Via Mark Thoma a paper a self-recommending paper by David Romer. A key take away – I think this comes from James Kwak paraphrasing.
To put this in perspective, an elasticity of 0.19 implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.
This is roughly inline with my reading of the data which says a marginal tax rate of around 70 – 80% would maximize the government’s take.
An important thing that is not commonly talked about is the way income and work effects interact and this has important implications.
We usually think of income effects as causing people to substitute away from work towards leisure. However, causal empiricism suggests that one important use of income is to substitute out of household production.
For example, one definition of the “work” I do is attempting to interpret data for the benefit of public officials and my blog readers. However, at my current wage I also have to cut my own grass and wash my own dishes.
If I were paid more I would use some of that money to have my grass cut and a maid do my housework which would leave me with more time to look at data.
However, it would be wrong to interpret that as a substitution effect – which is how most studies would pick it up. Its really an income effect. If I won the lottery the same thing would happen. I wouldn’t look at less data, I would look at more data, because now I can pay someone to do household production for me.
The same thing is likely true with folks who become superrich. You might think that they became super rich because of they wanted to make a lot money. Unlikely. It is more likely that their obsession just so happened to coincide with something the market paid a lot of money for.
And, so as they get richer they can spend more and more time with their obsession. At lower levels of income it looks like you are picking up a substitution effect. Higher wages –> more work. But, you are really picking up an income effect. More wealth –> less household production.
Thus once you get to the super wealthy it looks like a surprising drop in the substitution effect, but its not. You have simply satiated the income effect. They now do almost no household production so it doesn’t matter.
The ironic thing is that even if you are a Randian, you can see this. Hank Rearden says he only cares about making money but this is an obvious lie. Like most male obsessives he cares about steel and about women who care about steel and about nothing else.
If he made money, so be it. If not, so be it. If metallurgy made you a billionaire he’d be a billionaire. If it made you a homeless crank, he’d be a homeless crank.
That’s the way obsession works.
What pisses him off is not taking away his money, its taking away his metal.
Its funny that intuitively folks pick up on that but then in an effort to defend egoism make up this story about loving money that is actually both less accurate and less compelling.
22 comments
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Tuesday ~ February 28th, 2012 at 12:02 am
Ettaroo
brilliant
Tuesday ~ February 28th, 2012 at 12:07 am
Don Gibson
Are there any studies that estimate a peak value when tax compliance is not perfect?
Tuesday ~ February 28th, 2012 at 12:21 am
noiselull
This is why we need Scott Sumner:
http://www.themoneyillusion.com/?p=12054
Tuesday ~ February 28th, 2012 at 12:36 am
Carl Shulman
>If he made money, so be it. If not, so be it. If metallurgy made you a billionaire he’d be a billionaire. If it made you a homeless crank, he’d be a homeless crank.
People with the demographic characteristics (height, conscientiousness, IQ, family SES, attractiveness, etc) of wealthy founder-CEOs are very unlikely to wind up as homeless cranks, to at least a second or third approximation. Obsessions are not random and independent of financial or other reward. Status keeps rising with wealth (Forbes 400 rank, if nothing else) even if one doesn’t spend it on personal consumption.
Tuesday ~ February 28th, 2012 at 5:33 am
reason
Maybe your right. That sort of sociapathy often leads to prison, and prisoners aren’t homeless.
Tuesday ~ February 28th, 2012 at 1:44 am
Chris
Genius.
Tuesday ~ February 28th, 2012 at 1:47 am
Chris
But don’t forget the empirical cutting off one’s nose to spite one’s face effect.
Tuesday ~ February 28th, 2012 at 4:27 am
Links for 2012-02-28 | FavStocks
[…] When Does Atlas Shrug–Why Does Atlas Shrug – Karl Smith […]
Tuesday ~ February 28th, 2012 at 10:21 am
The First Thing We Do Is Tax All the Rich | liamcmalloy
[…] Matt Yglesias, Karl Smith, and Mark Thoma and James Kwak are pointing out the (previously mentioned) Romer and Romer research […]
Tuesday ~ February 28th, 2012 at 11:26 am
Becky Hargrove
The knowledge prior is everything. Sometime we get hung up on the monetary prior and try to burn down the house with it (destroy knowledge use-as-utility). But money is only an incidental to knowledge, even though money has been structured as though exactly the opposite were true.
Tuesday ~ February 28th, 2012 at 11:26 am
Russell Conner
What if they don’t shrug, but vote with their feet to go somewhere else with lower taxes and continue to work there?
It is, after all, a Global economy, and they would be the most mobile.
Tuesday ~ February 28th, 2012 at 11:35 am
teageegeepea
Much of the Laffer Effect doesn’t even require moving your feet, but just rearranging your finances to make less of it easily taxable. Capital is much more mobile than labor, which is why it’s usually taxed at considerably lower rates.
Tuesday ~ February 28th, 2012 at 5:15 pm
Matt
It is a global economy but not all countries are equal. It is one thing to move between states. It is an entirely different thing to move between countries. Cultures, language, quality of life, family proximity, laws, make it less likely that those that threaten such action will actually make the jump. Generally speaking the US has a pretty decent tax rate/quality of life balance. Of course the GOP wants you to think otherwise and that the “job creators” have their bags packed ready to fly to Korea, Turkey, or Mexico. Its just not true. The tax issue is more political than anything else.
Tuesday ~ February 28th, 2012 at 12:43 pm
Tax me, I dont give a rip
Affirmation i suppose, but enjoyed the write up never the less. Thanks
Tuesday ~ February 28th, 2012 at 1:55 pm
Tuesday links: the housing drag | Abnormal Returns
[…] How much do taxes matter to the really rich? (Baseline Scenario, Modeled Behavior) […]
Tuesday ~ February 28th, 2012 at 8:48 pm
Kaleberg
This is probably true for 10% of the working population. Most workers are paid hourly and their problem is getting enough hours in the face of a falling work week. Very few of them are seriously in love with their jobs checking groceries, placing traffic cones, making reservations and the like. Tax rates have no impact on their decisions at their level of income, and they are way far from using additional money to increase their leisure time or cut their level of household production. In fact, if they had more hours and more money, they might actually do more household production because they could buy a steak rather than settle for a dollar meal or microwave some noodles.
Most Americans are just so far down the utility curve, that this argument rings hollow.
Tuesday ~ February 28th, 2012 at 11:53 pm
PJR
Mike Kimel at Angry Bear and Presimetrics has done a lot of econometric analysis that shows GDP growth rates are best when the top income tax marginal rate is 60-70 percent, and he has interesting thoughts on why this is the case. Data indicate that our economy and tax base are strongest with such a rate on the top-most earners, but nobody willing to speak truth to power. Fear. What was it FDR say about fear?
Wednesday ~ February 29th, 2012 at 9:01 am
Romney Wins AZ and MI – Tyler’s AM Reads – February 29, 2012 « Blog of Rivals
[…] Karl Smith has some commentary on the recent Romer paper that looks at the implications of tax rate …. […]
Thursday ~ March 1st, 2012 at 12:07 am
Randall Parker
No way is 84% the point of max tax revenues. Consider what 84% tax rates would cause:
– Many people with their own business grow the business by consuming less and spending more back into their business. They take after-tax income from the day job to invest in their own start-up. Take away that money and those businesses would grow much more slowly or they wouldn’t get founded at all.
– Lots of people would drop out due to spite or anger.
– Lots of people would emigrate. (me for example)
– Lots of people would spend far more time using their own labor directly on their own lifestyle (making their own clothes, furniture, etc). They’d invest more heavily in skills they can use to make stuff for themselves rather than skills for the market. High taxes would reduce specialization of labor.
– At very high tax rates much of the economy would go underground. Corruption would be widespread.
Put yourself in the shoes of highly motivated and talented people faced with high tax rates. Think about their choices. The effects of a high tax rate would become greater over time as black markets, emigration, changes in skills development choices, and other factors ripped thru the economy.
Thursday ~ March 1st, 2012 at 12:18 pm
Thursday Political Sausage | Crasstalk
[…] Wonkery – Taxes could be increased to 84% before reduced incentives would outweigh the higher […]
Saturday ~ March 3rd, 2012 at 12:32 pm
Asymptosis » Where’s the High Point on the Laffer Curve? And Where Are We?
[…] tip Karl Smith and Mark […]
Sunday ~ August 4th, 2013 at 1:13 pm
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