Ezra on taxes

Ezra claims that we shouldn't try to compete with Ireland and Greece on taxation because . . . "But that's nothing compared the odd idea that we have to kick the legs out of our revenue collection in order to fend off challenges from...Greece and Ireland. Operating costs are cheaper in smaller, less advanced countries, and much cheaper in smaller, much less advanced countries."  Ireland is the richest country in Europe, except for Luxembourg, which is basically one big tax-advantaged bank.  Its per-capita GDP is nearly as high as America's.  In 1980, the year before Ireland cut its corporate income tax, the country's GDP was half the size of America's.  I agree--why would we want to emulate soaring growth?

He also argues for narrowing the tax base and raising the rates, though that's probably not how he thinks of it:

I've argued often on this blog that given how much income is concentrated in the hands of the rich, you can cut taxes for the majority of the country, raise taxes on a small slice of wealthy Americans, and raise revenue, even as the average American's tax bill goes down. As Leonhardt argues, the relentless march of wealth accumulation -- the rich getting much richer, year by year -- made this truer in 2008 then it was in 2007, truer in 2007 then in 2006, and a helluva lot truer in 2006 then it was in 1993.

High taxes on a narrow base are about the opposite of optimal tax theory.  This is not because economists are mean, cruel people who are primarily interested in serving their corporate overlords, but rather because the narrower the base, and the higher the rates, the more sharply the marginal returns to rate increases diminish.

Take an extreme example.  The top 1% of households, about 1 million in all, have about 20% of national income.  They've also experienced most of the income gains in the last twenty years.  So let's say we want to fund federal operations entirely out of their pockets.  Well, to do so, we'd need an income tax rate of 100%.  Even ardent liberals will surely concede that at these levels, the supply-siders are right, and we'll soon end up with no tax base.

Even a less extreme example--make them pay half the tax burden--ends up with a 50% effective rate on high earners.  And to get a 50% effective rate, you need an even higher marginal rate.  The problem for people who want to load tax increases on these people while cutting taxes for everyone else is that if you actually succeed in shifting the tax burden this way, you'll rapidly end up on the wrong side of the Laffer Curve. 

But Megan, I hear you cry, don't you spend all this time saying that the supply siders are wrong about the Laffer Curve?  Well yes.  But they're not wrong that the Laffer Curve exists; it's practically a tautology.  You collect no revenue if tax rates are 0%, and no revenue if they're 100%, because people won't work.  The curve must maximize somwhere in between.  Where supply-siders go wrong is in claiming that we're to the right of that maxima, where cutting tax rates actually raises revenue.  Empirical evidence indicates that we're still on the left.  But that doesn't mean we can't end up on the right, if we screw up our tax policy.

Barack Obama's tax plans probably won't put us there, even with the partial lifting of the payroll tax cap.  But Barack Obama's plans do nothing to close the really fairly gargantuan deficit we're staring down--he wants to use the money to fund new spending.  (And also, to fund his tax cuts for other people, which is sort of a problem; like most politicians running for office, he seems to be planning to spend the same tax increase several times over.)  We've got an enormous budget gap coming down the pike in the really not-very-distant future.  And the next round of tax hikes, if confined to the rich, will almost certainly put us on the wrong side of the Laffer Curve--you're talking tax rates on them of 60% or more.  Rich people have the most discretion over their incomes, the most room to cut back and consume more leisure instead of work.  Not everyone will--I doubt the president of GM will decide to take up golf instead.  But on the margin, some will, or they'll shift their income to more tax advantaged forms, or places.  If we try to concentrate all our taxation on the rich, we will quickly reach the limits of our ability to tax.

There are also prudential reasons to be against this sort of system; people who vote for programs should not treat those programs as if they are free.  Society has limited resources, and it should not allocate them without regard to the cost of using up scarce human, physical, or financial capital.  I think that the tax system should be progressive--Warren Buffet sacrifices a lot less when he gives up 10% of his income than does his secretary when she gives up 10% of hers.  But no one should be voting as if new spending were costless.  Loading all the tax burden onto the rich practically guarantees that they will do just that.