I am new to experimental econ, but have been working on some experiments that will help me understand the shape of the Laffer curve. As a starting point, nobody should doubt that the Laffer curve exists, only what shape it is. Nevertheless, most commentary (like mine about the gas tax earlier this week) uses the static assumption that tax rates do not affect behavior. For example, the top marginal tax rate has been lowered, even though the rich are getting richer. But which caused which?
Greg Mankiw comments on just how big that mistake might be to assume incomes are unrelated to taxes:
Over the past half century, the top marginal tax rate has fallen from 91 percent in the 1950s and early 1960s to 35 percent today. Thus, the amount a person gets to keep at the margin has risen from 9 percent to 65 percent, that is, by a factor of 7.2. If the elasticity of taxable income with respect to 1-t is one, as some studies find for high-income taxpayers, then the incomes of the rich would have risen by a factor of 7.2 as well. If the elasticity is one-half, then their incomes would have risen by a factor of 2.7. In either case, the change in pretax income attributable to the tax cuts is substantial.
The pickle is that self-employment seems to rise along with tax rates. That may seem counterintuitive, but it makes sense if you consider tax avoidance. Employees can't hide income, entrepreneurs sometimes can. Think about the next time you see a small restaurant offer discounts to cash customers.
It’s true that we don’t know what we’ve got until we lose it, but it’s also true that we don’t know what we’ve been missing until it arrives.
Posted by: replica watches | July 15, 2010 at 05:51 AM