A new academic journal paper has something pretty interesting to add to the debate on the impact of higher than currently normal top rates of income tax. In their paper entitled 'Top marginal taxation and economic growth' Santo Milasi and Robert J. Waldmann argue that there is a positive correlation between high rates of economic growth and high marginal top rates of tax. In their opinion:
The [estimates] suggest that the marginal effect of higher top tax rates becomes negative above a growth-maximizing tax rate in the order of 60%.
In other words, until that point is reached growth is stimulated and after it there is evidence that it falls. They add:
As top marginal tax rates observed after 1980 are below the estimated growth-maximizing level in most of the countries considered, a positive linear relationship between top marginal tax rates and GDP growth is found over the sub-period 1980—2009.
Or, to put it another way, cuts in top rates of tax had a negative impact on economies over this period. Their explanation is that:
Overall, results show that raising top marginal tax rates which are below their growth maximizing has the largest positive impact on growth when the related additional revenues are used to finance productive public expenditure, reduce budget deficits or reduce some other form of distortionary taxation.
So, top rates should fund infrastructure and reduce inequality. They might also reduce deficits. I would add, that would not be my choice.
The finding is, of course, entirely logical. We have known for a long time that the so-called Laffer effect, where higher rates of tax supposedly reduce effort, does not kick in until rates are sixty per cent or more. And we know, as a rule, that higher rates of tax encourage effort over observable ranges as people work harder to achieve net incomes given that the whole of our economy is geared to consumption, rightly or wrongly. Add the two effects together and the effect that this paper observes is the logical consequence.
Bring it on, I say.
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:
Seems like a good case for reducing the marginal tax rate for the lower orders. That Universal Credit taper rate of 63% for example is a disincentive to work. As the top marginal tax rate for a PAYE employee is currently ‘53.4% + council tax’, then it seems absurd that those on welfare are facing a steeper withdrawal rate than that.
I agree with that
Richard, (sharp intake of breath), are you now saying the Laffer Curve exists when so many like you have said it’s bunkum? And the rate is 60%? I’m guessing that’s the US where the state makes sure you are part of it even if you try to leave.
If “Increasing top income tax rates would increase economic growth” then it should be 100%, or more, and cash can be given back where deserved.
I have always said that the Laffer effect could be observed at very high rates
It is not observed at any rates currently in use
So I have always said referencing an idea that has no consequence in observed ranges makes no sense
Please do not quote out of context or extrapolate to aburdity: it helps no one
But isnt the marginal rate of tax already 60% once you take account of NI?
Only at low levels
It’s 47% over £150,000
The Milasi and Waldmann paper is behind a paywall. Does it echo the work of Piketty, Saez and Stantcheva in the American Economic Journal: Economic Policy in 2014: ‘Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities’ or does it use a different method?
It’s effectively an analysis of panel data
You seem to be slightly grumpy with me, not sure why as I’m agreeing with you. (My friend who pointed me here said you could be a bit prickly). Searching your blog I see 76% is a good figure for the peak of the curve, so we should screw everyone’s taxes up to that to get maximum revenue.
I suspect it is a bit lower
60% feels comfortable
I respect all of these opinions of course but everything I have learned suggests that Laffer still walks among the zombies of “Voodoo Economics”.
It does
Because it has no relationship with the observable world even if it exists in one we will never be concerned with
Firstly, I thought you had said on many occasions that the Laffer effect didn’t exist. Now you are saying it does? It either does or doesn’t, you can only argue about the peak of the curve.
What rule are you reffering to when you say that higher rates of tax make people work harder? I’m pretty sure no rule like that exists. If you could give me the name of this rule I would greatly appreciate it.
I have always said what I have reiterated here: Laffer effects do not exist within the range of plausible tax rates
And of course people with income needs work harder with higher tax rates: they have to do generate what they need. Isn’t that glaringly obvious?
You can’t say that the Laffer curve doesn’t exist for certain tax rates and does for others – it either exists or it doesn’t. You can argue as to the peak of the curve – you are saying it is around 60% here, but that is all. As I said, I remember you repeatedly saying it doesn’t exist. Now it seems that you have found some research that argues for higher tax rates saying the Laffer peak is higher that current taxation and suddenly you are all for it.
“And of course people with income needs work harder with higher tax rates: they have to do generate what they need. Isn’t that glaringly obvious?”
No, it isn’t. For some people maybe, but it is certainly not a general rule. If you increase marginal tax rates there is a lot of research showing quite the opposite – that people limit their working hours – because they simply aren’t getting the reward for the time spent. Are you simply saying that the vast quantity of research showing this is all wrong?
My language has always been quite plain but you seek to misrepresent it
I cannot waste my time with that
And as for your claim on reducing working hours – you ignore the realities of the world in which most work and meet their commitments
Richard, I obviously agree with most of what you are saying here, but is it really glaringly obvious? I mean, when cigarettes taxes are increased, I don’t think smokers mostly react by increasing their smoking. They react by cutting back on the fags, and getting their pleasures elsewhere. In fact, that is the very point of the tax increase. It is what is wanted by the taxing authorities.
Tax cigarettes more = at least some smokers substitute something else for smoking, and none increase their smoking in response to the tax. Tax employment more = at least some employees substitute something else for working, and none increase their working in response to the tax.
Why do the two taxes have mirror image effects?
The number of cigarettes smoked a week is not regulated by things like employers demanding presence under contracts not renegotiated because of tax changes
Your examples simply do not compare
Why is it that it is so hard to see this? or are fatuous comparisons the preserve of those who do not like tax?
Is 60% an average figure or a maximum top rate? You’re the tax guru, but for incognoscenti like myself I figure that calculating income tax levels – and the subsequent effect on a national (sovereign) economy – is no easy, straight-forward task. However, perhaps 60% IS too low. According to Saez and Picketty ‘the top tax rate could be over 80%’ – http://voxeu.org/article/taxing-1-why-top-tax-rate-could-be-over-80.
The evidence for the negative effect of lowering income tax is more conclusive, as we have almost 40 years of empirical evidence for Reaganomics (totally disregarded by Trump of course). A specific recent example was in the State of Kansas where Laffer was totally discredited : https://www.salon.com/2015/06/11/sam_brownback_guts_kansas_even_more_this_is_life_under_americas_worst_republican_governor/.
That said, it would take a very courageous Labour Chancellor to raise income tax significantly, wouldn’t it? The predictable reaction from the Mail, Times & Telegraph aside, according to Positive Money’s recent poll 85% of MPs still don’t know how money is created. Presumably some of the more knowledgeable 15% are Tories, who still push the ‘Magic Money Tree’ scarcity fable onto their constituents. Hypocrisy ot ignorance?
It’s marginal rate
And I note Saez et al and am not convinced, entirely
I’m with you generally on this John D but I think that fear of the Daily Mail et al. died at the last General Election (if not long beforehand).
I believe the highest tax rates post war reached over 80%. Yet the period from ’45 to ’75 has been called the “economic golden age”, suggesting that extremely high tax rates had little effect on economic growth.
Any increase in tax rates towards these kind of levels would need to include other measures to prevent income being disguised in forms that either avoided tax at all or placed it in lower tax brackets. In fact, why should other forms of “income” attract no or little tax which are available mostly to the wealthy?
In theory the rate got to sums ion excess of 100% and 98% inspired George Harrison
This was 83% earned income rate + 15% unearned top up rate
I do not believe that such rates help
I think a balance can be found between them and the absurdly low top rate we have now