Sunday, March 22, 2009

Dr. Laffer on Tax Rates

It should not be a hard concept: if you increase tax rates to punitive levels, the ones who pay the most tax would find ways not to pay, be it legal backdoors or outright relocation. Quote: "Laffer readily admits that middle and lower-income folks lack the flexibility of the rich when it comes to changing behavior in response to changes in tax rates. Where the rich can shelter, defer and give away income, taxpayers at the bottom rung are like lambs going to the slaughter. Raise tax rates, and they fork it over to the government. Lower tax rates, and the government gets less revenue."

Quite so. I would contend, however, that the middle and lower income folks have a different weapon at their disposal - numbers. If they were to simply start massively underreporting income, they would be in theory criminals, but the government would not have the means to enforce, and most singular audits, let alone lawsuits, would not be cost efficient for the government. The bureaucrats may know Joe Average is screwing with them, and this may get any single Joe in trouble, but not any reasonable number. As it is, the IRS audits approximately 1% of individual returns, with a heavy focus on those with "red flags" - tax shelter investment losses, complex investments, large business expenses relative to income, tax transactions without explanation, etc. Thus, Joe Average is (mostly) safe, and the government is reduced to raising the rates on the "low-hanging fruit" - the wealthy and the corporations. This is precisely the counterproductive thing to do. Quote #2 from the above article: "If the government is truly interested in maximizing its revenue, not in redistributing income, it should cut taxes on the rich. Blasphemy, I know."

As Churchill put it, "If you destroy a free market, you create a black market. If you have ten thousand regulations, you destroy all respect for the law." Transocean, Weatherford, and Tyco are just the pioneers moving to corners of the world where capital is treated with respect, not villified and extorted.

1 comment:

Rob Davies said...

I think that your observation about Joe Average under reporting income is very insightful. In the neighborhood I grew up in, in Philadelphia, working "under the table" was far from unusual. A huge majority of the people, probably above 75%, earned money tax-free at some point. I knew of many, many people who spent most of their lives off the books. It was the way things were done. When Reagan cut taxes most people continued working under the table when they could. Thus, high tax rates result not only in lower tax revenues, but in a general disrespect for the law.