Tax Rates and Coercion

[Tim Lee]

Will Wilkinson has a question:

Libertarians and many conservatives often talk about lower taxes as a matter of liberty. But a higher tax isn’t more coercive than a lower one. You’re either being coerced or you’re not. A guy who mugs five people with thin wallets is no less guilty of coercion than a guy who mugs five people with thick wallets. The harm from coercion might be greater if more is taken, but there is no more or less coercion. But if you don’t think that the size of the opportunity set is a matter of liberty, then you should not think of lower taxes as a gain in liberty, but just as a reduction in harm. Yet libertarians and conservatives don’t tend to talk this way. Why not?

I think the way to think about this is to remember that taxes have two effects, which economists would dub the income effect and the substitution effect. The income effect is the one most people think of when they complain about taxes: when taxes go up, people are able to consumer less of stuff than they were before. Under the substitution effect, in contrast, consumers react to rising taxes by shifting their consumption to something that's untaxed. For example, if you raise taxes on income, people shift to consuming more leisure.

The income effect dominates for low tax rates. The substitution effect dominates for high tax rates. As tax rates approach 100 percent, the tax system increasingly comes to resemble a prohibition on whatever is being taxed. And that has two important consequences: first, the definition of what's taxed becomes all-important. And second, tax evasion becomes a more and more serious problem.

For example, in an economy with a 99 percent tax rate, barter would be extremely common. Rather than paying the mechanic to fix my car, I'd ask him to fix my car in exchange for mowing his lawn for a month. Rather than giving me a raise, my boss would let me have a company car. If there's still a deduction for health care, health care plans would suddenly get obscenely generous, as all sorts of perks only tangentially related to health care would suddenly come with health care plans. And of course businesses would live and die by the tax status of various transactions. When "income" is taxed at a higher rate, people do less of things that lead to "income," as that's defined by the government.

And that, in turn, would mean that the IRS would have to get increasingly involved in policing every aspect of peoples' lives to make sure that no tax-evading bartering was going on. Has your daughter been volunteering to watch your lawyer friend's kids because she provided some free legal advice to you a few months ago? Did the contractors who re-did your deck really do it for $1000, or did you give them some money under the table? Should your company have to report the fair market value of the meals they provide you at work as income for you? To achieve the same compliance rate, the IRS would have to hire more agents, conduct more audits and investigations, and bring more people to court over alleged tax evasion.

Moreover, tax loopholes would become an increasingly potent mechanism for social control. You'd see a huge increase in lobbying over the tax code, which gives Congress and IRS officials much stronger positions of authority. A lot of people think we've inflated home ownership rates with the home mortagage deduction. Imagine how potent such incentives would be if the tax rate were 90 percent.

Finally, you'd see a large increase in the black market, as more and more people did business under the table rather than report income that would be largely confiscated anyway. Forcing people into the black market undermines liberty in a variety of ways, including weaker property and contract enforcement, a need for secrecy, and being vulnerable to extortion from government officials. A world in which almost everyone earned money on the black market is a world in which tax officials have the power to harass anyone they wanted.

The effect is easiest to see at the top end of the tax scale, but the effect exists all along it. As a recently self-employed individual, I'm newly conscious of all the ways that the tax code shapes my behavior. I can deduct computer purchases as business expenses, so I am, on the margin, more likely to buy computer hardware. Hiring a plumber means that both he and I have to pay income taxes on the transaction, so on the margin I'm more likely to fix the plumbing myself to avoid that tax wedge. At a lower tax rate, I'd be more likely to hire the plumber.

In all of these cases, the effect of higher taxes isn't just that I'm able to buy less stuff, it's that the incentives of the tax code more strongly distort my behavior. One way to look at the tax code is as a series of rewards and punishments for doing certain things. The tax rate is a scaling factor for all of these rewards and punishments. If we think a $1000 fine is more coercive than a $100 fine, which I think it is, then a 95 percent tax rate is less coercive than a 50 percent tax rate.

Photo courtesy Beatrice Murch

A feature, not a bug

Econospeak identifies a "problem" with carbon taxes:

But relying on carbon taxes is also a terrible way to finance the government. We are talking about half a trillion dollars or so in revenue, so the percentage of financing would be quite large. Income fluctuates, and that is a problem, but the spending on a particular set of items, like fossil fuels, has the potential to fluctuate even more. Example: suppose we really are facing an oil production peak, and scarcity causes the price to spike? Every 10% rise in oil prices will tend to cause something like a 5% reduction in long run demand (I’m rounding here – and thanks to Gar Lipow for his valuable work in collating the evidence), but this also means less carbon tax revenue, potentially a lot less. This is a serious problem, one that the green taxers have not really confronted.

Oh no! Less revenue for the government! Why, we might have to do something unthinkable impossible, like--cut spending.

In fact, gas tax revenues aren't particularly volatile. In 2004, picking one state at random, Minnesota raised $648 million with its gas tax. In 2006, after the efficiency effects of higher prices, it raised . . . $629 million.

Compare that with income tax revenue. Just between 2003 and 2006, Federal tax revenues grew by $625 billion, somewhat less than double what would have been expected had they remained constant as a percentage of GDP.

Long, slow declines in revenue, such as those seen in the gas tax, are easily dealt with by cutting spending, or, more likely, raising the other taxes. States worried about gas tax revenues, for example, are now experimenting with GPS-based road-pricing. At the federal level, we could raise marginal income tax rates or decrease the standard deduction to compensate.

Update A confused commenter demands that I document the changes in percentage terms. All right; the fall in Minnesota gas taxes, during a period in which the price of oil roughly doubled, was less than 3%. The change in federal tax revenues over a slightly longer period (4 years rather than 3) was 11.5%. We are clearly able to handle changes of the magnitude that carbon tax revenue declines represent, particularly if politicians don't use every increase in revenue as an excuse to go on spending binges--a wan hope, I realize.

More Big Con blogging

I have to admit to a bit of private hilarity at the multiple accusations that I couldn't possibly have read Jon Chait's book because a mere thirty six hours before I posted my review of it, I complained of not having a copy. I hadn't realized that so many people considered reading a 250-page book, set in the EZ Reader Xtra Large typeface popular among political polemics, such a heroic feat. I'm sorry to disappoint, but shortly after that post, I borrowed a copy from my colleague Matt Yglesias, then sat down and read the book.

At any rate, in order to clear any lingering doubts that I am incapable of finding passages to critique unless some smarter guy such as Will Wilkinson discovers them for me, let me offer one of my early favorites:

Next, conservatives insist that tax revenues actually did rise under Reagan. And in a literal sense this is true: as the Wall Street Journal editorial page writer and supply-side propagandist Stephen Moore triumphantly declared: "From 1982 to 1989 income tax receipts climbed from $298 billion to $446 billion -- a 50 percent increase." But this is like saying that your policy of feeding your children nothing but marshmallows for six months has been proven correct and healthful because your children have continued to grow. It's a meaningless measure. In any growing economy, tax revenues will tend to rise in nominal dollars -- from inflation alone, if nothing else. The more accurage measure of revenue growth is as a percentage of the economy, and by that count revenues dropped under Reagan. [Emphasis mine]

This is where the book totally went off the rails for me--on page 34, for those following along at home. This is a huh? moment so profound that one really doesn't know where to look. This passage seems to indicate that Jonathan Chait has completely failed to understand the supply side arguments that he is trying to take apart. It's hard to comprehend how he could make such an error, for the supply side argument just isn't that sophisticated. Learning to tie your shoes is considerably harder and more time consuming.

The whole point of the supply side argument is that if you lower the fraction of the economy that the government consumes, you will spur economic growth, which will raise the absolute amount of revenues that the government collects, allowing them to do more spending with lower marginal tax rates. It is definitionally true that under supply side policies, tax revenues will fall as a share of GDP. Saying "tax revenues grew in absolute terms, but fell as a share of GDP" is not a rebuttal of the supply-siders; it's support. Yet Mr Chait seems blissfully unaware of this. He has not only scored an own-goal; he is doing a victory dance in his side's end-zone.

To be sure, what Mr Chait is trying to say is correct: the Reagan tax cuts did not increase revenues in the way that Stephen Moore is claiming. In the first place, there was a little bit of inflation between 1982 and 1989; the 1989 equivalent of $298 billion was about $382 billion, meaning that most of that growth in tax revenues came from the falling purchasing power of each individual dollar. The rest could be accounted for by even relatively meager economic growth rates of the 1970's. And even if that weren't the case, it conveniently ignores the rather large tax hikes and base broadening that took place later in Reagan's term. Finally, to the extent that growth did improve, deregulation, falling oil prices, tax simplification, and better monetary policy all seem like better conservative explanations of the change than do the rather ephemeral tax cuts.

With all that armor at his disposal, I am mystified by Mr Chait's decision to borrow a simplistic argument from other liberal/conservative arguments about taxes, and employ it where it is not merely inappropriate, but actively counterproductive. It's not as if arguments against tax cuts are all just interchangeable parts. The good arguments tend to be somewhat theory specific, not general panaceas against the bad vapors of tax cuttery. It's particularly unfortunate that he should be so indiscriminate in a book that is supposed to take on the broad-spectrum economic snake oil sold by the hard-core supply siders.

Feel that earning power

I'll have more on the Obama tax plan sometime in the next week; I'm trying to go through and look at the sum total spending and tax proposals by the candidates, which takes time.

Meanwhile, one proposal I'm surprised not to find being talked up is the Earned Income Tax Credit, a variation on Milton Friedman's famed negative income tax proposal that is very well regarded by Democrats and Republicans alike. Defying the aphorism that "a program for the poor is a poor program", the EITC has been expanded in every major tax package in the last two decades, and with good reason: it helps out marginal members of the labor force, while still encouraging work.

But this Raj Chetty profile suggests that it may not work as well as it could:

Chetty is drawn to the psychological underpinnings of economic theory. Before deciding on a change to the tax code, he argues, politicians should study how consumers think about taxes. With that in mind, he created an experiment to determine whether separately labeling the sales tax on an item would affect a shopper’s behavior. He persuaded a large grocery chain to allow him to post tags next to 750 of their products for three weeks, showing how much the item would cost after sales tax was added. Fearing the experiment would result in lower sales, the chain did not allow Chetty to post signs on its most popular items.

The store management’s fears were well founded. When consumers knew just how much more taxes would cost them, they reduced their purchases of the items by about 7 percent. As part of the working paper—titled “Salience and Taxation: Theory and Evidence,” coauthored by Adam Looney of the Federal Reserve Board and Kory Kroft of Berkeley’s economics department—Chetty surveyed customers entering the store to determine whether they knew which goods were taxed and which ones weren’t. They were generally able to distinguish the two categories. In other words, they knew that an item was taxable, but actually seeing the total cost—including the tax—at the time of a potential purchase discouraged them from buying it.

“It may not sound unusual. But in economics, most people don’t do experiments. They’re happy to take the data as they find it. They don’t create novel experiments to understand the way the world works,” Feldstein says. “It was a very ingenious way of showing how taxes actually affect shopping behavior—that people actually shopped less when they recognized the full cost of what they were doing.”

Given that consumers seem to weigh taxes more heavily when they are reminded of the burden, Chetty wondered whether Americans understand the implications of the Earned Income Tax Credit, a program meant to motivate low-income people to work by subsidizing their wages. Enacted in 1975, the program was expanded in 1986, 1990, 1993, and 2001. It is considered one of the government’s central anti-poverty policies. Under the program, those who earn, say, $10,000 a year might be given a credit once a year for $4,000, or 40 percent of their salary. But after surveying some of the beneficiaries of the EITC , Chetty found that most people who get it don’t understand how it works.

“They just know that after they file their taxes, they get a big check,” Chetty said. “That is seriously problematic for public policy, because the whole point of the program is to give people an incentive to work. To give them an incentive to work, they really need to understand that they’re really being paid $14 an hour, not $10 an hour.”

The EITC seems to function less as a wage boost than as a system of forced savings for the poor. That's not a perjorative, either; forced savings are popular even with the forcees. Witness the number of (middle class) people I used to work with who would overwithhold in order to experience the joy of getting a check back from the IRS. When I tried to explain that they were essentially making an interest-free loan to the government, they countered that they liked having a big check they could spend on something memorable, like a vacation or a downpayment on a car. The EITC beneficiaries I've known seemed to view it much the same way.

But how to make it work more like a direct wage subsidy? Refunding the money in each paycheck would be outrageously expensive to administer, and poor people who were overpaid the credits in the beginning of the year are vanishingly unlikely to have the money to cover a shortage at year's end. Moreover, the forced savings aspect can be a real benefit; money that would otherwise trickle away on small sundries can instead be put towards a reliable car to get to work, a rental deposit, or something else that measurably improves their lives. Perhaps a statement issued with each paycheck, showing the accumulated EITC?

Process of deduction

A couple of commenters and emailers have asked me to defend my assertion over at TPMCafe that:

At the time, Gore was offering tax deductions or credits for practically anything one might do, from getting born to entering a nursing home. These sorts of tiny lump-sum deductions are generally frowned on by economists; they distort activity, are costly to administer, and unlike marginal rate cuts, provide no positive incentives to increase work.

This is not actually particularly controversial, and the economics is (I think) kind of interesting and important, but at the same time, the explanation is not quite right for the TPMCafe format, so I'll try it here. For anyone who cares, it's below the fold, as it's rather lengthy and a little bit technical. Apologies for those who know all this and find it old hat; this is only for wannabe tax wonks.

Continue reading "Process of deduction" »

I wouldn't do that if I were you

Jonathan Chait has apparently gotten the notion somewhere that Martin Feldstein is about half a step above George Gilder and Jude Wanniski in intellectual heft:

I see that, in their efforts to show that Republican budget policy is actually driven by sensible people rather than raving loons, conservatives are now citing the work of Martin Feldstein (see here and here.)

I will concede that Feldstein is more credible than, say, George Gilder or Jude Wanniski. That, however, is not saying much.

I've only been a journalist for a few years. But I've developed a small list of phrases that should never come out of one's mouth:

"Peter Singer--what a 'tard!"

"I just don't think Stephen Hawking is all that bright"

"Well, fine, Crick and Watson may be smarter than your average creationist, but not much."

Since I mostly write about economics, that means I mostly try to avoid saying, or implying, that highly respected economists are not very good at their job¹. Even when you think their research is mistaken, you want to tread carefully with the accusations of stupidity or bad faith. Especially when that economist is a holder of the John Bates Clark medal, which is harder to get than the Nobel Prize in economics. Extra especially when he is a chaired professor at Harvard, and the head of the National Bureau of Economic research. For one thing, when you do write things like that, anyone who knows anything about the subject is not reading it and thinking, "that McArdle chick sure must be smart, if she knows more about trade theory than Paul Krugman!"

Moreover, you run the risk of having to prove that you are smarter than said professor, when trust me, you aren't. There is no way an argument between you and Martin Feldstein, or any other economist of his stature, about their subject is going to end except with you backing away slowly, eyes fixed on your shoes, mumbling "I'm sorry, I just didn't quite understand . . . I'm sorry, yes, listen, I really ought to go . . . I think I left something on the stove . . . no, no more equations, PLEASE MAKE IT STOP!"

And of course, sometimes my old employer notices what you've said, and then things like this tend to happen:

JONATHAN CHAIT apparently is unimpressed by citations to the work of personages such as Martin Feldstein, the president of the prestigious National Bureau of Economic Research and the George F. Baker Professor of Economics at Harvard University. Indeed, Mr Chait has a knack for drawing the bounds of intellectual respectability so tightly around himself that by late afternoon even his shadow falls outside the charmed circle. Even so, one must admit that Mr Feldstein's Clark medal and his endorsement by the New York Times for the job of Chairman of the Federal Reserve does leave one with a residue of suspicion. The Bank of Sweden has not bestowed upon him its coveted prize—though it's true he has been mentioned, specifically for his work on the theory of taxation. So let's not be too hasty to take him seriously. 

Because Mr Chait is a self-avowed empiricist, perhaps he will favour this new NBER paper (free version here) by Christina and David Romer of the Univesity of California, Berkeley (despite somewhat embarrassing credentials, even slightly more lackluster than Mr Feldstein's). It is a dazzling empirical investigation of the effects of tax cuts and increases on economic output in the United States since the end of the second World War—one that significantly improves on the methodology of earlier attempts to estimate the effects of tax changes. They find that

tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects.

The economists Romer looked at every tax change legislated at the national level since WWII. Impressively, they scoured "presidential speeches, executive-branch documents, and Congressional reports ... to identify the size, timing, and principal motivation for all major postwar tax policy actions." They then categorized each tax change based on whether or not it was intended as a forward-looking correction to the direction of the economy (they call these "endogenous" changes), or intended for other reasons, such as to reduce an inherited deficit or to boost long-run growth (the "exogenous" changes.) This allows them to tease out the output effects of tax cuts and tax increases set in place for different reasons.

Those interested in raising taxes, but unwilling to take seriously Martin Feldstein's estimate of the deadweight loss of tax increases, will need to grapple with Mr and Ms Romers' new findings. For example:

Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

This is bad news for those with aspirations to higher levels of tax-financed spending. However, they find that not all tax hikes hurt the same. Tax increases specifically intended to offset budget deficits largely avoid the negative effects of other kinds of increases, in part by improving the climate of investor confidence.

The deadweight loss of taxation is still a matter of hot debate, and other economists would push forward other numbers. But Mr Chait's recent writings seem to imply that he hasn't really understood the terms of the debate, or learned how to separate the cranks from the titans, which may be why his article lumps all of their claims together. Unfortunately, I haven't a copy of the book, so I can't tell if it's any better than the article in The New Republic.

"It's true because Martin Feldstein said it" is a stupid argument--but no stupider than "Tax cuts are bad because Art Laffer likes them".

¹ But what about Paul Krugman, I hear you cry. I don't care for Paul Krugman the columnist, which is a job I know something about. You won't see me airily dismissing his work on trade, however, nor other respected economists whose work I disagree with, like Card and Krueger.

Substantive arguments against tax increases

Will Wilkinson quotes Martin Feldstein:

[F]inancing additional government spending by an acrosss the board rise in all marginal tax rates would make the cost per dollar of government spending equal to $1.76.

These two facts — that the actual revenue is only 57 percent of the static gain and that the deadweight loss is 76 cents per dollar of revenue — should be central to any consideration of tax policy. And yet they are not.

It is possible that the state can make its citizens better off by taking $1.76 to spend $1.00, if those very expensive dollar bills are spent on highly valuable public goods folks can’t coordinate to provide privately. But I reckon this kind of bona fide public good is a pretty small part of the existing budget.

At the very least, it's the sort of thing you have to factor into arguments that we as a nation can save money via nationalised health care . . .

This should go without saying

But indeed, it hasn't, since I've already said it, and no one has noticed. I am not fighting for the Bush tax cuts; I'm fighting the notion that people who are in favor of tax cuts are all a bunch of liars or loonie tunes. Politicians in favor of tax cuts are all liars, as are all the politicians against tax cuts; in politics, lying is, sadly, the stable equilibrium. But most politicians are not loons; and most of their economics advisors are sober and intelligent fellows.

Apart from the capital gains tax cuts, of which I am in favor and stand foursquare in favor of continuing, I don't particularly care about the tax cuts one way or another. Economically, I don't think they made much difference either way; socially, I think the contribution to increasing either income or consumption inequality will end up being trivial (since the rich will eventually pay whatever tax increases are necessary to pay off the relevant bonds); personally, I'd like to pay lower taxes; ideologically, I think the government spends to much money on things it shouldn't; but morally, I think that once we've voted for spending, we've already got the tax, and having created the tax, we ought to do the manly thing and pay it ourselves.

Overall, I'm mildly in favor of ratcheting back the Bush tax cuts, starting with the income breaks for the wealthiest brackets, until we hit budget balance. But on my list of policy priorities it's somewhere around "What shall we do about France?"

I expect that we will get a Democratic president in 2008, and (s)he will raise taxes, which will be fine, except (s)he will also play with the capital gains tax, which won't be fine, and will furthermore spend the money on programs I dislike, which won't be fine at all, instead of reducing our national debt or further closing the budget deficit or doing something about our future entitlement problems. And unless that president takes on something like a gas tax, or serious tax simplification, or (on the negative side) promises a zillion stupid tax credits, I will have about the same level of interest in their tax policy as I do in George Bush's, which is not overmuch. It's spending I care about.

Ask me a hard one

A commenter demands proof that the Bush administration has ever had any rationales besides the Laffer Curve for its tax cuts. Well, you could start with the White House statement on the tax plan.

Supply me

Ezra's post is an example of exactly what's wrong with Jonathan Chait's article on supply-side economics. Chait, and others writing in this vein, refute the strongest claims of the supply-side movement: that tax cuts produce astonishing growth, or that cutting taxes can increase tax revenue. Then they imply that they have thereby refuted all the economic claims in favor of tax cuts, which they haven't, not even close. I haven't read the book, and the article may well have gotten muddy in the trimming. But from the article, it's not even clear that Chait is familiar with the moderate arguments about things like deadweight loss and fiscal stimulus that motivate many academics in favor of tax cuts. He certainly doesn't address, much less refute them. But nonetheless, a lot of people seem to have gotten the misimpression that there are no serious intellectual, economic arguments in favor of tax cuts. There are.

I agree that any Laffer-type arguments offered by the administration are wrong, and should not be taken seriously, and that Republicans should be pressure not to deploy them. But contra Ezra, it's not some sort of weird, uniquely awful Republican behaviour to sell your policies using dubious economic claims. I'll never forget being asked, in an interview with BET, how much Clinton's Urban Empowerment Zones contributed to economic growth in the 1990s. The correct answer--not in any measurable way--met with a great deal of skepticism, since the producer had seen Bill Himself making grandiose claims about the effects on growth and (slightly more plausibly) poverty. Politicians often assemble policies for a variety of reasons, and then sell them using the least plausible, but most appealing, rationale.

Any social worker, for example, will tell you that a core of their clients have no reasonable chance of getting off support. They have poor impulse control, drug habits, extraordinarily bad planning skills, and often, a rather lackadaisical attitude towards work. But almost no social worker ever says, "We need welfare benefits because these people are too screwed up to hold a job", because Americans do not care to give money to people whom they perceive as not trying. Whether this is appalling dishonesty, or merely putting your best foot forward, depends much on how you feel about the underlying program.

The actual rationale behind tax cuts was multiple. There was a fairness argument about how much of peoples' lives they should be compelled to spend laboring for the government; a fiscal stimulus argument about an economy sliding into (or just out of) recession; a deadweight loss argument; an efficiency argument about the structure of the tax code . . . these were serious beliefs, and they did, in fact, all get advanced during the policy debate. But liberal commentators have ignored all of these in favor of swiping down the few claims that are easy to refute.

Inside media baseball Wednesday

I'm diving into Jonathan Chait's piece in The New Republic on how a whole huge conspiracy of crazy supply-siders has taken over the Republican party. This is, to put it kindly, wildly overblown. I mean, I'm all for someone taking on the sillier kind of supply siders who fanny about claiming that tax cuts increase tax revenue, but they've been rather thin on the ground lately. Most tax cutters today want tax cuts because they think they are good for the economy, not because they think that it will increase tax revenue. And contrary to Chait's assertions, these are not wild, insane things to think.

Chait tars all tax-cutters with the ideas of the looniest supply siders. One can believe that tax cuts, by reducing deadweight loss and/or providing fiscal stimulus, will be good for the economy, without necessarily believing that the economy will be crippled by a 5% rate increase.

His primary exhibits for the nefarious influence of supply-side policy are: Larry Lindsay, Dick Cheney, Jack Kemp, Jude Wanniski, and George Gilder. Cheney I give you, but Larry Lindsay was drummed out of the administration in disgrace (for unrelated reasons) even before Bush's major tax cut, and Chait somehow neglects to mention the more conventional economists who have occupied the job since. Jack Kemp hasn't had access to serious power since I was snoring my way through Algebra I, and what power he did have was over HUD. Moreover, though I agree that Jude Wanniski and George Gilder are barking moonbats, they have, to put it kindly, limited influence on today's Republican party; which is hardly surprising given that Wanniski was kicked out of the party in disgrace before he died in 2005, and George Gilder has turned his attentions to that hugely influention Republican mouthpiece, the Gilder Technology report. This motley collection of names is hardly proof that the Supply Siders Have Taken Over the Building.

Chait also elides the difference between statutory and effective marginal rates in "proving" that the latter group is wrong: after all, if high marginal rates are so bad for the economy, how come we grew so fast in the fifties, when the top marginal rate was 91%? The answer is that there was a pretty big difference between effective and actual tax rates, thanks to various generous deductions that were largely done away with by the middle of the Reagan administration.

Chait then claims this as evidence for the notion that "whatever negative effect such high tax rates have, it's relatively minor. Which necessarily means that whatever effects today's tax rates have, they're even more minor." For the record, I don't think that increasing the marginal tax rate on the rich (or almost anyone else) will have much effect on the economy. But Chait's breezy assertions are not good evidence for my belief. Perhaps growth in the 1950's could have been even more fabulous absent the high tax rates. Also, our tax code, and our economy, is substantially different in structure from the tax code of the 1950's, so extrapolating from then to now is very, very silly. Again, it might be that the changes would make the effects of rate cuts even more minor--but in fact I doubt it; the tax base is much broader now, and labor and capital mobility much higher, which should greatly magnify the effects of a change in rates.

The article features this kind of simplistic, off-the-cuff journalistic reasoning over and over. And it's often flat wrong, as in its discussion of the Laffer Curve:

That fateful night, Wanniski and Laffer were laboring with little success to explain the new theory to Cheney. Laffer pulled out a cocktail napkin and drew a parabola-shaped curve on it. The premise of the curve was simple. If the government sets a tax rate of zero, it will receive no revenue. And, if the government sets a tax rate of 100 percent, the government will also receive zero tax revenue, since nobody will have any reason to earn any income. Between these two points--zero taxes and zero revenue, 100 percent taxes and zero revenue--Laffer's curve drew an arc. The arc suggested that at higher levels of taxation, reducing the tax rate would produce more revenue for the government.

At that moment, there were a few points that Cheney might have made in response. First, he could have noted that the Laffer Curve was not, strictly speaking, correct. Yes, a zero tax rate would obviously produce zero revenue, but the assumption that a 100-percent tax rate would also produce zero revenue was, just as obviously, false. Surely Cheney was familiar with communist states such as the Soviet Union, with its 100 percent tax rate. The Soviet revenue scheme may not have represented the cutting edge in economic efficiency, but it nonetheless managed to collect enough revenue to maintain an enormous military, enslave Eastern Europe, fund ambitious projects such as Sputnik, and so on. Second, Cheney could have pointed out that, even if the Laffer Curve was correct in theory, there was no evidence that the U.S. income tax was on the downward slope of the curve--that is, that rates were then high enough that tax cuts would produce higher revenue.

Ownership of the means of production doesn't really model the same way as an income tax, and at any rate the Soviet government did not take 100% of any worker's output. And no economist that I have ever met doubts that the Laffer Curve holds true, to the extent that there is a revenue-maximizing tax rate which is well to the left of 100%. The Laffer Curve isn't wrong, as Chait wrongly implies; it's just that we're not anywhere near its maxima in the US, this being what responsible tax-cutters like Greg Mankiw have been saying all along.

Chait finishes up with another, really inexcusable bit of journalistic sloppiness: he complains about the share of national income going to the very richest, without informing the reader that these figures are calculated pre-tax. The implication is that the tax cuts have somehow altered the income composition of America at the behest of corporations and mean rich people, when at the most they have acted as a somewhat smaller check on inequality that is growing for reasons unconnected to the tax code.

It is not that I do not support Chait's project: refuting the sillier supply-side notions about tax revenues and growth is God's work. Except . . . this isn't the way to do it. This article isn't going to convince the people at the places Chait excoriates like the Club for Growth or the Weekly Standard--or indeed any of their supporters--that they should jettison their more extreme claims. It's too easy, reading this article, to claim bad faith.

A Laffer curve for cigarettes?

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.