Sunday, February 26, 2012

Brits Learn Laffer Lesson

The Right-o-sphere is buzzing from a WSJ editorial which shows how when Britain recently raised the tax rates on the wealthy from 40 to 50%, the revenue collected actually dropped 5%:
"Speaking of higher taxes (and President Obama always does), there's news from once fair Britannia. Preliminary figures out this week show that Britain's 50% top marginal income-tax rate may have reduced tax revenue from top earners by as much as 5%, compared to the old 40% top rate. Tax revenue from those filing self-assessments due January 31 was down some £500 million versus last year.
This is generally consistent with the "Laffer Curve" after Arthur Laffer, an economist for Ronald Reagan, made the fairly obvious observation that if you didn't tax at all you get zero revenue, and if you tax at 100% you also get zero revenue (at least in the long run), and that somewhere in the middle (not necessarily 50%), there was a tax rate where you got a maximum yield of revenue.  The notion, despite it's obvious truth, is somewhat in disrepute, largely due to it's association with Reagan and "trickle down" economics so hated by the media.

Curiously, the same obvious observation lies behind much of fisheries science.  In this case, if you don't fish, you don't catch any. But if you fish hard enough, you eliminate the breeding stock, and ultimately you don't catch anymore. Somewhere in between is the Goldilocks zone.  In fisheries, this is called "The Maximum Sustainable Yield", and commonly occurs when the tax rate fishing mortality exceeds about 30% annually.

The difficulty with both the economy and fish is determining where the point of the maximum is.  with fish you can experiment a bit, and try different levels, and follow the population response.  In real fisheries, of course, the fish vary with more than just the fishery and the  data are messy and rather than a clean curve you get a cloud of points which suggest a maximum.  With tax policy, you have similar noise issues, and you have to fight it through the political process. Finally, there are some people who would prefer a higher tax rate even if it results in lower revenue on the basis of "fairness".

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