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Wednesday, February 22, 2012

Bartlett: What Is the Revenue-Maximizing Tax Rate?

Tax Analysts Bruce Bartlett, What Is the Revenue-Maximizing Tax Rate?, 134 Tax Notes 1013 (Feb. 20, 2012):

Barack Obama has proposed raising taxes on the well-to-do, both for revenue and distributional reasons. This raises, anew, the question of what the revenue-maximizing top rate is. Conservatives continually assert that the United States is always on the wrong side of the "Laffer Curve," such that a tax rate reduction will increase revenues. A review of recent literature on this subject, however, indicates that the top tax rate could rise very substantially before a further increase would lead to lower revenues. Estimates suggest that this rate is at least 63% and probably much higher.

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Comments

Well said, but in some danger of having readers miss the point. We don't need to maximize revenue. We do need to tax enough to pay our bills... even allowing for some reasonable ongoing deficit. The idea of managing the economy for maximum growth is insane, and the idea of managing it by tax policy is an invitation to tax gaming.

And of course lower taxes forever is how we got here.

But it's nice to know we can raise taxes enough to control the deficit without killing growth. That ought to be everybody's taxes, progressively, not just "tax the rich." Nothing wrong with taxing the rich... they have the money... "but don't tax me" is bad politics and bad mental hygiene.

Posted by: dale coberly | Feb 22, 2012 7:26:45 AM

Sixty-three percent or higher? Let's see how a tax increase, but to even lower rate, is working out in the UK.

50% tax rate 'failing to boost revenues’
"The amount of income tax paid fell sharply last month in the first formal indication that the new 50% higher rate is not raising the expected amount of revenue."

Posted by: Woody | Feb 22, 2012 1:26:30 PM

Quoting from Bartlett's paper: "Also in 2009, economists Mathias Trabandt and Harald Uhlig examined revenue-optimizing tax rates for the United States and Europe. They found that the United States is well below the revenue maximizing top rate of 63 percent, that taxes on labor could be increased by 30 percent before labor supply dropped enough to reduce revenues from further increases, and that taxes on capital could be increased by 6 percent."

Got that? The 63 percent result refers to wage income. For capital income, we only have 6 percent to play with.

I looked up the calculation in the referenced 2009 paper at http://www.ecb.int/pub/pdf/scpwps/ecbwp1174.pdf

Figure 6 toward the back shows the Laffer curve for capital income. It shows a revenue peak at a tax rate of 37% (an after-tax ratio of 0.63). Considering that California taxes capital gains at 10% which is not deductible against the AMT, the combined federal and state capital gains tax rate for 2013 will be at 30% not counting the numerous rate bumps due to phase-outs. The revenue at a 30% tax rate is within 2% of its maximum attainable (Laffer peak) value.

If this analysis is correct further tax increases on capital gains will be fruitless, perhaps even counterproductive. Unlike Bartlett, we need to carefully parse tax proposals so that high-elasticity capital gains are not lumped in with low-elasticity wage income. Unless we are complete ideologues we don't want to support proposals that cause economic damage and reduce revenue at the same time.

Posted by: AMTbuff | Feb 22, 2012 1:45:46 PM