NYU Tax Policy Colloquium: Pecoraro, Moore, and Splinter's "Are Laffer Curves Flat?"

 Yesterday at the NYU Tax Policy Colloquium we hosted Brandon Pecoraro and Rachel Moore, Joint Committee on Taxation economists who are two of the three co-authors (with David Splinter) of Are Laffer Curves Flat?, an empirical paper that deserves attention but that has actually – through no fault of their own – received it for the wrong reasons, rather than the right ones.

 Are Laffer Curves Flat? examines one main question. Suppose we were to raise the top individual rate on ordinary income, while keeping everything else entirely the same. What would be the revenue effects? In other words, where are we now, as compared to the peak of the Laffer Curve? It finds that, at present, given the 37 percent top individual rate plus a whole lot else – including other federal taxes and all state and local taxes – we are already close to the peak (which is actually, although it varies close to 50 percent once everything else is all in. Thus, simply raising the top individual rate while doing nothing else whatsoever would raise very little, supporting the view that it wouldn’t accomplish a lot if the aim is to get more tax revenues from the top.

 

It is important to keep in mind (as the paper makes clear) that this is a very limited exercise. It says nothing whatsoever against a policy change that combined increasing the top rate with other base-broadening – pertaining, e.g., to the use of various income tax preferences (including but not limited to the vile §199A), the much lower corporate rate, and the long-term capital gains rate.

 

Given all that, a standalone rate increase at the top reminds me of a scene in the Mel Brooks movie Blazing Saddles. In the middle of the wide-open prairie, the villains install a tollbooth through which all the riders who are out there on horseback believe that they must pass. The joke is that there appears to be no reason why they would do this, as they could just go two yards to the left or right and get by without paying anything.

 

The relevance here of Mel Brooks’ joke is that it’s a bit like asking what would be the revenue-maximizing rate of his silly tollbooth, given how readily one can avoid it. The posited rate increase is so readily avoidable that one would be wholly unsurprised by its failing to raise extra revenue. Or to put it differently, any serious effort to raise more from the top 1% would be foolishly ill-designed if not accompanied by other measures that either (1) made incurring ordinary income subject to the rate less avoidable, or (2) raised the rates on types of income that could avoid bearing this rate.

 

This is no knock on the paper’s research design, as I’ll discuss in a moment. But it does open the door for intellectually dishonest people to misrepresent its findings and their significance.

 

Case in point, a Washington Post editorial some months back that cited the research as supporting the proposition that there is absolutely nothing to be gained by trying to increase taxes on rich people. You may have seen this editorial – I did at the time, and immediately recognized it (even though I hadn’t read the paper yet!) as dishonest garbage. 

 

A student in the colloquium class observed last week in our private class session on the paper that the editorial’s authors apparently hadn’t made it as far as to page 6 of the paper, if indeed they had read it at all. But perhaps this is unfair. The editorial wasn’t written for you or me. More likely, it was written for an audience of one – Jeff Bezos – and I would presume that he was quite happy with what his now captive, intellectually compromised Wa Po editorial page had dutifully churned out for him.

 

Although I am no expert on the empirical side, I found the paper’s result credible and (given the Mel Brooks problem) unsurprising. But that alone wouldn’t make it as valuable a contribution as I believe it is. Rather, its big contributions are at least twofold:

 

1) Taking advantage both of data that is available to the JCT and of the authors’ model-building, it builds in far more institutional detail that can yield more accurate and insightful empirical analyses. As the paper notes, the assumed tax bases that academic economists typically use in asking Laffer Curve-type questions tend to be either too broad or too narrow. For example, they may assume that the top rate applies to all capital income (despite the long-term capital gains rate and other favorable rules) or to none of it (despite the taxation of, say, short-term gains, interest, and unqualified dividends). The paper, by contrast, looks at what it calls the “true” tax base – i.e., what I might be more inclined to call the “actual” tax base, since by “true” they only mean that it matches what current law actually does. With this methodology, better-designed efforts to increase tax revenues from the top 1 percent could likewise be better-estimated than was possible under the prior state of the art.

 

2) It helps to show that there is no such thing as a “natural” Laffer Curve that applies at all times and places to a given instrument such as the federal income tax. The Laffer Curve at any time is endogenous; what is actually being taxed and how, including the relative treatment of adjoining “lanes” in a given instance, will drive the result. In short, the Laffer Curve is to a degree what we make it, even if also reflecting such hard-to-control inputs as people’s attitudes towards labor supply.