Conservatives are very fond of the Laffer Curve, which says that sometimes, lowering taxes can raise revenue. Liberals love to make fun of it by pointing out that all the Republican claims that this would happen have, in practice, failed to pan out. The liberals have the better of the empirical, though not the theoretical argument. Tautologically, the curve must be true: at 0% tax rates, you raise no revenue; and at 100% tax rates, you raise no revenue, because why would anyone work? (Plus they'd find it hard to, having no money for food or shelter to keep themselves alive). Somewhere in between, the curve must maximise. Unfortunately for conservatives looking for practical justifications for tax cuts, that point is at some rate higher than current American income taxes.
But that doesn't mean the Laffer Curve still can't be interesting! There are, after all, other taxes than the income tax; and some areas may be hitting the Laffer point, as Jacob Sullum points out:
In an Asbury Park Press op-ed piece, Gregg Edwards, president of New Jersey's Center for Policy Research, argues that the state's cigarette tax—at $2.57½ a pack, the highest in the country—has reached a "tipping point" where a higher rate no longer brings in more money. In fact, he notes, the latest increase in the tax was followed by a reduction in revenue, from $787 million in fiscal year 2006 to $764 million in fiscal year 2007. The decrease in cigarette purchases is partly due to smokers who cut back or quit (an avowed goal of higher cigarette taxes), but Edwards notes that many smokers may be getting cigarettes online, in neighboring states with lower tax rates (cigarette sales in Delaware are mysteriously on the rise), or from the black market. The differential between New Jersey's tax and other states' is a smuggler's dream. Imagine what you could make by hauling a truckload of cigarettes from, say, South Carolina, where the tax is 7 cents a pack.
For cigarette taxers, of course, cutting back is a feature, not a bug, of the tax. (As it is for the kind of people who favour raising the income tax in order to dampen status competition). But Laffer effects don't always come from cutting back; they can also come from shifting activity. People may simply shift their shopping, or earning, elsewhere--to a place, or time period, in which it's more advantageous. Here in DC, a proposed car trip to Virginia seems to be an invitation to one's smoking friends to place cigarette orders. (In New York City, trips to Westchester and New Jersey had much the same effect.)
If New Jersey is simply an altruistic cancer-hating state, of course, that doesn't matter. Some people will cut back, which is good; and some other people will buy cigarettes in New York or Pennsylvania, which is too bad, but not really any of New Jersey's business.
This does not, however, strike me as a very good model of the behaviour of actual politicians. I will be curious to see what happens to New Jersey's cigarette tax henceforth.
at 100% tax rates, you raise no revenue, because why would anyone work
This has *nothing* to do with the laffer curve. It has to do with substitutes. What's important about the laffer curve is that its a tax on income, not consumption.
Get rid of all the bogus references to the Laffer curve, and you have an interesting and useful point.
"The liberals have the better of the empirical, though not the theoretical argument."
if the data says it doesnt work, then who gives a rat's ass about the THEORY? typically, at least in, you know, science, when your data completely and totally fails to support your hypothesis, you revise your hypothesis.
also, what fucking planet are you from?
rageahol:
http://leiterreports.typepad.com/blog/2004/10/is_economics_a_.html
justin:
"economists are the court astrologers of the 20th and 21st centuries"
How many cartons is picking some up for your friend and how many is smuggling?
"if the data says it doesnt work, then who gives a rat's ass about the THEORY?"
I think it is a lot like special relativity. Until you get near the absolute limit, the speed of light, you don't notice relativistic effects. Perhaps if we taxed near the limit, say 99.99%, we'd see some of that Laffer curve action at work.
Or you could just make stuff up like the Wall Street Journal http://delong.typepad.com/delong_economics_only/2007/07/most-dishonest-.html
I think what Megan meant was "The Laffer curve is correct in theory, but empirically we are not anywhere near the point on the curve at which raising taxes would lower revenues."
Maybe "rageahol" should, you know, lay off the rageahol for a while?
"not really any of New Jersey's business."
I disagree with this. New Jersey's tax is causing a positive externality for the citizens of Pennsylvania and New York. Because NJ can't capture all the benefit of their tax, this means that NJ would tend to set the level of the tax inefficiently low (if you ignore public choice issues). In order to get the taxes to "optimal" levels, the states would need a mechanism to essentially "collude" on their taxes. This is an argument for setting cigarette taxes at the national level.
Of course if you hate taxes, you might see this as a feature rather than a bug.
>This has *nothing* to do with the laffer curve.
>It has to do with substitutes. What's important
>about the laffer curve is that its a tax on income,
>not consumption.
Income taxes raise the cost of work relative to leisure so at a theoretical level, the Laffer curve is about substitution too. The difference is that it's about substituting activities (bought with time) instead of goods (bought with money). Likewise, about a year ago City Journal had an article arguing that sentencing had gotten so punitive that deterrence had enough of an effect to suppress aggregate prison time -- an in-kind Laffer curve where crime is labor and incarceration is tax. (I'm skeptical of this particular case since I think criminals heavily discount the future, but it's a good theoretical fit).
Note: I agree with Ms. McArdle that the curve exists, but the inflection point is a lot closer to 100% than it is to 0%. Roman provincial tax-farming probably exceeded the inflection point, but American income tax in 2007 is not even close.
Gabriel, you're missing my point. If she's interested in the income-reducing effects of too high of a cigarette tax, she's not inducing a discussion about the laffer curve, she's talking about substitution problems in a somewhat competitive market with alternate sources of purchase.
Talking about the laffer curve will just get the actual discussion off point - which you can see by reading the commenters.
It may be that subtle distinctions are lost on me because I'm on the periphery of econ (I'm an economic sociologist), but when I hear that raising a tax rate allegedly reduces the state's revenues from that tax, I think Laffer curve. I agree that it's confusing because the effect can occur both through reducing the taxed behavior (less smoking) and through evading the tax (inter-state smuggling), and most of the discussion here has focused on the latter. However, this is also the case for the classic Laffer curve where raising income taxes allegedly leads to lower labor force participation AND more working under the table.
States don't lower taxes, on anything... so how would anyone know if Laffer is right?
One would have thought after 12 years of Republican control of congress Laffer's theory would have been put to the test. Instead, under the GOP we've seen a quantum leap in the size of the federal government.
States, as laboratories of democracy, have fared no better. The GOP controlled states are often the first to raise taxes.
Unless Democrats buy into Laffer, we'll never know.
Grant,
Republican legislatures often cut taxes. Usually, the taxed activity rises, but only enough to partially finance the cut. Therefore the evidence is against the notion that before a cut we are to the right of the curve's maximum.
You seem to be confusing cutting taxes with cutting spending, and indeed, legislatures of either party seldom do the latter. Orthodox economics says that deficit-financed tax cuts are really tax deferrals, but supply-siders say such tax cuts are free. Therefore tax cuts absent spending cuts are fair tests of the Laffer hypothesis.
This is about the price elasticity of demand. At lower tax rates demand for cigarettes is inelastic so an increase in the tax increases revenue. As taxes go up, the price goes up and you can get into the elastic range of the demand curve. At that point, as tax rates go up, revenue decreases.
Here in Arizona we appear to have just about hit the tipping point between inelastic and elastic demand. Prices have increased about 20% and it looks like sales may have decreased by an equivalent amount. In a few more months we’ll probably know for sure.
Or course the equation changes if Virginia gets wise and decides to raise its taxes on cigarettes.
Scott gets it. I'm not sure if I agree exactly, but he's understanding the question.
If the Laffer curve was about people reincorporating in Mexico, or something, Megan would hae a point. But even under a broad view of the Laffer curve, Megan admits this is about smuggling, not going without.
Justin, I don't know why you think the Laffer Curve only applies to income taxation; actually, its original formulation was as an analysis of a particularly exotic form of non-income taxation (hyperinflation seignorage). It has dominated the public debate as a question of marginal federal income tax rates, true, but that's no reason it shouldn't be applied to more general problems of revenue maximisation.
Scott, by definition, the Laffer Curve is about price elasticity of demand (for leisure/legal protection). Almost everything in economics is about price elasticity of demand at some level.
That's not to say that this isn't an interesting question; it's just not the relevent question for revenue maximisation.
There's no law that says we can't tax cigarettes over 100 percent, or am I wrong about that? It seems like you'd have to jigger your conception of the "Laffer Curve" to something more open-ended, since all taxing cigs 100 percent does is double their price to consumers, which many consumers would be willing to pay.
On the matter of the Laffer Curve in relation to income tax, I just want to say that this statement:
"Tautologically, the curve must be true: at 0% tax rates, you raise no revenue; and at 100% tax rates, you raise no revenue, because why would anyone work?"
Isn't tautological at all. You take two particular logically unique situations: no taxation and total taxation, and assume that there is a mathematical continuity between the two. THERE ISN'T ONE!!! Now, if we try to redefine our situation, the much vaunted Laffer Curve looks stickier-define it in a continuum of taxation rates between, say 10 percent and 90 percent (our ideal tax rate has to be in there some where for all of this ruckus about it to make sense anyway, right?). If income taxes are at 90, do we start seeing employment drop off? Where's the evidence for this? It seems like income is special, because it is a prerequisite for survival. You've gotta make money to live, and just because your state is siphoning off most of your income doesn't alter that fact. It isn't enough to suggest that people would stop working-you have to explain why people would stop working. High tax rates don't negate the human needs that propel individuals into employment to begin with. Your Laffer Curve, nominally explained, is total bullshit.
What you might see with grossly high tax rates is a much higher amount of tax evasion, the development of more robust underground economies, that sort of thing. Trying to figure out how these phenomena will alter tax revenues isn't simple, however, and take us away from the concept that led us to buy the Laffer Curve to begin with. Obviously, at some point taxation can be too great a burden on the public. But that's what revolutions are for, not wholesale withdrawal from employment.
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