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Over the curve and far away

By Daniel M. Ryan
web posted October 12, 2009

Believe it or not, there are some people who still deny the principle behind the Laffer Curve. Said curve posits a tax rate that brings in the most revenue. If the set rate is below or above that optimal rate, then tax revenues will fall. Laffer's conclusion is really an application of the Law of Diminishing Returns; the insight consists in realizing that governments are not above the laws of economics.

The pretexts for denying it seem thinner once histories are read. Governments recurrently over-reach, even powerful ones. Anyone with more than a passing knowledge of the Roman Empire will have come across the term "imperial overstretch." In medieval Europe, princes overborrowed to the point where sovereign loans carried risk premiums. If there's any relevant lesson of history, it would be that governments are more prone to flouting the Law of Diminishing Returns than are other institutions. Having and accessing the powers of war, tax and arrest does tend to inflate the ego. So does the flattery that accompanies the deployment of tax funds. These ego points suggest plainly that un-humbled government officials are, if anything, more prone to the Law of Diminishing Returns than are other people.

Despite widely varying tax rates, this graph of U.S. government tax revenue as a percentage of GDP shows a real continuity. Between 1952 and 1999, the U.S. government's take ranged between 16 and 20% of GDP. The two years with the highest take were 1945 and 2001. In the post-WWII timeframe, the low point was reached in 1949 – a year when the top income-tax bracket was 90%. Some may blame the loopholes that were prevalent at the time, but those loopholes did coexist quite comfortably with an age now vaunted as one where income equality was the greatest. As is often the case, a careful study of history shows today's liberals lauding an age that contemporaneous liberals complained bitterly about.

It isn't just the federales that are subject to the Laffer Curve. Steven Malanga has shown that state governments are quite capable of overshooting the point of diminishing returns, to the detriment of their tax take (as well as the economy.)

Tax Avoidance: Easier Than You Think

When it comes down to brass tacks, there's a surefire way to avoid paying income tax: forego earning income. The easiest way to lower your income, in a market economy, is to add less value to the economy. People with a little wealth can become property-poor. All it takes is a nice chunk of land in a hinterland area where property taxes are low and the neighbors are mostly scraping by. It's easy to live poor in such an area. Investing in growth stocks that pay piddling dividends is one way of retaining large wealth while receiving an apartment-level income. Margin loans can be used for one-time expenditures to defer paying capital-gains taxes for a time. There are many other ways of dodging income taxes that are just as legal and almost as straightforward. None of them involve schemes of any sort.

Of course, such methods aren't often used when economic ambition is conjoined with psychological coping mechanisms that facilitate tax-paying. For the average paychecker, concentrating on the take-home figure does the trick. Gross pay is cast as "theoretical," only good for bragging rights, and the take-home figure is used as the real one. "I would have only made thirty thousand anyway." Ironically, given its free-market orientation, neoclassical economics – particularly, partial-equilibrium analysis - aids in this structuring. Earnings are lowered, leading to people seeking other work (or none at all,) impelling employers to push take-home wages up to the free-market level so as to ensure the positions are filled. The employer tries to push the added cost forward to the consumer, leading to a new hampered-market equilibrium.  

It's coping mechanisms such as these that form the human base of the Laffer Curve. They sketch out how much people acquiesce to taxes. When the tolerance is lower, the maximum tax take settles in at a lower rate and vice versa

Governments, consequently, have a vested interest in raising the maximum percentage of GDP that can be extracted in taxes. One way of doing it wrong is taxing punitively, and bad-mouthing the economically successful as a flank maneuver. The more psychic disutility is piled on wealth-seeking, the fewer people will bust their hump seeking wealth. (It's useful to ask what kind of people would be least affected by said punitiveness, as they're the ones who are most likely to proceed.) Attacking wealth, rather than deploring or ignoring wealth, is thus an effective way to lower the maximum tax take from an economy. People who are attacked tend to retaliate, if only passively-aggressively. Those E-Z tax-avoidance strategies are tailor-fit for the passive-aggressive, and the more well-known ones are well suited for people who like to thumb their nose at the unreasonable. The conclusion is hard to escape: the U.S. government's take is relatively low because of left-liberal hostility to wealth, and not because of any vast Republican conspiracy.

It's a bitter irony for left-liberals, but the most effective way to up the government's share of the GDP – outside of a widely popular war that isn't seen as a wag-the-dog ploy – is to make the tax-paying rich guy a "Hero of the People." Stroking costs nothing; so does a handshake and posing for a joint picture. The same thing goes for any non-monetary incentive of this sort.

Of course, with rubbing shoulders comes influence. It too is a non-monetary incentive, provided that anti-corruption strictures are adhered to. Ever wonder why a government seemingly of, for, and by the rich coexists quite well with the top 1% of income earners paying about 40% of individual income taxes? It's hard to avoid the conclusion that a progressive income tax, combined with rational tax-gathering, progresses towards plutocracy. We're discovering that governments are also not above a more home-spun economic law: "the cow that gives the most milk gets the best stall." ESR

Daniel M. Ryan dances with the Grim Reaper.

 

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