Tax Day Special: Understanding the Laffer Curve and the Failures of the Soak the Rich Mentality
ByThe Laffer curve describes the relationship between tax rates and tax revenues collected. This relationship is key to understanding why taxing the rich as means of raising enough revenues to create a welfare state is extremely limited.
The core explanation for why this is so, is that a tax increase discourages people from engaging in the taxable activity, (earn income in the case of income tax,) and it encourages them to avoid the tax (by shifting money around, taking it out of the country, etc.) or even illegally evade it, thereby reducing the tax base. At some point, the increase in tax rate is not enough to compensate for the reduction in tax base, resulting in a reduction of tax revenues despite the rate increase.
Now, it is debatable at which point tax revenues start decreasing with increasing rates. However, it is apparent, that there is no tax rate for “the rich” sufficient to support a significant expansion of the welfare state. The evidence is the tax structure of the social democracies in Europe, whose tax rates are considerably higher than those in the U.S. for lower income brackets. In addition, sales taxes, which are paid by all regardless of income, are considerably higher in Europe than in the U.S. Those tend to hover around 20% in most of Europe, a figure which is twice as large as that of the highest sales tax state in the U.S., California. If anyone could figure out how to support a large welfare state by soaking the rich, it surely is a Western European socialist, but no one did!
Therefore, any politician claiming he/she will soak the rich for “social justice” is being very dishonest, to put it delicately.
To learn more about the Laffer curve, watch the following series of videos. They do a great job explaining these concepts.
- Part II -
- Part III -
5 Comments
April 15th, 2010 at 5:25 pm
So… let me get this straight. We shouldn’t tax the rich at a level that is commensurate with their wealth because they’ll just find ways to avoid paying it? So it’s better to just provide them with lower tax rates and hope that they’re honest when we give them that break? I just want to make sure that I understand. (BTW – the “curve” theory is “Laffable.”) — Mark
April 15th, 2010 at 6:02 pm
So… let me get this straight. We establish a welfare state on the account that we can tax the rich to pay for it, and then when those revenues do not materialize, we tax the middle class and just lie to them and tell them that we’re soaking the rich more. Like Barack Obama you’re one of those who would rather forcibly take the property of others for “fairness” just to feed your own envy rather than do what’s economically right. I just want to make sure that I understand. (BTW – Name calling does not make a well established economic theory less correct.)
April 15th, 2010 at 10:04 pm
@ Mark, I just want to get this straight, so, are you saying the rich should pay for all the things that those that don’t make as much, or those that don’t want to work want? They have government programs giving out FREE cell phones & usage.. and you think its only the rich paying taxes? Why do you think the cost of what you buy keeps going up?
Scenario #1, Think about this, you own a company, you make widgits everybody loves your widgets, you pay your employees well that make your widgits, you might even pay their healthcare.
You are $500k a year, and you are paying 35% in taxes, (or $175k) the IRS (government) raises your taxes to 40% ($200k) but at the same time, they are raising taxes on all those companies that supply with the materials to make the widgets.
The people supplying your materials raise their prices to reflect the ax increase on them, you just $25k a year in income, PLUS it is now going to cost you 5% more to make your widgets, do you REALLY think you are going to keep selling your widgets at the same price?
No, you are going to raise the price of your product to reflect your increase in costs, SO, the person REALLY paying the tax is the person buying the widgets.. (usually people that can’t afford it).
Scenario #2, You make $500k a year, after taxes and living expenses for the year you have $50k left over (yes they spend more to live on than people making less do) (and let me get this straight, I made around $30k last year, so I don’t fall into the rich boat, but I am smart enough to figure this out) so you want to do something with this money, maybe invest it, make more, you can invest it in the US, and pay a higher tax rate, with a lower return, or invest it overseas where it won’t be taxed, or at a lower rate, which do you do??
Historically if you look at the tax rates of the nation, as weird as it sounds, the percentage of taxes taken in, is the always very close. People are happy to pay smaller percentage tax rates, and balk at higher ones, so those that really make a lot of money (lets say over $1 million a year) find ways not to pay taxes.
If you REALLY want a fair tax code, lets have everybody pay taxes on what they buy, lets say 15%, so if you make $50k a year, and spend $30k you pay $4.5k PERIOD, and if you make $500k you spend $300k, you pay $45k PERIOD, its collected when you buy something, no more IRS, and if you want, if you make less than $30k, you get a rebate check at the end of the year for 15% of 70% of your income (there wouldn’t be a 15% tax on your mortgage or rental) this would raise the same as they are now, or more, and no filing income taxes.
There are a lot of ways out the mess we are in, it has been said, government is not the answer, its the problem, its true..
April 17th, 2010 at 10:34 am
“So… let me get this straight. We establish a welfare state on the account that we can tax the rich to pay for it, and then when those revenues do not materialize, we tax the middle class and just lie to them and tell them that we’re soaking the rich more.”
Fair share/soaking the rich – which is it? It’s all semantics, and your take is relative to how much your annual salary might be. Or, in the case of most “conservatives” – what Glenn Beck tells you your take should be.
Amd like him, you create more disinformation rather than addressing the question. Is it ignorance or intentional deceit?
BTW: Unless you are in the top 5% of earners, your taxes are going DOWN in 2010. That’s not lying to the middle class.
Jim, let’s say I DO run a successful small widget business. And when taxes go up, it might mean I make a little less profit. Bummer. But I DON’T raise the price of my widgets and pass on the costs to my middle-class customers – instead, I man up and perhaps don’t take THREE trips to Cabo this year. I cut back to two. Do you know why? Because I’m not the only company around that makes widgets. The other widget-makers will eat my lunch if I raise the price on my widgets. It’s that whole “capitalism works” thing that you guys always harp about – but conveniently forget when it renders your points moot.
If I was really smart, I’d get out of widgets and start dealing in oil – that’s where the money is – and where you don’t have to pay taxes at all.
http://thinkprogress.org/2010/04/06/exxon-tax/
April 17th, 2010 at 11:15 am
Not true. Lower income tax brackets remain unchanged, not lowered. And the upper brackets go up starting at over $200,000 for single income and $250,000 for a couple in 2011. Hardly “rich” income levels, especially in places such as NYC. And there is also a VAT tax proposal being thrown out there. Why even consider it if the intention is to only raise taxes on the rich? The bottom line is that revenues for an expanded welfare state cannot be raised on the backs of the rich alone. Europe hasn’t done it. Why not?
You’re conveniently forgetting that other widget makers’ taxes would go up as well and they too would be raising their prices to compensate.
Or in case of most “liberals” what Barack Obama tells you the “rich” should be paying.
No disinformation here or on Glenn Beck. It may only seem this way to you because you’ve been indoctrinated into the religion of liberalism and have your head permanently buried in the sand.