There’s that damn Laffer Curve again

That it exists we know, where the peak is is arguable.

Earnings above £7,717 are briefly taxed at a rate of 12.1pc; above £7,769 this jumps to 22.7pc; then the combined tax rate shoots up to 40.2pc from £9,440, briefly reaching 57.8pc above £41,450; it then falls back to 49pc from £41,558; rockets to a bonkers 66.6pc from £100,000; falls back again 49pc from £118,880 and then settles at 53.4pc from £150,000. Labour’s 5p hike would push the combined tax rate above £150,000 to 57.8pc.

Diamond and Saez argue that in a system with tax allowances (ie, the ability to bugger off abroad, as we have here) the peak is around 54%.

We’re over that in parts of the income distribution.

10 thoughts on “There’s that damn Laffer Curve again”

  1. And, as they point out in the article, those are straight tax figures. Before you factor in benefits withdrawal at either the lower end or the £50k – £60k range.

  2. Is the magic Laffer rate meant to apply to your highest marginal rate, or your effective overall rate?

    Tim adds: Marginal. Everything happens at the margin in neoclassical economics.

  3. @ Luke

    I guess it could be either.. it depends on your circumstances.

    If it’s about whether someone will bugger off somewhere else, then the overall rate is what matters. If it’s about selective withdrawl of labour, then marginal rates are probably the most important.

    That probably means that high earners will be more interested in their overall rate, and lower earners more interested in their marginal rates.

  4. My income fell into the 100-118K black hole last tax year, so I every extra pound I earned, 66p of it went to the State. You can bet your bottom dollar I will make damn sure my income drops significantly next year.

  5. Diamond and Saez argue that in a system with tax allowances the peak is around 54%.

    No they don’t. They have an elegant analysis which, given convenient assumptions about the shape of income distributions and the nature of tax elasticity, gives a formula for the revenue-maximizing high-end marginal tax rate. Using consensus parameters for the USA, they find that that rate is 73%. However, they are arguing for higher taxes, so they also give the tax rate corresponding to the highest plausible estimate of elasticity – hence the lowest plausible revenue-maximizing rate. It’s that rate which is 54%. They carefully point out that “the elasticity e is not an immutable parameter and can be reduced through base broadening and tax enforcement”.

    The values of these parameters will be different in the UK.

  6. Another query. Is the Laffer idea that higher taxes will not raise more cash because:
    A) people affected will work less/emigrate; or
    B) people affected will dodge/evade/avoid the taxes; or
    C) both the above?

    Tim adds: C.

    To make things more complicated we also assume that some people (most some of the time, some much of the time actually) have an actual post tax income in mind. So they will work harder if tax rates go up (there have been good experiments showing this to be true among piece rate workers like taxi drivers for example).

    What we’re really saying about the Laffer Curve peak is that this is when the disincentives to work (or report taxes accurately, or stay in the country) overcome the effects of people working more to maintain their income.

    And do note, this is all about averages. There are undoubtedly people who wouldn’t be affected either way by any rational tax rate. We’re talking about when it changes the behaviour of enough of the population that we can see the difference in revenues collected.

  7. Thanks again.

    I’m just not sure how useful a concept the Laffer curve is, given the varying and sometimes contradictory pressures. (And I’m guessing non-income taxes might have an effect – a smoking drinking plumber on 40k might go to France?) True, yes, but useful? Sort of opposite to EMH, which I’ve heard is not quite true but very useful.

  8. “I’m just not sure how useful a concept the Laffer curve is, given the varying and sometimes contradictory pressures.”

    Which probably indicates it can be used historically to indicate the effects of taxation but trying to work the other way, such a rate of taxation will have this effect, isn’t reliable.
    Doesn’t mean it isn’t useful. Last time we did this, this happened, so maybe not a good idea to do it again is worth a world of mathematics..

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