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Where Is the Peak of the Laffer Curve?

43098708.xls

If the peak of the long-run Laffer curve happened to be at a top rate of 40%--and thus an average tax rate of 25%--the graph to the right, plotting average tax rates against revenues for the OECD countries, would show a peak at an x-axis value of 25%. It doesn't. If you squint you can convince yourself that there is some curvature to the graph, but the squinting has to be really, really hard. If revenues actually dropped off when top rates went above 40%--or 15%, or 19%, or 33%, or even 50%--we really ought to be able to see it looking across OECD countries. We can't.

For additional background, first read McMegan: I take it all back and Mark Thoma: Yet Again, Tax Cuts Do Not Pay for Themselves--the second about a Wall Street Journal editorial of which Dylan Matthews's boss Ezra Klein wrote:

The American Prospect: Brad DeLong described this as "Most Dishonest Wall Street Journal Editorial Ever." I thought that was obvious hyperbole, if for no other reason than the data set encompassing dishonest Wall Street Journal editorials is far, far too large for Brad to have comparatively evaluated in a mere day or two. It'd be like declaring a yawn from moments ago your favorite breath of air ever. It might have felt that way, but that's a hasty choice from a large pool. Brad, however, may be right.... The manipulation of the graph was embarrassing, but the argument it served made the whole thing malicious...

With that as prologue, Dylan Matthews:

Where does the Laffer curve bend?: With the Bush tax cuts due to expire soon and debates about raising top rates further to cut the budget deficit soon to follow, the Laffer curve is bound to come up again.... I decided to ask some tax experts and political activists where, in the current personal income tax, and particularly in the top tax bracket, they think that Laffer curve peaks -- that is, what that revenue-maximizing rate is. The responses were varied, to say the least. Let's start with the experts....

Emmanuel Saez, E. Morris Cox professor of economics, University of California at Berkeley: "The tax rate t maximizing revenue is: t=1/(1+a*e) where a is the Pareto parameter of the income distribution (= 1.5 in the U.S. and easy to measure), and e the elasticity of reported income with respect to 1-t which captures supply side effects. The most reasonable estimates for e vary from 0.12 to 0.40 (see conclusion page 47) so e=.25 seems like a reasonable estimate. Then t=1/(1+1.5*0.25)=73% which means a top federal income tax rate of 69% (when taking into account the extra tax rates created by Medicare payroll taxes, state income tax rates, and sales taxes) much higher than the current 35% or 39.6% currently discussed."

Joel Slemrod, Paul W. McCracken Collegiate Professor of Business Economics and Public Policy, University of Michigan: "I would venture that the answer is 60% or higher.... The idea that we're on the wrong side has almost no support among academics who have looked at this..."

Brad DeLong, professor of economics, University of California at Berkeley: "At 70%."

Dean Baker, co-director, Center for Economic and Policy Research: "It would be somewhere around 70 percent and possibly a bit higher. It is important to realize that you can have many different rates so we can have only a very small fraction of people actually paying the top rate and even then only on a small portion of their income."

Larry Kudlow, host, CNBC's The Kudlow Report: "Personal income tax of 15-20%, business, sales tax rate of 8-10%..."

Pat Buchanan, syndicated columnist, former presidential candidate: Would prefer not to be quoted exactly, but says the revenue-maximizing combined state and federal rate is about 33 percent.

Donald Luskin, columnist, SmartMoney.com, National Review: "19%... I am saying that the way to maximize the take from personal wage income tax is with a 19% rate on that tax."

Stephen Moore, senior economic writer and editorial board member, Wall Street Journal: "The revenue maximizing rate is probably around 40 or 50 percent...."

Amity Shlaes, senior fellow, Council on Foreign Relations; author, The Forgotten Man: Declined to answer.

Bruce Bartlett, columnist, Forbes.com; former adviser to Reagan and Bush I: "I would hate to venture a specific number.... I think 50 percent is an important threshold and I would be very reluctant to go higher even if it raised net revenue.... Anthony Atkinson, probably the leading public finance economist in England, estimates (PDF) that the top rate could go as high as 63% to 83% before it became counterproductive in terms of revenue.... The European Central Bank...finds that only two European countries are on the wrong side of the Laffer Curve. All other countries could raise substantial additional revenue by raising tax rates. Since our rates are much lower than those it Europe, it suggests that we have a very long way to go before the top rate became counterproductive."

Andrew Samwick, professor of economics, Dartmouth College: "I would not hazard a guess. Even a guess requires a careful study of the data on high income taxpayers, which I have not done."

Greg Mankiw, Robert M. Beren professor of economics, Harvard University; former chairman, Council of Economic Advisors: "My guess is that that the short-run answer and the long-run answer are quite different.... I will pass on offering a specific number, as it would require more time and thought than I can offer just now, but I will opine that I think the long-run answer is actually more important for policy purposes than the short-run answer."

Edward Lazear, Jack Steele Parker Professor of Human Resources Management and Economics, Stanford University; former chariman, Council of Economic Advisors: "Sorry, no."

Martin Feldstein, George F. Baker Professor of Economics, Harvard University, former chairman, Council of Economic Advisors: "Why look for the rate that maximizes revenue? As the tax rate rises, the "deadweight loss" (real loss to the economy rises) so as the rate gets close to maximizing revenue the loss to the economy exceeds the gain in revenue.... I dislike budget deficits as much as anyone else. But would I really want to give up say $1 billion of GDP in order to reduce the deficit by $100 million? No. National income is a goal in itself. That is what drives consumption and our standard of living..."

Marty and Bruce are, of course, correct: you don't want to be at the peak of the curve: you want to be way down on the left side. Note that if you take Emmanuel's high estimate of the elasticity of reported taxable income to the tax rate you get a peak at a taz rate of 62.5%; for Emmanuel's low estimate the peak comes at a tax rate of 85%

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