Saturday, January 26, 2008

The Laffer Curve in the 1980s

In 1980, the highest marginal tax rate was 70% and by 1988 the highest rate was cut to only 28%. The chart above shows what happened during that decade, exactly as predicted by the Laffer curve:

1. In constant dollars, the total tax revenue collected from the top 1% of taxpayers increased by 50%, from $58 billion in 1980 to to $87 billion in 1990.

2. On a per return basis, the average taxpayer in the top 1% paid 23% more taxes in 1990 compared to 1980 (inflation-adjusted real dollars).

Bottom Line: As the Laffer Curve predicts, significant cuts in the highest marginal tax rates during the 1980s caused both: a) total tax revenue collected (in real dollars) from the top 1% to increase, and b) the tax collected per return (in real dollars) for the top 1% to increase.


At 1/26/2008 1:51 PM, Anonymous Anonymous said...

With that 9 trillion dollar budget deficit I guess we had better raise taxes on the poor and middle class as they are obviously not paying their fair share.

At 1/26/2008 2:23 PM, Anonymous Anonymous said...

Normalized for incomes, for the period 1980-1990, the top 1% of taxpayers realized real income growth of ~100% but paid only a ~50% real increase in taxes. The bottom 90% saw real income gains of ~13% with no real increases in income taxes.

In other words, the effective tax rate declined on out-sized income growth for the 1% group relative to 90% group. And that's all the posted charts say when taxes are normalized to incomes.

At 1/26/2008 2:55 PM, Anonymous Anonymous said...

I'm with Marmico. These charts don't validate the Laffer curve at all because real income for the top earners doubled over the time period 1980 to 1990. If tax rates would have remained the same, the tax income from the top earners would have approximately doubled. Instead, you find that they only increased about 50%. Sorry Professor, you got this one wrong.

At 1/26/2008 4:26 PM, Blogger Mark J. Perry said...

To Marmico:

But why did real income go up so much? BECAUSE of the cuts in marginal tax rates, that's the whole point of the Laffer curve.
If the top marginal tax rate had stayed at 70%, the disincentives for work and incentives for tax avoidance would have both remained high, and taxable income would NOT have increased so much.

You seem to be indirectly agreeing that the Laffer curve works: By changing the incentives, the low marginal tax rates of 28% CONTRIBUTED TO the increase in reported, taxable income, that's the whole point of the Laffer curve. High marginal tax rates are a disincentive to earn and/or report income, and when you lower tax rates, you change incentives, especially for the "rich," and INCOME INCREASES. Without the tax cuts, we wouldn't have gotten the increase in income.

From Laffer's WSJ article:

"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.

Moreover, the culture surrounding low income earners is not nearly as focused on tax avoidance as it is in higher income earners; fewer lower-income earners, therefore, even avail themselves of the limited programs, laws and other opportunities to reduce their tax liabilities. This means that the supply of taxable income in the highest tax bracket should be far more responsive to incentives than it is in the lower tax brackets, all other things being equal.

Many tax-avoidance methods require expert advice and counsel from people such as tax accountants, lawyers, deferred compensation experts and, yes, even economists. Higher-income people find tax accountants and lawyers and other financial professionals far more cost-effective than do people with lower incomes, not only because the costs are spread over larger sums, but because the pursuit of tax avoidance is, dollar of income for dollar of income, more profitable at higher tax rates. This makes the taxable incomes of those who earn more, more variable, and the taxable incomes of those who earn less, less variable."

At 1/26/2008 4:55 PM, Anonymous Anonymous said...

No professor, you have to show that collections would have gone up if tax rates were cut and incomes stayed the same. The fact that incomes are rising totally negates your analysis. You must correct for income growth to make your point valid.

At 1/26/2008 8:10 PM, Blogger Thomas Coolberth said...

No, the whole point of the top tax cuts is to stimulate revenue by providing incentives to work, invest, to create jobs.

There's no point in keeping taxes on the rich high and then forcing them to do nothing with their own money and time.

At 1/27/2008 8:23 AM, Anonymous Anonymous said...

Let's bring some more long term data via Tables 5 & 6 of The Tax Foundation to further illustrate my point about the top 1%.


where AGI is percentage of total adjusted gross income and Tax is percentage share of total income taxes paid.

Now it is self-evident that there is a point on the Laffer Curve somewhere between 100% taxation and 0% taxation which may optimize income tax revenues and that the 70% top marginal rate was punitive.

But it seems clear to me that income has become more concentrated in the top 1% (162% increase since 1980) but the corresponding taxes paid have have only increased by 105%.

However, the point is not proven with Laffer's data. As to your point as to why there was out-sized income gains, I don't know the answer but would posit a combination of variables such as education, utilization of technology, federal reserve "puts", preferential tax treatment on some forms of compensation, no bracket creep for the lowest 50% of taxpayers, etc.

At 1/27/2008 8:56 AM, Anonymous Anonymous said...

Ooops....mea culpa...I didn't refresh the blog. I see that there is a lot of data in subsequent posts.


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