Sunday, August 15, 2010

Is It The ‘Laffer Curve’ or the ‘Laugher Curve’?

We think it is neither.  Which we will explain later.

A friend of ours who is a professor of health care economics at the Terry Sanford School for Public Policy at Duke University (they do more there than just win basketball and lacrosse championships, you know) sent this link to us from the Washington Post.

We are not exactly sure what the first economist from Berkeley is talking about in his answer to Mr. Dylan Matthews in the Post article but we did see the figure '73%'...and thought he might as well have been speaking Klingon. Cause we know that 73% just ain't 'the right answer'!

There is this popular notion that lawmakers in Washington somehow are omniscient enough to 'know' what the 'correct' or 'optimal' tax rate is for everyone else to be paying.

How do they know that?  Did Moses hand it off to them on the flip side of the Ten Commandments etched in stone or something?

Does anyone really believe that any elected official in the US Congress has the capacity to pick out the one magical marginal and optimal tax rate based on any decision made up there in the past decade?

Here's what we think is the 'bend point' for the marginal tax rates:  It is whatever 'point' truly wealthy people decide it is for them...and them alone!

Wealthy people can afford the best tax lawyers and accountants in the universe. If they hate government and don't wanna send any of their hard-earned money to Washington, they usually don't and they can do it in legal ways unimaginable to the average person. And they turn the Laffer Curve into the 'Laugher Curve', at least for them.

Ever wonder why Warren Buffett makes a big deal out of taking 'only' a $100,000 salary every year?

Or wealthy people use the basic ‘Marginal Cost > Marginal Benefit’ argument to pay more taxes when the cost and the headache of tax avoidance is more than the amount they owe so they just stroke a check, send it to Washington and are done with it.

We have run into a few mega-wealthy people, believe it or not, over 22 years in Washington, DC and 2 of them have told me 2 very different things when it comes to how they view new tax bills that will raise their taxes:

1) The first guy, let’s call him ‘Mr. Midas’, told me he sits down with his army of accountants and lawyers (he has 'hundreds' in his employ...seriously!) at the end of each fiscal year to plan for the next. He asks them what it will take to get his 'effective tax rate' down to around 19%. He doesn’t care about ‘marginal’ tax rates at all when it comes to his own personal situation.

‘Effective tax rate’ is what percentage of your earned income you send to Washington at the end of all the calculations. ‘Marginal tax rate’ is the rate you pay on the 'next dollar earned' above a certain threshold set by Congress. Most of the news and cable-jabber focuses on the ‘marginal’ tax rate but the key point for each individual is how much you send total during the year, regardless of what the next rate threshold is.

His rationale? He believes 19% is the 'optimal' level for federal spending as a percent of GDP and he is 'willing' to part with the same percentage of his income to pay for it. No more, no less.

And then he does it....each and every year.

2) The second man, call him ‘Mr. Croesus’ told me: "I am the luckiest SOB on the face of this planet (actually one of the total of 403 "lucky' but hard-working, smart billionaires in the US today). I just pay whatever Washington tells me to pay because I got rich in the best country in the world!"

I told him he was a sheer lunatic and might as well be howling at the moon. I offered to send him a copy of the federal budget, all 2400+ pages of it with 2400 Post-It notes attached to every page to show him where at least 50% of what he sends to Washington each year is wasted.

He gracefully declined and sighed: "I would really rather not know!'

He is truly insane. But he did sleep at a Holiday Inn last night so we guess he really does know what he is doing.

We hate to step on the distinguished Professor Laffer's toes.We also hate to step on the toes of the professor from the University of Klingon or even Martin Feldstein.

But in our humble opinion, there is no single 'bend point' when it comes to generating the optimal amount of tax revenue with tax policy for anyone making over $500k in annual income or have a net worth of, let's say, over $5 million.  To assert that there is some sort of 'magical' marginal tax rate that gleans every available dollar out of people's pockets to be paid in taxes to Washington strikes us as being more than a little bit ridiculous to be honest about it.

The truly wealthy make their own decisions on what they are willing to pay in taxes to Washington. The rest of us have darn little choice but to have it withheld from our paychecks or make quarterly payments and hope for the best.

Like 'hope for' the days when we will have some adults elected to Congress to reduce spending, balance these horrific budgets and then reduce our taxes as they reduce spending every year for the rest of our lives.

That is what it is gonna take, people. Spending is something Congress can control down to the penny each year and we have to elect people who will vote to hold down the rate of growth in federal spending to below 3% annually for the rest of our lives.

Congress can not control the 'optimal' amount of tax money that will be sent to the US Treasury every year any more than Captain Kirk could control the Klingons, Romulans or even the Vulcans.

'It just is not logical.'


  1. Telemachus frequently observes that, in our democracy, the fabulously wealthy can (and typically do) avoid tax burden by using an arsenal of legal resources that are unaffordable by citizens of lesser means … this while we are served by a government that fails to balance expenditures with revenues. The Telemachus forum has offered lengthy discussions on the importance of dramatically reducing government expenditures … a position with which i agree. Nonetheless, there is merit in also examining the manner in which our government generates revenue … in particular, the imposition of income taxes.

    I have always regarded the 16th Amendment (like all income tax legislation) to be a curiosity. A tax on annual income (a crude measure of rate of change of wealth), as opposed to taxing net present wealth, is a clumsy approach for financing government activity. It is similar to requiring a pilot to land a crowded commercial airliner while viewing only an accelerometer (which gives a crude measure of rate of change in air-speed) … ignoring the air-speed indicator. Such derivative based controls are not robust; hence, it is quite understandable that balanced federal budgets are rarely achieved.

    A primary function of our government is to ensure the right of citizens to privately hold wealth. The financial burden for ensuring this right is high, consuming vast economic resources given to defense, judicial, legislative, executive, law enforcement, and even entitlement spending (bribing the less fortunate). Fairly guaranteeing the security of privately held wealth is central of our democracy; yet, the revenues needed to operate government are not collected in direct proportion to the private wealth that it protects. I am not simply complaining that Warren Buffett does not pay the true cost of protecting his wealth … I am observing that wealth holding Americans (like you and me) in aggregate do not wish to pay for the cost of a government that functions largely to protect their private wealth. Rather, we are satisfied with perpetuating and complicating arcane taxation strategies that eschew fairness.

    All private wealth, in this country, is held by individuals in equity instruments (e.g., stocks, real estate, bonds, livestock, bank accounts, etc.), memberships (e.g., churches, country clubs, etc.) and other wealth accumulating mechanisms. The bill for government should be proportionally divided among individuals according to their wealth that is being protected … yep, similar to a property tax. Do away with clumsy derivative (rate) taxes: personal income tax and corporate income taxes. Tax the beneficiaries of "wealth protection" proportionally … and if you, as a wealth holder, don't like what you are paying for, then elect some legislators who will get you a better value for your money.

  2. that's a creative way to think about it.

    the ancient Athenians had a similar concept when it came to holding had more, you paid more in some instances.

    The Romans...well, just like any other great empire in history, the next would-be Emperor or Caesar would fund an invasion of some neighboring country with his own funds, as sort of a 'loan'; go out and conquer said nation; rape, pillage and plunder all wealth; pay himself back FIRST, of course, and then enrich himself, of course...and then use any spoils left over to build Colosseums and other magnificent edifices to his power and greatness.

    think 'infrastructure and public construction projects'....

    the main problems with taxing people based on wealth are: 1) getting them to willfully report all they personally own and then 2) getting them to pay 20% each year to fund the government.

    Eventually, even the wealth of Bill Gates and Mr. Buffett (Warren AND Jimmy) will be reduced to zero.

    a better proxy is to replace the existing tax system with a consumption tax completely. You build a $100 M house on a hill overlooking all that you command? You pay $20M in taxes, 20% rate.

    you join 20 exclusive country/golf/tennis clubs at $100k initiation fees/per? You pay $400k in taxes at a 20% rate.

    1 consumption sales tax nationwide on everything...and show it at the bottom of the receipt: "This 20% tax of $0.60 on your purchase of Crest toothpaste is going to pay for the following programs: 20 cents for Medicare; 20 cents for Social Security; 10 cents for defense of the country and 10 cents for debt service..and that is all we can pay for anymore!"

    worth thinking about....both of them

  3. While consumption taxes exhibit certain features that are preferable to income income taxes, both are a tax on the "flow rate" of money (analytically, a first time derivative of wealth). Again, a difficulty with taxing money "flow-rates" is the volatility in tax revenue (i.e., net present wealth can remain relatively stable as a function of time while its first time-derivative can exhibit enormous swings in magnitude ... leading to extremely lean tax revenues in recession and unjustifiable tax cuts (foregoing revenue that might have recharged coffers ... e.g., social security) during fat years.

    In aggregate, most individuals spend such that their long-run average (i.e., over a lifetime) income per unit time equals their long-run average consumption per unit time ... this is because, for most of us ordinary folks, "money in" very nearly equals "money out"over a lifetime. Hence, taxing consumption is not terribly different from taxing income. So long as we insist on taxing the flow-rate of money we will suffer a volatility of tax revenue that feeds waste as legislators thrash with short-run budgeting agendas that fuels debt because of waste and an inherent negative drift induced by tax cuts in the "fat income years."

  4. but how then do we roll a backhoe up to a gated community behind which all the rich people live next door to the NBA mega-millionaires nowadays and then politely ask them to: "ante up 20% of your net worth...or else we will excavate it out of your pockets for you!'?

    I am not sure there is a way to tax net worth per se. You need a transaction of sorts to be able to separate it from the corpus of wealth.

  5. ... backhoe??? ... unnecessary. Simply continue borrowing money to pay for government (the services of which protect my modest wealth, your wealth, and Warren Buffett's wealth), and require a future generation to be responsible. We wealth holders don't have to pay the true cost for "civilization"; we can simply forward expense it. Right?
    You are equating a tax on net present wealth with "a scheme for taxing the super-rich" ... this is incorrect. (Even if we confiscated at gunpoint the entire wealth of this country's super-rich, we could not cover our present government expenses.) ALL TAXES are paid by "wealth holders" like you and me. As a taxpayer, I hope for a government that will protect and foster my quality of life by efficiently investing my tax dollars in a portfolio of programs and services that ensure acceptable civilization. Efficiency is lost whenever money must be borrowed to finance government ... i.e., when costs exceed tax revenues.

    A plain and simple fact is that government is more expensive when operating on borrowed money. Rate-taxes (income and consumption) encourage borrowing and impede the velocity of money within the economy. The VOLATILITY (with often dramatic magnitude swings) of rate-tax revenues virtually ensures a wide mismatch with expenses to which congress reacts with either borrowing, and/or tax cuts that typically induce more borrowing.

    As an ordinary wealth holder (one of the guys who REALLY foots the bill for government), I would greatly prefer a wealth tax ... similar to my property taxes where the government's revenue stream is more predictable. When government can more ACCURATELY PREDICT revenues and costs, it will require less borrowed money. (I suspect that the super-rich would also prefer less government borrowing.)

  6. no doubt that any sentient humanoid walking on hind legs would 'prefer less government borrowing' what does that make current Members of Congress?

    I'd have to think more on the 'property tax' idea of taxing wealth on a federal scale. My first thought is that if 'cheating' on income taxes is widespread, cheating on property taxes might be 10 times that and very difficult to enforce and monitor.

    Our current system is essentially 'voluntary' in that less than 1% of taxpayers ever get audited so unless we unleashed an army of accountants and lawyers to comb through every financial statement or portfolio of every taxpayer, there would be enormous room for deceit in this regard.

    A consumption tax at point-of-purchase is very hard to game the system on and it is right there for you to see on each and every transaction at your local Wal-Mart.

    It might be easier to get the natural gas system 'frakked' properly first than to fix our current income tax system