Higher taxes less revenue

A reader sent me the link to this YouTube clip which supports my contention that a higher tax rate doesn’t mean a higher tax take.

The speaker is UCLA Economics professor, Tim Groseclose who uses the Laffer Curve to explain why:

He gives examples from the USA but we’ve had similar results here where increasing the tax rate decreased the tax take and lowering taxes raised more revenue.

He also quotes Christina and David Romer who wrote a paper on , “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks.

Access to that requires a subscription to access but Professor Groseclose wrote about it in  the Laffer Curve and new evidence that taxes stifle economic output:

The Romers examined the effects of tax policy on GDP.  They found that the effects are very large.  Specifically, they found that for every 1% that taxes rise (as a percent of GDP), this causes GDP to fall about 3%.  The authors employed some clever methods to try to find what economists call “exogenous” changes in tax rates.  When they employed their methods, they found much higher effects than economists had previously found.

The article was something of a Nixon-goes-to-China phenomenon.  That is, while conservatives tend to claim that taxes strongly decrease GDP, liberals tend to claim that taxes have at best a weak influence on GDP.  When the Romer-Romer article reported a strong influence, one of the most interesting aspects of the finding was that it came from a very liberal quarter – namely, one of its authors was a senior member of the Obama administration. . .

. . .  the Laffer Curve specifies that there exists a “hump” tax rate – a rate that maximizes revenue to the government, and if the government raises taxes above the hump rate, then its revenue actually decreases.

Academic economists generally agree that the hump rate is very high, something like 70%.  However, although Romer-Romer article did not explicitly discuss the Laffer Curve, its results imply that the hump rate is much lower, something like 33%.

To see this consider the following example.  Suppose a country’s GDP is $100 billion, and suppose its tax rate is 33%.  Then its tax revenue will be 33% of $100 billion, or $33 billion.  Now suppose it raises taxes to 34%.  If the Romer-Romer result is accurate, then this will decrease GDP by 3% to $97 billion.  Tax revenue will be 34% of $97 billion, or $32.98 billion.  Note that this is slightly less than the revenue at the 33% rate.  If you experiment with other tax rates, you’ll see that revenue is maximized when the tax rate is 33 1/3 %.   Moreover, as the tax rate increases to rates higher and higher than 33 1/3 %, government revenue becomes smaller and smaller. . .

Remember this next time someone suggests raising taxes over 33 1/3%.

6 Responses to Higher taxes less revenue

  1. Hollande in France has found that when you raise theft from one which statists think they can justify, to one even statists can’t justify, such as 75%, then you find you have a mass exodus from your economy of those very people who were formerly being extorted to prop up the whole edifice of state. As the below article reports, France is now facing a massive, and prudent, exodus of the rich … politicians have to learn, there never was a free lunch, if they want to avoid eventual revolution, then they need to slash the size of state:

    http://www.thetimes.co.uk/tto/news/world/europe/article3569234.ece#.UH31taxqTO0.twitter

    Furthermore, as Stephen Franks last post showed, Europe is possibly in for some real ugly trouble:

    http://www.stephenfranks.co.nz/?p=4716

    Detouring now, but this is interesting. Europe is currently in every bit as large a social and economic chaos as it was in early and mid 1930’s: if someone had told a Frenchman in 1935 that in just four years time there was going to be a massive conflagration in Europe on the back of this, he would have said they were mad. Well while many of the modern day causes are different, the stresses are the same, and the multicultural issues are essentially irresolvable, so, it’s interesting to look ahead, and a bit scary, given fascism is already marching the streets for the first time since the Nazis in Greece, again, and it’s looking like upwards of half the Greek police force voted for their fascist party, Golden Dawn.

    It appears humans don’t learn very quickly, and the twentieth century risks replaying the nightmares of the twentieth, all in a cruel, but predicable irony, flowing from the policies of Keynesian socialism that tried to create the ‘caring’ society, by destroying the liberty the Allies fought so hard for. And our governments (plural) here have been little different. As I’ve already said on here once, plus on my blog, 2014 in NZ will be a watershed election. …

  2. Brian says:

    I think that to most on the left tax rates have nothing to do with revenue gathering but everything to do with “fairness” and punishing successful people.

  3. If tax cuts pay for themselves why did the nats have to raise GST and cut spending to pay for theirs?

  4. homepaddock says:

    Could it be because lots of people pay less than 33.3% and too many pay no net tax?

  5. I don’t see how? If we were to the left of the peak, and cutting taxes would increase revenue then they wouldn’t have had to pay for the tax cuts, surely?

  6. *right* of the peak, obviously

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