As Nobel Laureate Robert Mundell explained in his 2000 article, “A Reconsideration of the Twentieth Century” published by the prestigious academic journal, American Economic Review:
“Monetary deflation was transformed into depression by fiscal shocks. The Smoot-Hawley tariff, which led to retaliation abroad, was the first: between 1929 and 1933, imports fell by 30 percent and, significantly, exports fell even more, by almost 40 percent. On June 6, 1932, the Democratic Congress passed, and President Herbert Hoover signed, in a fit of balanced-budget mania, one of its most ill-advised acts, the Revenue Act of 1932, a bill which provided the largest percentage tax increase ever enacted in American peacetime history. Unemployment rose to a high of 25.9 percent of the labor force in 1933, and GDP fell by 57 percent at current prices and 22 percent in real terms.”
The Macroeconomic Effects of Tax Changes: Estimates based on a New Measure of Fiscal Shocks [19] by Christina Romer and David Romer theorizes the effects of taxes on GDP. The paper found for every 1% increase in taxes above the peak, as a percent of GDP, will cause a 3% decrease in GDP. As an example: If a country with a GDP of $100 billion has a tax rate of 33%, the country will receive $33 billion in taxes. Once this country raises the tax rate to 34% of GDP, it is theorized to decrease the national GDP to $97 billion. This will lower tax revenue to $32.98 billion. [20]
ReplyDeleteIf this paper is proven to be accurate, this means a tax rate for a country above 33% will decrease a countries Gross Domestic Product and decrease taxes collected. This paper was not theorizing on tax rates for an individual. This is an aggregate number for all income in a country.
One of the uses of the Laffer curve is in determining the rate of taxation which will raise the maximum revenue (in other words, "optimizing" revenue collection). However, the revenue maximizing rate should not be confused with the optimal tax rate, which economists use to describe a tax which raises a given amount of revenue with the least distortions to the economy.[18]
ReplyDeleteTax rate at which revenue is maximized[edit]A possible non-symmetric Laffer Curve with a maximum revenue point at around a 70% tax rate, based on "How Far Are We From The Slippery Slope? The Laffer Curve Revisited" by Mathias Trabandt and Harald Uhlig.[11]
ReplyDeleteThe New Palgrave Dictionary of Economics reports that a comparison of academic studies yields a range of revenue maximizing rates that centers around 70%.[2] Economist Paul Pecorino presented a model in 1995 that predicted the peak of the Laffer curve occurred at tax rates around 65%.[12] A 1996 study by Y. Hsing of the United States economy between 1959 and 1991 placed the revenue-maximizing average federal tax rate between 32.67% and 35.21%.[13] A 1981 paper published in the Journal of Political Economy presented a model integrating empirical data that indicated that the point of maximum tax revenue in Sweden in the 1970s would have been 70%.[14] A paper by Trabandt and Uhlig of the NBER from 2009 presented a model that predicted that the US and most European economies were on the left of the Laffer curve (in other words, that raising taxes would raise further revenue).[11]
The Laffer curve and supply-side economics inspired Reaganomics and the Kemp-Roth Tax Cut of 1981. Supply-side advocates of tax cuts claimed that lower tax rates would generate more tax revenue because the United States government's marginal income tax rates prior to the legislation were on the right-hand side of the curve. As a successful actor, Reagan himself had been subject to marginal tax rates as high as 90% duringWorld War II. During the Reagan presidency, the top marginal rate of tax in the United States fell from 70% to 31%. According to OMB historical data, federal government revenue as a percentage of GDP fell from 19.0% of GDP in 1980 to 18.4% by 1989. However, absolute revenues nearly doubled during the same time period.[28]
ReplyDeleteSome have criticized elements of Reaganomics on the basis of equity. For example, economist John Kenneth Galbraith believed that the Reagan administration actively used the Laffer curve "to lower taxes on the affluent".[30] Some critics point out that tax revenues almost always rise every year, and during Reagan's two terms increases in tax revenue were more shallow than increases during presidencies where top marginal tax rates were higher.[31] Critics also point out that since the Reagan tax cuts, income has not significantly increased for the rest of the population. This assertion is supported by studies that show the income of the top 1% nearly doubling during the Reagan years, while income for other income levels increased only marginally; income actually decreased for the bottom quintile.[32]
DeleteIf the tax-payers complain to you of the heavy incidence to taxation, of any accidental calamity, of the vagaries of themonsoons, of the recession of the means of irrigation, of floods, or destruction of their crops on account of excessiverainfall and if their complaints are true, then reduce their taxes. This reduction should be such that it provides them opportunities to improve their conditions and eases them of their troubles. Decrease in state income due to such reasons should not depress you because the best investment for a ruler is to help his subjects at the time of their difficulties. They are the real wealth of a country and any investment on them even in the form of reduction of taxes, will be returned to the State in the shape of the prosperity of its cities and improvement of the country at large. At the same time you will be in a position to command and secure their love, respect and praises along with the revenues.
ReplyDelete—Ali ibn Abi Talib, Nahj al-Balagha[27]