08 February 2013

Maybe I’m Right After All

A while ago I theorized that:

The Laffer curve suggests that there is a revenue-optimal tax rate between 0% and 100%. Where this specific point is for federal revenue is unknown, but history suggests that revenue will not generally exceed 20% of GDP, and that optimal tax rates generally tend to be below 50%. My personal opinion is that, assuming a highly simplified tax code (one or two collection points and few to zero loopholes), the optimal tax rate will be in the low to mid twenty percent range.

When Congress was considering raising the capital gains tax rate from 20 percent to 28 percent in 1986, the Congressional Budget Office advised Congress that this would increase the revenue received from that tax. But the Congressional Budget Office was wrong, not simply about the amount of the tax revenue increase, but about the fact that the capital gains tax revenue actually fell.

So, when a tax rate was raised from 20% to 28%, revenue from that tax decreased.  This moderate upward adjustment in rate led to a revenue decline, and serves as anecdotal evidence that my theory that the optimal tax rate is in the low to mid twenty percent range is probably correct.  Of course, standard caveats apply:  this is just one example; this example may not be indicative of other taxes;  more proof is needed.

Still, if this anecdotal is proof of anything, it is interesting to note that tax cuts may actually do double duty, in that it makes economic recovery more feasible by reducing people’s tax burdens while also reducing the budget deficit.  Given the dual benefits of decreasing nominal tax rates, I fully expect congress to raise taxes even higher.