Friday, July 18, 2008

Marginal Tax Rates

Following up on "Alex's" comment on the results of my cleaning study, let's turn now to the real Laffer Curve, which holds that there is a theoretical optimum marginal tax rate (if by optimum you mean revenue-maximizing). Too low, and you give up tax revenue that people would otherwise be willing (if not necessarily happy) to pay; too high, and people theoretically would slow down or stop working or investing, so there is less money made and taxed.

Certainly at 100% tax rate there would be no point in working, unless sustenance was provided by the state. For all but the most patriotic people, however, this amounts to slave labor, and such a regime would tend to be violently coercive.

Rather than get into trying to figure out what the optimum marginal tax rate is, I want to focus on an oft-repeated line from billionaire investor Warren Buffett. Here he is in a recent interview with Tom Brokaw:
Tom, I've been around rich people all my life. And I have seen capital gains taxes close to 40 percent. No one went home at 3 in the afternoon and said, "I've worked enough, and because tax rates are so high, I think I'll-- I'll go to the movies." ... I've been managing capital for 50 years for other people. No one left and said, you know, "This-- the taxation system's too tough. I-- I think I'll just stick it all under my mattress." They can't stick under their mattress. They're going to invest their money regardless.
This sounds good, but I wonder if it is really true. First, Buffett is conflating working and investment a little bit here. Certainly there are investments, especially hot-money financial investments (as opposed to cold-money capital investments like building a factory), that are especially sensitive to the tax rate. While Buffett is right that a financier won't stick her money in a mattress, a given tax rate might induce her to keep it in cash equivalents instead of taking a flyer on a new venture. None of this has anything to do with "working."

As for "working," I wonder: Has there really never been someone who took a look at the tax rate and decided it wasn't worth it to work an extra hour? Probably not, especially recently, with the top marginal tax rates at historically low levels, particularly on income from capital. But, it would only take one tax-deterred worker to falsify Buffett's claim, at least if we take the guy's word for it that he stopped working because of high taxes and for no other reason.

On the other hand, it would also be easy for someone to blame the tax system for making him stop working when he was actually just bored or lazy.

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