Tradeoffs

Apparently The New Yorker now runs web-only articles (who knew?) and one of them is this great James Surowiecki piece about the Laffer acolytes of the world. Since I've sort of blogged this general subject to death already, though, it's worth echoing a point that Hacker and Pierson make in Off Center, namely that this bogus idea about tax cuts and revenue is just one of several arrows in a quiver that's designed to obscure the existence of real tradeoffs when the subject of tax policy gets debated.

At the end of the day, it's just very hard to get people agitated about even the most regressive tax cut imaginable simply because the number of people motivated by pure resentment against the hyper-rich turns out to be pretty small. On top of that, these cuts are usually structured so as to at least throw a bone to the common man. I get $50 while some much richer person gets $50,000 and though I might wish I'd gotten more, at least I'm walking away with $50. But if the proposal on the table were structured explicitly as a choice between that and a different plan wherein the $50,050 goes to guarantee health insurance and a day care subsidy for me and for the rich guy, then suddenly the programs look like a much better deal.

Thus even when spending cuts are put on the table legislatively, it's always done as a separate piece of legislation from the tax cuts. Meanwhile moderate (i.e., vulnerable) Republicans who wouldn't necessarily embrace Lafferite dogma explicitly have a tendency to vote for tax cuts but then against the spending restraint measures required by the logic of tax cutting. Obviously, trying to avoid explicit discussion of tradeoffs is a trick of the trade beloved by politicians of all stripes all around the world, but the Laffer concept is an uncommonly effective tactic since the US press adamantly refuses to treat it as a "gaffe" when a Republican politician goes and puts patently untrue claims at the center of his economic policy.

Comments

Surowiecki has a wonderful observation about the recent Republican penchant for excessive spending -- turns out spending restraint isn't necessary if you're a true believer:

But, while Republicans still talk a good game about the need for spending discipline, in practice it matters far less to them than tax cutting. After all, if tax cuts pay for themselves, then there’s not much reason to worry about restraining government spending—we can afford it all. In fact, if government spending grows too big, you can cut taxes again to pay for it.

Posted by David in NY | October 24, 2007 6:51 PM

Every time a wingnut makes the claim that lowering taxes increases revenues, he should simply be asked 'then lowering taxes to zero will maximize revenues, right?'.

The sputtering will replace carbon-based fuels in our economy

Posted by msn (LI, NY) | October 24, 2007 6:55 PM

If you reduce the tax rate but continue to spend the money, you don't have a tax cut, you have a recess in collection. Unless you intend to default on your debts, the money will have to be collected sometime, and with interest.

Posted by Robert Fiore | October 24, 2007 7:43 PM

The GOP, with full control in D.C., had no interest in the only measure that has successfully restrained spending, which is PAYGO, the pay-as-you-go rules (for each spending increase, must be a cut elsewhere) that they let expire and failed to reinstate.

That's all you need to know about their commitment to spending restraint.

Posted by bob | October 24, 2007 7:52 PM

It's important to note that the Laffer curve isn't bogus, it's most applications of the curve that are bogus. It is, none the less, still the case that under any remotely sane assumptions about human responses to taxation, it's going to be possible to push the rate of taxation high enough that the taxed activity ceases or flees the reach of the taxing authority, and revenue drops off.

Of course, the income tax is nowhere near that rate, anymore, but that's not Laffer's fault.

Posted by Brett Bellmore | October 24, 2007 8:48 PM

Well, in all fairness to the tax-cut lunatics, didn't all this "Laffer Curve" talk begin in the late 1970s, when marginal rates were something like (???) 70%?

But now marginal rates are something like 30%, or maybe 15% if you're a billionaire hedge-fund manager.

Now unless I'm mistaken, ordinary percentages can only range between 0% and 100%, so there's really a pretty wide difference between 70% and 15%...

Posted by RKU | October 24, 2007 9:17 PM

RKU: but the "tax-cut lunatics" contend that at current rates, tax cuts increase revenues. It's a lie. Indeed, it's clear that at the higher rates before the last Bush cut, it was a lie. But to be a Republican, you have to say you believe it, and, even worse, you have to say that further cuts would again raise revenues. And every single one of their candidates goes along with this. It's unmoored from reality, but nobody will call them out.

Posted by David in NY | October 24, 2007 9:49 PM

It's important to note that the Laffer curve isn't bogus, it's most applications of the curve that are bogus.

I'm not sure I'd agree. I accept that increasing tax rates may produce declining returns to revenue (i.e., if raising tax rates 1% brings in $x in additional revenue, the next 1% raise will bring in something less than $x in additional revenue). But that kind of "everything else being equal" analysis makes sense only over relatively small changes in tax rates. With larger changes, it really matters what you are spending the money on -- infrastructure? deficit reduction? an ill-thought out war? And the idea that you could actually draw the curve for all possible tax rates from 0% to 100% is kind of insane. Is it meaningful to talk about a curve that's so ill-specified that no one could ever construct it?

By way of example, suppose I suggest that for some people, they could actually work more money if they worked fewer hours, because they would be more refreshed and alert, and more likely to get a raise or a promotion. Even accepting that that's true for some group of people, I don't think that analysis is sufficient to specify an "Alkali Curve" where if you work 0 hours a week you earn $0, and if you work 168 hours a week you earn $0 because you get fired for constantly falling asleep on the job (or you drop dead).

Posted by alkali | October 24, 2007 9:50 PM

msn: Every time a wingnut makes the claim that lowering taxes increases revenues, he should simply be asked 'then lowering taxes to zero will maximize revenues, right?'.

The wingnut will then draw you the Laffer curve on a napkin. No, you have to argue that we're on the left side of the Laffer curve, and when he asks you how you know that, you can point out that Bush Sr. and Clinton's tax cuts resulted in an increase in revenues. If we were on the right side, they would have gone down.

Posted by fling93 | October 24, 2007 9:52 PM

Really, Alkali, the only assumption you have to make to prove the Laffer curve valid, is that people won't stand still and mindlessly continue to work at a job even after you're taxing away 99.9999% of their pay. They can't afford to! They'll either go on the dole, become part of a black market, or emmigrate to someplace that lets them actually keep part of their pay. Either way, YOU don't get any more tax revenue from them.

Once you've established that letting people keep 1 cent a year isn't enough to make them keep working, the Laffer curve is proven, and the only question is it's exact shape.

Posted by Brett Bellmore | October 24, 2007 10:16 PM

Oh, fling. You forget that the Clinton tax increase of '93, the biggest tax increase in the world, according to Republicans, imposed at a time when tax rates were even higher than they are now, also increased revenues -- which became great enough to erase the deficit. A tax increase really does increase revenues, so we're clearly on the left side of the curve. But of course, revenues almost always tend to go up some, simply because the country grows, even if taxes are cut. The studies that have controlled for this variable have uniformly found that, even where revenues ultimately increased (they always drop at firstafter a cut), it was because of that latter fact, not because of any effect of the tax increase. You could look it up, but I suppose you won't. You might even read the Surowiecki article and the links in it, for a starter.

Posted by David in NY | October 24, 2007 10:30 PM

The Reagan/Greenspan FICA tax "Raw Deal" cinched the Supply Side Tax Swindle in 1983.

The 1983 Social Security commission headed by Chairman Greenspan gave President Reagan political cover to raise taxes on wage earners while cutting marginal taxes on millionaires (the old school 1980's term for billionaires).

FICA Taxes for "Reagan Democrats" during the so-called tax cutting glory days...
(1978 - 1989)

1978 6.05%
1982 6.70%
1986 7.15%
1989 7.51%

The idea was boomer generation "Reagan Democratic" wage earners were told that their higher FICA taxes would build a next egg of cash to pay for their Social Security retirement benefits.

In reality their hard earned wages went to the financial scammers on Wall Street, merging & busting up companies, slashing payrolls & benefits, offshoring manufacturing jobs and importing low wage competition from Mexico.

The ironic capper came in 2001 when Mr. Greenspan agreed with President Bush's plan to slash capital gains & dividend income tax rates to fifteen cents on the dollar.

Poof! Guess what? During the Spring of 2005 President Bush told an audience in West Virginia: "There is no "trust fund, just IOUs...". The Social Security trust fund had vanished!

President Reagan, Mr. Greenspan and their Republican successors including President Bush brilliantly executed the stealth "Raw Deal" tax heist of boomer generation "Reagan Democratic" Social Security Trust Fund.

The perverse outcome of the supply side tax scam in 2007 has a "Reagan Democratic" wage earner paying a 40%+ total (FICA + MEDICARE + FED MARGINAL RATE) to the Federal government while a Billionaire private equity manager pays a pitiful fifteen cents on the dollar in "carried interest".

Posted by James S. | October 24, 2007 10:41 PM

Matt, after you finish beating this point to death ( I thought you done that weeks ago), why not take a look at your side's use of the "investments" concept.

Posted by Thomas | October 24, 2007 11:02 PM

David, I did mean to say their tax increases increased revenues, showing that we're on the left side of the curve. For tax cuts to pay for themselves, we'd have to be on the right.

Posted by fling93 | October 24, 2007 11:34 PM

Once you've established that letting people keep 1 cent a year isn't enough to make them keep working, the Laffer curve is proven, and the only question is it's exact shape.

The fact that you can specify the endpoints doesn't mean that the remainder of the "curve" is sufficiently well specified to have a "shape." (In any event, it is unclear that the endpoints are actually well specified: it does not seem possible that you could operate any kind of industrial society with no taxes whatsoever, and it would be impossible to implement 100% or near-100% taxation in anything resembling a capitalist state.)

Posted by alkali | October 24, 2007 11:48 PM

Shorter Thomas: My political party's entire economic philosophy is based on a gigantic lie, but I don't want Matt Yglesias to mention that any more because it makes me feel icky inside.

Oh wait that's longer Thomas.

Posted by Mr. Sparkle | October 25, 2007 12:05 AM

Alkali, whether or not the end points of the curve are feasible for a nation to reside at is beside the point. And how well "characterized" a curve is is pretty much irrelevant, if the point you're making is anchored in fundamental axioms of mathematics which no curve is going to violate.

Why is it so damned important to argue that revenue increases monotonically up to 100% rates of taxation? (Which is what you're claiming if you insist the Laffer curve is nonsense.) Even if it makes you look like a dogmatic fool to anybody who understands some basic econ and math? The appropriate response to the modern day Laffers isn't to prove yourself an ass by declaring that Laffer was wrong, it's to say, "Nice try, chum, but we're not on that part of the curve!"

Posted by Brett Bellmore | October 25, 2007 7:01 AM

All you really have to know about the Laffer curve is that neither the ordinant nor the abcissa are labeled. Therefore, we have no way of designing a test capable of falsifying the implied hypothesis that an inflection point in taxation can be reached where people will no longer work more. Until you see a version of this graph with the axes labelled, you can safely ignore it.

In the '50s, the highest marginal tax rate was around 90%, and this decade included a remarkable period of growth in the American economy.

James S, if you are paying 40% of your income in federal taxes, you need to fire your accountant. I think you are assuming that everyone pays the highest marginal rates on their entire gross income and takes no deductions.

Posted by Joel | October 25, 2007 7:08 AM

The bogosity of Laffer Curve is mostly in ignoring that it matters what is done with collected taxes.

In the case of Clinton's tax increase, government stopped issuing more debt and this decreased interest rates and thus active investments were encouraged. But tax cut of Bush did not increase interest rates much, in large part due to the intervention of East Asian central banks that was done for mercantilist reasons (letting Americans to borrow money so they could afford imports, keeping the exchange rate favorable for dollar).

The other part of the equation is how does the government spend the money. Education, training, healthcare and infrastructure can be conducive to economic activity, so if the government spends money well, the drop in taxable economic activity can be small, if any. The economy in Scandinavian countries should collapse according to Laffer-curvists, but it did not. US economy should grow faster than Canadian, but most of the time it does not, especially if we compare Michigan with the neighboring Ontario, two economies heavily dependend on car production.

The notion that we can capture the impact of revenue change in separation from the impact of the changes in rhe government spending strikes me as bogus.

Joel: as James S. explicitely referred to federal MARGINAL rate, he can be offered benefit of the doubt that he was calculating the total marginal rate. Another thing is that a working stiff who just has salary, bank account, perhaps one mortgage, hardly needs an accountant. It is a bit if you would see my front yard and concluded that I should fire my gardener (my method is to keep only the hardiest flowers, and let the other perish).

Posted by piotr | October 25, 2007 8:45 AM

The bogosity of Laffer Curve is mostly in ignoring that it matters what is done with collected taxes.

In the case of Clinton's tax increase, government stopped issuing more debt and this decreased interest rates and thus active investments were encouraged. But tax cut of Bush did not increase interest rates much, in large part due to the intervention of East Asian central banks that was done for mercantilist reasons (letting Americans to borrow money so they could afford imports, keeping the exchange rate favorable for dollar).

The other part of the equation is how does the government spend the money. Education, training, healthcare and infrastructure can be conducive to economic activity, so if the government spends money well, the drop in taxable economic activity can be small, if any. The economy in Scandinavian countries should collapse according to Laffer-curvists, but it did not. US economy should grow faster than Canadian, but most of the time it does not, especially if we compare Michigan with the neighboring Ontario, two economies heavily dependend on car production.

The notion that we can capture the impact of revenue change in separation from the impact of the changes in rhe government spending strikes me as bogus.

Joel: as James S. explicitely referred to federal MARGINAL rate, he can be offered benefit of the doubt that he was calculating the total marginal rate. Another thing is that a working stiff who just has salary, bank account, perhaps one mortgage, hardly needs an accountant.

Posted by piotr | October 25, 2007 8:46 AM

If you reduce the tax rate but continue to spend the money, you don't have a tax cut, you have a recess in collection. Unless you intend to default on your debts, the money will have to be collected sometime, and with interest.

Actually, except for the portion you are borrowing from foreigners, you are taking the money out of the private sector now, not just in the future. If you cut taxes but continue to spend, and are running a deficit, then the extra money is either borrowed, which means that someone else cannot borrow the money, or inflated (i.e. the government prints money), which devalues the money, taking money out of the economy in real terms. The only way to borrow money without taking it out of the U.S. private economy is if you borrow it from foreigners and they would not have lent it to others in the U.S. if we hadn't borrowed it.

So Laffer-curve style revenue increases from tax cuts only work if (a) the government is running a surplus, (b) spending cuts are made that are roughly equivalent to the tax cuts (c) all of the money to pay for the immediate drop in revenues comes from foreigners who would otherwise not get involved, (d) the entire Laffer increase is due to people's psychology (I'll work more if taxes are lower) rather than by the increase of money in the private sector for investment (as the government is still taking just as much money from the private sector regardless of tax rates), or (e) the other means of generating the needed funds (borrowing or inflating) are less destructive than income taxes.

Posted by Glaivester | October 25, 2007 8:47 AM

piotr,

The reference to an accountant was partly tongue-in-cheek. But the higher your income, the higher marginal tax bracket you find part of your income in and the better you can afford (and more likely you'll need) an accountant.

The larger point I was trying to make is that the idea that anyone has to pay 40% of their income in federal taxes is just plain wrong. Anyone who does has a fool for an accountant, even if they do their own accounting.

It is amusing to see others discuss the Laffer curve as though they actually know what it means. Until the intervals between 0 and 100% are explicitly indicated, it is simply impossible to test the validity of the Laffer model. It is merely a cartoon of an idea.

Posted by Joel | October 25, 2007 9:03 AM

Belated apology to fling, whose comment I totally misread.

Posted by David in NY | October 25, 2007 9:29 AM

Joel,

I am saying that the productive energy per hour that is generated by a wage earner is taxed at a higher rate today than in 1982.

Remember that the FICA tax is matched by the employer, which means that the labor rate of
a skilled worker is taxed at 12.4% for all income up to ~$95K.

The same rule applies for the 1.4% Medicare tax.

That means that base wages and overtime (the productive energy expelled by the worker) is
taxed at 15% for all income up to ~95K.

If you add the federal marginal rate of all income generated up to 50K, you would find that a worker pays twice as much in federal income taxes than a hedge fund manager who is taxed at a 15% rate on his 20% cut of long term capital gains made by "trading activity".

Posted by James S. | October 25, 2007 11:13 AM

Lafferism is just right-wing Keynesianism under another name. Both doctines lead to unbalanced budgets, but at least Keynesianism harnesses budget deficits for useful purposes.

Posted by jonp72 | October 25, 2007 12:59 PM

Don't forget that, in noting the government collections/tax rates of the 1950s, that the United States was still trying to sort out the socks of a huge mixed laundry of tax-code decisions made during World War II.

Remember too that we spent the large part of federal goverment money during the Fifties on highway construction and immense delivery systems for nuclear weapons. Entitlement programs of today were either small then in payout vs. collection (Social Security) or triggered by other goverment needs (more education spending to create more scientists/engineers to create even better nuclear-weapons delivery systems.)

Posted by Emerson Schwartzkopf | October 25, 2007 7:00 PM