A new academic journal paper has something pretty interesting to add to the debate on the impact of higher than currently normal top rates of income tax. In their paper entitled ‘Top marginal taxation and economic growth‘ Santo Milasi and Robert J. Waldmann argue that there is a positive correlation between high rates of economic growth and high marginal top rates of tax. In their opinion:
The [estimates] suggest that the marginal effect of higher top tax rates becomes negative above a growth-maximizing tax rate in the order of 60%.
You knew that Richie was going to pounce upon this one, didn’t you?
Sadly, can’t see the paper itself. But it would be interesting to know whether they really mean income tax or taxes upon income. For Diamond and Saez find a not dissimilar result, a few percentage points away, for taxes upon income. Including, they insist, employer paid taxes upon employment etc.
But what’s really fun from Snippa is this:
The finding is, of course, entirely logical. We have known for a long time that the so-called Laffer effect, where higher rates of tax supposedly reduce effort, does not kick in until rates are sixty per cent or more.
Ah, good, so we do now all agree that the Laffer Curve is correct then. We’re only arguing about the rate, not the existence. That is an advance, isn’t it? And NB again, D&S tell us that it’s 54% for taxes upon income, in a system which contains allowances. Which, when you take NI into account, comes to an income tax rate of 40 – 45%. Which is also where the Treasury says the peak of the curve is.
BTW, allowances includes such things as being able to reside outside the taxing jurisdiction. Something the EU insists we all can do.
At which point, the giggles:
And we know, as a rule, that higher rates of tax encourage effort over observable ranges as people work harder to achieve net incomes given that the whole of our economy is geared to consumption, rightly or wrongly. Add the two effects together and the effect that this paper observes is the logical consequence.
Err, no, we don’t know this as a rule. In fact, if this were the rule then there wouldn’t be a Laffer curve at all. For if we all did target our net income then the higher the tax rates the more labour would be on offer to make up for the tax bite out of that desired income level. A 90% tax rate would see us all working 100 hours a week as we desperately tried to still afford a crust.
This does not happen. Therefore the assertion must be wrong.
And it is wrong of course. For the basic analysis which leads to that very Laffer Curve is that there are two different processes at work. One is the income effect, which is that very idea that we’ve an income we want and we’ll work to get it. Tax rates go up, we work more to hit that net income. On the other hand there’s also the substitution effect. If I’m only going to get 5% of my next hour’s work, a quid, fuck it I’m off fishing.
It is the interplay of these two effects which produces the Curve. We all, a little bit at least, work to the income effect, we all of us, a little at least, work to the substitution effect. The balance of the two changes as tax rates and incomes change. That’s what produces the Curve in the first place.
We cannot, therefore, point to the income effect and conclude that it proves Laffer wrong, because the income effect is one of the two things which produces the very curve.
Finally, how goddam ignorant does an economics teacher have to be to ignore that going fishing is consumption, the consumption of leisure?
Update: And reading the paper (thank you to DIAM who sent it to me) it does indeed seem to be looking at taxes upon income, not income taxes. Which rather neatly disposes of Snippa, doesn’t it?