April 24, 2012

The Left vs. Laffer

By Don Kirk in Left-Liberalism, Socialism's "intellectual suicide"

Economics Nobel laureate Peter Diamond and Berkeley economist Emmanuel Saez have an Op-Ed in today’s Wall Street Journal which argues that higher personal income tax rates upon the wealthy will not impede national economic growth. This argument is,  of course, postulated by two Left-liberal economists in the nation’s pre-eminent conservative newspaper in an attempt to influence passage by Congress of the Buffett Rule, which will raise income taxes on the wealthy.

Part of their argument is that our current tax rates on the wealthy are not even close to the top range of the Laffer Curve, which is a supply-side economic theory of maximizing tax revenues by avoiding over-taxing. The two brilliant Left-liberal economists argue that the current top rate of 35% on the richest Americans could be safely increased to 50%, or even to 70%, without harming economic growth. They back up their argument by noting that since tax rates in Ronald Reagan’s first term were at 50% maximum and yet an economic boom began in Reagan’s mid-term, 50% is not anti-growth.They conclude their argument by calling for higher taxes upon the already-wealthy, while also suggesting that, in the interest of promoting economic growth, the approaching-wealthy should not have their tax rates increased.

Oops. This is an intellectually-corrupt example of using fact-filtered ideology to make an argument. The Diamond/Saez argument relies, in part, upon what is known in philosophy as a fallacy by conflation and in economics as a “static” analysis: 50% maximum taxes in 1982 yet we had a boom, so we can safely raise maximum taxes to 50% in 2012 and the higher rates will not shut down growth. In a “dynamic” analysis, the economic historian would quickly point out that the 50% tax rates under Reagan were a Laffer Curve DROP of rates from 70%, thus spurring economic growth. If we adopt 50% taxes now, that represents a RISE in tax rates from 35%, thus likely to dampen economic growth.

As I understand their second argument, once you are rich you no longer invest for greater economic growth but instead invest for passive income, therefore you should be taxed at higher maximum rates. Otherwise if you are merely almost-rich, you are still investing in greater economic growth and should pay a lesser tax rate.

Let’s first tackle their Laffer Curve argument. When I studied the Laffer Curve at university years ago, the optimum personal income tax rate was believed to be 40%. Above 40% would result in a fall of tax revenues as the wealthy altered their productive behavior in order to avoid paying at the higher tax rate. Perhaps there is just something about the human being ever since the Roman Empire that naturally resents paying more than half their income to the government, and if that’s true then keeping the maximum tax rate below 50% makes sense if you want to maximize actual tax collection.

The argument that the Laffer Curve permits 50% to 70% as the top tax rate for individuals before negatively affecting economic growth is fallacious. 40% is the suggested maximum, which is perhaps why President Obama years ago suggested increasing personal income taxes only to a maximum of 41%; he was apparently trying to squeeze an extra 1% for the maximum tax rate just above the Laffer Curve’s 40% optimum.

Also, the Diamond/Saez secondary argument–that the wealthy are no longer active investors in economic growth so they should therefore pay higher tax rates on passive income–is plainly wrong. Many tax-free municipal bonds that the wealthy purchase finance infrastructure projects for local cities, counties, and States. As the two eminent economists point out elsewhere in their Op-Ed, infrastructure investments can be high-return investments in future economic growth. So their argument that the wealthy are not investors in economic growth is refuted by their ignoring the greater infrastructure investment financed by the wealthy who buy tax-free bonds. Their argument is self-contradictory, hence, fallacious. If their ‘static’ argument is flawed about the maximum tax rate that diminishes tax revenues, and if their argument is also wrong about the wealthy being non-investors in greater economic growth, then doesn’t their main argument–that higher taxes do not impede economic growth–suffer from an irrational grounding?

They make a collander argument, full of holes. Higher tax rates on the wealthy might very well be a policy most Americans want, but this argument is too hollow to achieve the goal. This Diamond/Saez argument is an example of socialism’s “intellectual suicide,” the ideological myth-making by the liberal-Left, which is no better than the ideological myth-making in economics by the conservative-Right.