The View From 1776

What Happens When Liberals Raise Taxes

The creator of the Laffer Curve explains.

In an op-ed article in the January 25 edition of the Wall Street Journal, Arthur B. Laffer reviews the statistics on results of changes in income tax rates.  A few quotations:

But missing from the discussion are the huge differences in how the top 1% of income earners respond to changes in tax rates versus, say, the bottom 75% or 80% of taxpayers—the so-called middle class and lowest income groups. The “rich” quite simply are not like the rest of us…

Some 99% of all taxpayers paid taxes at the 10% rate in 2005, for example. Yet only 25% of all taxpayers had 10% as their marginal tax rate. Thus a cut in the 10% tax rate would have a supply-side impact on a relatively small portion of all those who pay the 10% rate—while for the rest who pay the 10% rate, a tax cut would result in a deadweight revenue loss.

On these grounds alone one should expect a greater supply-side response with a change in the highest tax rate than any other tax rate.

In addition, low-income earners have a lot less flexibility to change the form, timing and location of their income—and the avenues open to them to reduce their tax liabilities are far fewer. The avenues open to higher-income and highest-income earners include 401(k)s, IRAs, Keogh plans, itemized deductions, lifetime gifts, charitable gifts, all sorts of deferred income compensation plans, trusts, tax free bonds, etc…

Academicians and politicians have finally come to understand that it’s the after-tax rate of return that determines people’s behavior. Even though statutory tax rates are far lower today than they were when, say, Kennedy or Reagan took office, it is still very true that for every dollar of static revenue change there is a much larger incentive affect in the highest tax bracket than in the lowest tax bracket.
But what actually happens to tax receipts by income tax bracket when tax rates change?

Since 1980, statutory marginal tax rates have fallen dramatically. The highest marginal income tax rate in 1980 was 70%. Today it is 35%. In the year Ronald Reagan took office (1981) the top 1% of income earners paid 17.58% of all federal income taxes. Twenty-five years later, in 2005, the top 1% paid 39.38% of all income taxes.

There are other ways of looking at tax receipts by income bracket. From 1981 to 2005, the income taxes paid by the top 1% rose to 2.96% of GDP, from 1.59% of GDP. There was also a huge absolute increase in real tax dollars paid by this group. In 1981, the total taxes paid in 2005 dollars by the top 1% of income earners was $94.84 billion. In 2005 it was $368.13 billion….

Over the last 25 years, the bottom 75% of all taxpayers’ tax payments fell and their tax rates fell. This is the group the Democrats are targeting for tax cuts…

Using recent data, in other words, it would appear on its face that the Democratic proposal to raise taxes on the upper-income earners, and lower taxes on the middle- and lower- income earners, will result in huge revenue losses on both accounts. But some academic advisers to Democratic candidates have a hard time understanding the obvious, devising outlandish theories as to why things are different now. Well they aren’t!

In the 1920s, the highest federal marginal income tax rate fell to 24% from 78%. Those people who earned over $100,000 had their share of total taxes paid rise—from 29.9% in 1920 to 48.8% in 1925, and then to 62.2% in 1929. There was no inflation over this period.

With the Kennedy tax cuts of the 1960s, when the highest tax rate fell from to 70% from 91%, the story was the same. When you cut the highest tax rates on the highest-income earners, government gets more money from them, and when you cut tax rates on the middle and lower income earners, the government gets less money from them…

Mark my words: If the Democrats succeed in implementing their plan to tax the rich and cut taxes on the middle and lower income earners, this country will experience a fiscal crisis of serious proportions that will last for years and years until a new Harding, Kennedy or Reagan comes along.