes anywhere they like in the EU. Discrimination on the grounds of national origin is verboeten.If someone buggers off to France, Germany, Estonia or wherever, we are not allowed to tax them as if they are still in the UK.”

I think this is incorrect in one respect.

Denmark, for example, taxes all Danish citizens – even if they have settled permanently in another EU country. So they might have the right to work anywhere they like, but they still have to pay Danish tax! In theory the UK could do the same, but nobody seems to be suggesting it.

16. “Discrimination on the grounds of national origin is verboeten”

Not quite true – a State is allowed to discriminate against its own citizens. It just can’t discriminate against other EU citizens.

Didn’t this come up over the Scottish university fees? Scottish universities were free to Scots; they could charge the English but not students from other EU countries.

17. Richard – yes, this is counterintuitive but correct. It would be discriminatory for an EU student to have to pay higher fees in Scotland than a Scottish student – which seems fair enough, if my son were to go to the Netherlands to study I’d be ticked off if he were forced to pay a higher “non-Dutch” rate given that we are both EU countries. What seems unfair is that English students can’t benefit, as EU citizens, from this non-discrimination rule.

Another peculiar example can be found in the genteel world of county cricket. Because of the restrictions on “overseas” players, it’s quite usual for clubs to take full advantage of the law to allow foreign players to count as “home” ones. As case in point, see this BBC story about Sussex CCC this season – the New Zealander Lou Vincent has been recruited as a “home” player because he possesses a British passport. The South African Kirk Wernars has been recruited as a “home”player because he possesses a Dutch passport, and therefore qualifies under EU law – a straightforward application of non-discrimination.

A little more surprisingly, Naved Arif doesn’t count towards their “overseas” quota. He is Pakistani, and yet plays as a “home”-qualified player under EU law, because his wife is Danish and EU law extends many of the “Four Freedoms” rights to spouses of EU citizens . Again, this seems fair enough. As an EU citizen, your right to travel and work around Europe would be seriously impaired if other member states were allowed to say “you’re fine, but you can’t bring your spouse and family with you”.

But then we get on to the sorry tale of Iain O’Brien at Middlesex CCC. As a Kiwi he was initially recruited as an “overseas” player, but there are bigger and better names available in the foreign player market, so his job security relied upon him qualifying as a “home” player. He was well aware of this risk – specific provisions were made for it in his contract – but it would appear he wasn’t given good legal advice, as he was under the misapprehension that his marriage to an English woman would secure his future. But although marriage to a Danish citizen would have sufficed, marriage to a British citizen does not – the key isn’t marriage to an EU citizen, but specifically marriage to a non-UK EU citizen! When Middlesex signed the Australian batsman Chris Rogers for their overseas berth, it came to light that O’Brien’s attempt at home-qualification had failed and his contract automatically terminated. Unfortunately for him, non-discrimination works counterintuitively: it’s there to stop discrimination against EU citizens and their spouses and families moving and working freely between different member states, but that isn’t the category O’Brien fell into.