There has been some recent discussion of the Laffer curve on the blog as a result of reaction to a blog by Jolyon Maugham. As is, I think, quite well known, I am dubious about the existence of a Laffer effect at any of the current headline rates of tax in the UK, and the vast majority of those proposed. I think it may just appear if the Greens have a top rate of income tax of 60% with uncapped national insurance contributions.
In response to these comments Howard Reed, an occasional co-author of mine and a man whose work I much admire, posted some comments I thought worth sharing more widely. He said:
Most of the Laffer effect (I feel bad calling it the “Laffer effect” as Laffer is a total far-right crank and charlatan… for example, do a search on “Krugman New York Times Laffer” on Google and you'll find several examples of why Laffer is a nutjob…) is NOT due to reduced hours or effort by high earners because the tax rate is so high. It's due to increased avoidance activity and (e.g.) shifting remuneration from income to capital gains. A General Anti Avoidance Rule (as proposed by Richard) would put paid to most of the Laffer effect. Personally I think we would be fine up to at least 65-70% top rate but I appreciate this is a matter about which there can be intelligent disagreement. Some commentators (e.g. Saez/Piketty) have suggested that 80% is the revenue maximising top rate.
More fundamentally, it's not clear to me that Laffer is right even on its own terms. Would the revenue yield from a 100% tax rate be zero? If we had (e.g.) a very high Citizens Income, so that no-one *needed* to work, I'm sure some people would go on working because they enjoyed their work even if tax rates were 100%. This might well be a minority of people and so I wouldn't suggest 100% tax rates as a serious proposal, but Laffer's argument (that the yield of a 100% marginal rate is zero) seems to me to be flawed if work conveys any positive utility, at least for some of the population. And there are certainly people around who like their jobs — for example there is evidence of people who win the Lottery and carry on in their job.
I well recall several of my staff in some of the companies I have run in my time for whom pay (and by implication, therefore, tax) was not the key or even, in all likelihood, a significant motivation for their coming to work. Various other factors were at least as big a motivational effect. In other words, I think Howard may be right with his second suggestion.
That tax avoidance is the main reason for the Laffer effect is beyond dispute. And as Howard notes, we could beat that if we wanted to.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
“More fundamentally, it’s not clear to me that Laffer is right even on its own terms.”
I think it probably is correct, not that it should matter.
There may be people willing to work despite a 100% rate, though they would probably just do what they were doing without the paperwork. For a start, each of these “free” workers would also need HR and admin staff willing to manage the payment process, others to collect the tax and so on.
There would therefore be almost zero tax with which to pay the Citizen’s Income.
However, and this is what the neo-libs struggle with, the government can print the required money anyway.
We would be free from oppressive bosses, and free to create, to enjoy the sunshine and to LIVE.
I can think of one person who would continue to produce though ….
Richard, I think this may be another example of motivation to work being more than just money (and thus tax). In academia a fair number of people continue researching and publishing after retirement (whether taken early or at the state pension age). Of course, some continue to be paid through one mechanism or another, but I’ve met a fair few over the years who do it simply because they enjoy what they do. Unfortunately the direction in which UK higher education has been heading for the past few years appears to mean that the number of people wanting to do that (ie. enjoying what they do) across most universities is declining fairly rapidly.
Agreed
I will do this forever
Also agree far fewer people are enjoying what they do
Jolyon seems to be implying that the very nature of our inequality brings the Laffer Curve into effect:
“here is a rate of tax that is too high. Although we sustained marginal rates of income tax as high as 99.5% in the post-war years through to the late 1970s the world, our place in it, and the tax rates of our competitors, were all very different then. Today we are — like it or (more likely) not — highly dependent on the highest earning 1% who pay around 27% of all our income tax receipts. ”
Is it then fair to say: the greater the levels of inequality, the greater the Laffer effect?
No
The greater the avoidance
Which appears like a Laffer effect
As Howard said
This particular blog is such a joy to behold and reminds me of why I bother to try to be part of the whole blog in the first place.
Great stuff – thanks.
You speak of enjoyment of work. But the same can be said of enjoyment of where to live. There are many who would like to leave because they don’t enjoy living here. So their money would move abroad.
They are free to go
For any given Laffer curve there can only be one point which is a real value, the one that shows the actual tax rate in effect for a given time and set of circumstances and the actual tax yield? All the other points on the curve represent a guess at what the yield would be if the tax rate was different to what it actually is.
So the neat parabola presented is a work of fiction. I suspect the yield plunging off a cliff somewhere close to 100% would be more realistic.
In WW2 were there not some 100% rates that did raise money, and which did not have any effect on the work people put in for the war effort?
Agreed
Lions
The top rate was 98% in WWII (applied only to incomes in excess of £20k – the equivalent of c£700k. There are no figures as to how much this surcharge rate brought in.
EVERYONE earning less than £700k paid tax at the same rate of 50%.
Allowances were restricted and some of the extra tax raised was repaid to taxpayers as a credit following WWII, taking until 1973 to be fully repaid. The tax was in effect a loan.
I’m not sure if taxation under the threat of Nazi invasion produces any worthwhile lessons for the current UK situation.
(And, please don’t anyone compare anything that is happening under the coalition to Nazi Germany. It’s an insult to the victims.)
Thanks Tim for confirming the WW2 situation.
From the HMRC site: “In 1939, the standard rate of income tax was 29% with surtax at 41% for incomes over £50,000. Ten million people were liable for tax, and the total sum raised was £400 million.
Successive increases in rates and lowering of allowances led to 1944-45 figures of 50%, surtax at 48% for incomes over £20,000, fourteen million taxpayers and nearly £1,400 million raised.
An Excess Profits Tax introduced for business raised further revenue (£508 million in 1944-45). It compared war-time profits with pre-war or ‘standard’ profits, taxing the difference initially at 60% and then at 100%.”
If the latter had any yield at all at 100% then the appropriate Laffer curve would show that yield at 100% tax rather than the £0 we normally assume.
Of course nobody is calling for a 100% top rate, and WW2 was an exceptional time. No doubt the prospect of the Gestapo across the Channel made the normally selfish rich a good deal more public spirited than usual.
There is one point of reality on the Laffer curve showing the actual yield from an actual tax rate. I’d normally accept that a 0% rate and a 100% rate yield nothing, but there is even reason to doubt the latter.
Fascinating and a whole new dimension to this
Oh, and an ‘excess profits’ tax in WWII sought to impose surcharges on companies ‘doing well’ out of the war and leading to some bizarre tax cases where companies were arguing that their pre-war profits were HIGHER (so that their war profits weren’t ‘excessive’) while the Inland Revenue tried to argue the pre-war profits were LOWER.
Apologies for my absence – a minor ailment didn’t respond to biodynamic therapy but the NHS sorted it (though I still don’t really approve of scalpels). Sore but back!
I just wanted to endorse what Deirdre said – though she has said it much better than I can. A great but now unfashionable philosopher said it even better. “From each according to their abilities, to each according to their needs”. Neoliberals should be made to learn that by heart. It might improve their weltamschaung (karma).
Recover well