The Laffer Curve

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Re: The Laffer Curve

Postby ucim » Thu May 28, 2015 10:03 pm UTC

mcd001 wrote:There's no need to avoid or evade taxes that you're not paying.
On the flip side, there's no need to avoid or evade taxes that you're not feeling either. The less well-off arguably feel a given percent of income more than the wealthy do. They can less afford to lose it, so have greater incentive.

But less ability.

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Re: The Laffer Curve

Postby Tyndmyr » Thu May 28, 2015 10:39 pm UTC

Most CPAs, etc work off of fairly flat fees, so regardless of subjective interpretations, someone with a larger tax hit in dollars, regardless of percentage, is more likely to see gains by hiring someone. The bigger the bill, the more incentive to reduce it. Said reduction may not be handled personally, of course, so if it makes sense on a large scale financially, it'll probably happen regardless of perceptions of subjective pain.

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Re: The Laffer Curve

Postby jewish_scientist » Mon Jun 08, 2015 4:07 pm UTC

I have not taken an economics course yet, and I can still find some fundamental problems with this.

1: What if the graph of Tax Rate vs. Income is not a function. In other words, a given tax rate can earn the government a little or a lot of money depending on other conditions. For example; the amount of money the government gains through a tariff on grain changes as the international weather, and therefor grain production, changes.

2: What if the graph of Tax Rate vs. Income is a polynomial of order 4 or more? Polynomials like these can have more than one 'maximums' and each can have a different value. One could be at 5 and another at 142654. If your starting point is close to the lower maximum, then you will mistakenly conclude that it is at the best tax rate.

3: What if people continue to work even though the tax rate is 100%? Volunteers are happy to work for no money. People who enjoy their work will continue working even though they are no longer being payed. In a totalitarian society, people will work because they fear the government, not because they want money. I know that practically a tax rate of 100% will still generate very little money in all these cases, my point is that the assumption that the government cannot make any money when the tax rate is 100% is wrong.

4: What if the two different tax rates interact such that changing either one tax will cause a loss in income, but changing both will cause an increase. The best way to explain this is with an example. Imagine a country where the tax rate on all crops is 10% and the tax on all restaurants is 15%. Moving the tax rate of crops to 5% will generate only a little less money, but give farmers much more money after taxes. As an experiment, the tax rate on crops is lowered to 5% and the tax on restaurants is increased to 20%. Now that farmers have more money after taxes, they can afford to improve their farms and grow even more crops. The increase in crops lowers the price per crop, causing restaurants to lower their prices. This in turn causes more people to go to restaurants, which causes the new restaurant tax to generate more money. Even though there is slightly less income generated by the crop tax, the increased income from the restaurant tax more than makes up for it. The Laffer Curve does not consider situations like this.
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Re: The Laffer Curve

Postby Tyndmyr » Mon Jun 08, 2015 6:12 pm UTC

jewish_scientist wrote:I have not taken an economics course yet, and I can still find some fundamental problems with this.

1: What if the graph of Tax Rate vs. Income is not a function. In other words, a given tax rate can earn the government a little or a lot of money depending on other conditions. For example; the amount of money the government gains through a tariff on grain changes as the international weather, and therefor grain production, changes.


Complexity of a function doesn't make it not a function. Nobody is positing that no variables exist other than tax rate. Good weather is good weather regardless of the tax rate, and we cannot reasonably expect the tax rate to alter it. Thus, it's an independent variable.

2: What if the graph of Tax Rate vs. Income is a polynomial of order 4 or more? Polynomials like these can have more than one 'maximums' and each can have a different value. One could be at 5 and another at 142654. If your starting point is close to the lower maximum, then you will mistakenly conclude that it is at the best tax rate.


Multiple maxima are possible, and may exist, at least in theory. However, this seems pretty unlikely, as I am not aware of historical evidence supporting this, and this is not at all normal for supply/demand curves, or optimal profit curves, etc. You'd want some sort of explanatory reasoning for why you would expect to see this, rather than the much more normal continuous curves you generally work with in economics.

There's a HUGE gap between "it's possible", and "it's a reasonable assumption".

3: What if people continue to work even though the tax rate is 100%? Volunteers are happy to work for no money. People who enjoy their work will continue working even though they are no longer being payed. In a totalitarian society, people will work because they fear the government, not because they want money. I know that practically a tax rate of 100% will still generate very little money in all these cases, my point is that the assumption that the government cannot make any money when the tax rate is 100% is wrong.


All economics has a certain degree of error. It need not *actually* be exactly zero on a national level. Approaching zero is all the data you need, though. There is no functional difference between the two in what you would do with the resulting knowledge. Income approaching zero is still obviously sub-optimal.

4: What if the two different tax rates interact such that changing either one tax will cause a loss in income, but changing both will cause an increase. The best way to explain this is with an example. Imagine a country where the tax rate on all crops is 10% and the tax on all restaurants is 15%. Moving the tax rate of crops to 5% will generate only a little less money, but give farmers much more money after taxes. As an experiment, the tax rate on crops is lowered to 5% and the tax on restaurants is increased to 20%. Now that farmers have more money after taxes, they can afford to improve their farms and grow even more crops. The increase in crops lowers the price per crop, causing restaurants to lower their prices. This in turn causes more people to go to restaurants, which causes the new restaurant tax to generate more money. Even though there is slightly less income generated by the crop tax, the increased income from the restaurant tax more than makes up for it. The Laffer Curve does not consider situations like this.


It's an abstraction. Much like supply/demand curves. You first learn a nice simplified example in an abstraction. THEN you add on the complexity. The fact that complexity exists doesn't mean that the simplified example is wrong, any more than simplified physics problems are wrong. They exist to demonstate a principle without confusion. The non-existance of spherical, frictionless cows does not disprove physics.

In this particular example, you have two tax rates, both of which have their own laffer curve(not necessarily the same). When taken together, there will either be one or more optimal points for net taxation, or an optimal range of taxation, with a tradeoff between the two rates within that range/points. Any of these points will be pareto optimal. Which of them you select would be chosen for reasons other than net efficiency of producing taxes.

Any number of differing tax schemas could be assessed in combination like this, as one or more pareto optimal solutions must always exist, it just means a little more complexity in the math.

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Re: The Laffer Curve

Postby ucim » Mon Jun 08, 2015 7:34 pm UTC

Tyndmyr wrote:Multiple maxima are possible, and may exist, at least in theory. However, this seems pretty unlikely, as I am not aware of historical evidence supporting this...

Tyndmyr wrote:In this particular example, you have two tax rates, both of which have their own laffer curve(not necessarily the same). When taken together, there will either be...


If you add two laffer curves, one with a max at a low rate, and one with a max at a high rate, you could easily get a double humped composite laffer curve.

Life is of course more complex than this, but it's not unreasonable to posit multple maxima, which may shift with time and demographics.

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Re: The Laffer Curve

Postby Zamfir » Mon Jun 08, 2015 8:11 pm UTC

They exist to demonstate a principle without confusion.

Not the Laffer curve, it was invented solely to give politicians a bullshit talking point when they wanted to lower taxes. According to wiki, no less than Donald Rumsfeld and Dick Cheney in their younger years! Good thing they never applied that same flexible-with-the-truth attitude to foreign politics, people might have been hurt.

Raising confusion is the point. There are experts in every government who can give reasonable estimates of the effect of changes in the tax structure.They usually give the disappointing answer that lowering taxes is likely to reduce revenue, one hand other hand gripping hand ceteris paribus et cetera. The Laffer curve allows the politician to forget about those pesky experts and draw a vague curve instead. Who knows, we might be on the right hand of the peak!

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Re: The Laffer Curve

Postby Tyndmyr » Mon Jun 08, 2015 8:19 pm UTC

Zamfir wrote:
They exist to demonstate a principle without confusion.

Not the Laffer curve, it was invented solely to give politicians a bullshit talking point when they wanted to lower taxes. According to wiki, no less than Donald Rumsfeld and Dick Cheney in their younger years! Good thing they never applied that same flexible-with-the-truth attitude to foreign politics, people might have been hurt.

Raising confusion is the point. There are experts in every government who can give reasonable estimates of the effect of changes in the tax structure.They usually give the disappointing answer that lowering taxes is likely to reduce revenue, one hand other hand gripping hand ceteris paribus et cetera. The Laffer curve allows the politician to forget about those pesky experts and draw a vague curve instead. Who knows, we might be on the right hand of the peak!


Laffer's an economist, and he cited historical precident for the principle. It became a political talking point as well, but that's utterly irrelevant. The laffer curve existed as an example to convey an old principle. It just happened to also be a political football.

Dismissing the principle on the basis that it was once talked about inaccurately by politicians seems a strange practice. One would be unable to talk meaningfully about nearly any principles if one applied such a standard fairly.

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Re: The Laffer Curve

Postby duckshirt » Mon Jun 08, 2015 11:54 pm UTC

I don't think he is dismissing the principle, he is dismissing it in practice, at least as it is used in US political discussions.
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Re: The Laffer Curve

Postby ahammel » Tue Jun 09, 2015 5:25 am UTC

jewish_scientist wrote:1: What if the graph of Tax Rate vs. Income is not a function. In other words, a given tax rate can earn the government a little or a lot of money depending on other conditions.
It is quite obvious that this is the case. However, that doesn't prevent economists from fitting the available data to a curve described by a function and using statistical techniques to quantify the error.
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Re: The Laffer Curve

Postby jewish_scientist » Tue Jun 09, 2015 5:36 am UTC

Here is another VERY obvious flaw with the Laffer Curve that I forgot to mention. Laffer says you should keep lowering taxes until you reach the maximum. However, let's say that as the tax rate lowered, so did revenue. Then next step would be to start raising the tax rate until you reach the maximum. It is basically the Goldilocks Method, which requires that you try both extremes.

Tyndmyr wrote:
jewish_scientist wrote:1: What if the graph of Tax Rate vs. Income is not a function. In other words, a given tax rate can earn the government a little or a lot of money depending on other conditions. For example; the amount of money the government gains through a tariff on grain changes as the international weather, and therefor grain production, changes.


Complexity of a function doesn't make it not a function. Nobody is positing that no variables exist other than tax rate. Good weather is good weather regardless of the tax rate, and we cannot reasonably expect the tax rate to alter it. Thus, it's an independent variable.


My point is that the Laffer Curve has no mechanism to deal with these types of variables. The graph only has the labels Tax Rate and Revenue. Anything but these two is not considered.

Tyndmyr wrote:
jewish_scientist wrote:
2: What if the graph of Tax Rate vs. Income is a polynomial of order 4 or more? Polynomials like these can have more than one 'maximums' and each can have a different value. One could be at 5 and another at 142654. If your starting point is close to the lower maximum, then you will mistakenly conclude that it is at the best tax rate.


Multiple maxima are possible, and may exist, at least in theory. However, this seems pretty unlikely, as I am not aware of historical evidence supporting this, and this is not at all normal for supply/demand curves, or optimal profit curves, etc. You'd want some sort of explanatory reasoning for why you would expect to see this, rather than the much more normal continuous curves you generally work with in economics.

There's a HUGE gap between "it's possible", and "it's a reasonable assumption".

The fact that the function has only one maximum is necessary for the Laffer Curve to be applied. If you already have enough information to know whether or not this is true, then why would you use the Laffer Curve. Remember, it is basically the Goldilocks Method. If you already have information about each extreme and values in the middle, then the Goldilocks Method is not a good way to find the maximum.

Tyndmyr wrote:
4: What if the two different tax rates interact such that changing either one tax will cause a loss in income, but changing both will cause an increase. The best way to explain this is with an example. Imagine a country where the tax rate on all crops is 10% and the tax on all restaurants is 15%. Moving the tax rate of crops to 5% will generate only a little less money, but give farmers much more money after taxes. As an experiment, the tax rate on crops is lowered to 5% and the tax on restaurants is increased to 20%. Now that farmers have more money after taxes, they can afford to improve their farms and grow even more crops. The increase in crops lowers the price per crop, causing restaurants to lower their prices. This in turn causes more people to go to restaurants, which causes the new restaurant tax to generate more money. Even though there is slightly less income generated by the crop tax, the increased income from the restaurant tax more than makes up for it. The Laffer Curve does not consider situations like this.


It's an abstraction. Much like supply/demand curves. You first learn a nice simplified example in an abstraction. THEN you add on the complexity. The fact that complexity exists doesn't mean that the simplified example is wrong, any more than simplified physics problems are wrong. They exist to demonstate a principle without confusion. The non-existance of spherical, frictionless cows does not disprove physics.

In this particular example, you have two tax rates, both of which have their own laffer curve(not necessarily the same). When taken together, there will either be one or more optimal points for net taxation, or an optimal range of taxation, with a tradeoff between the two rates within that range/points. Any of these points will be pareto optimal. Which of them you select would be chosen for reasons other than net efficiency of producing taxes.

Any number of differing tax schemas could be assessed in combination like this, as one or more pareto optimal solutions must always exist, it just means a little more complexity in the math.


My point is that applying Laffer Curves to this situation is a little like Prisoners Dilemma. Each individual prisoner reaches the conclusion that they should become a traitor; but as a group the conclusion is that neither of them should. When looking at each individual tax Laffer would recommend not changing the tax rate; but when both are looked at together the best decision would be to change both.

Zamfir wrote:Good thing they [Donald Rumsfeld and Dick Cheney] never applied that same flexible-with-the-truth attitude to foreign politics, people might have been hurt.

I am 80% sure that this is sarcasm. If it is, yeah, that's a funny joke. If it is not, look up the Bush administration's reasons for invading any country that we invaded.
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Re: The Laffer Curve

Postby Zamfir » Tue Jun 09, 2015 7:11 am UTC

duckshirt wrote:I don't think he is dismissing the principle, he is dismissing it in practice, at least as it is used in US political discussions.

Yeah this. I don't mean the general point that tax increases tend to yield less than you would expect from simple extrapolation. It's the specific Laffer-curve argument where someone draws a curve with zeros at 0% and 100% and a maximum in between. That pretty much always shows up as political chaff. If its political uses are irrelevant, then the whole concept doesn't have much relevance.

From a theoretical point, it's no more than a funny idea. After all, we have a lot of data and knowledge about economic effects in the neighbourhood of the current tax schedules, while we can't say much about near-100% tax rates. The latter are pretty much restricted to Pigouvian taxes, or side effects of a quasi-nationalization. Oil companies that pay out most of their profits in return for a right to drill, or the Federal Reserve banks that give all of their profits to the US treasury.

So, someone talks about a rough global curve based on a fuzzy argument about 0% revenue at 100%, instead of the deeply studied (but still debatable) local effects near the present situation. It's the equivalent of a magician waving their white-gloved hands.

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Re: The Laffer Curve

Postby leady » Tue Jun 09, 2015 10:26 am UTC

Putting the politics aside it would be interesting to see politicians actively balance the tax rates vs the tax take vs the drag on future growth (which in effect is future tax take) rather than always making unfunded promises and using obfuscating tax structures.

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Re: The Laffer Curve

Postby Zamfir » Tue Jun 09, 2015 11:55 am UTC

How could that be done while putting politics aside? Who to tax and how much is surely one of the most political topics there is.

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Re: The Laffer Curve

Postby Tyndmyr » Tue Jun 09, 2015 6:34 pm UTC

duckshirt wrote:I don't think he is dismissing the principle, he is dismissing it in practice, at least as it is used in US political discussions.


Regan having been out of office for quite some time now, this is a bit akin to disliking that whole Watergate thing.

jewish_scientist wrote:Here is another VERY obvious flaw with the Laffer Curve that I forgot to mention. Laffer says you should keep lowering taxes until you reach the maximum. However, let's say that as the tax rate lowered, so did revenue. Then next step would be to start raising the tax rate until you reach the maximum. It is basically the Goldilocks Method, which requires that you try both extremes.


If you're maximizing revenue, yes. This is obvious. The idea of a rate being too low to maximize revenue is inherent, and uncontroversial.

jewish_scientist wrote:My point is that the Laffer Curve has no mechanism to deal with these types of variables. The graph only has the labels Tax Rate and Revenue. Anything but these two is not considered.


That is normal. You do not create an axis for every thing that could affect numbers, because 27-dimensional graphs are not very useful for presenting information. You graph the things you wish to depict, labeling them, etc, and discuss other elements in detail outside of the graph as appropriate. That's pretty much how all graphs are used everywhere, with statistical methodologies, independent variables, etc discussed elsewhere.

jewish_scientist wrote:The fact that the function has only one maximum is necessary for the Laffer Curve to be applied. If you already have enough information to know whether or not this is true, then why would you use the Laffer Curve. Remember, it is basically the Goldilocks Method. If you already have information about each extreme and values in the middle, then the Goldilocks Method is not a good way to find the maximum.


The curve is just a curve. The goldilocks method is merely a way to use the curve. Different data would inform different choices of action.

Discovering say, two maxima would still be interesting and useful.

jewish_scientist wrote:My point is that applying Laffer Curves to this situation is a little like Prisoners Dilemma. Each individual prisoner reaches the conclusion that they should become a traitor; but as a group the conclusion is that neither of them should. When looking at each individual tax Laffer would recommend not changing the tax rate; but when both are looked at together the best decision would be to change both.


They are distinctly different concepts. Yes, many people want lower taxes for themselves. That is, however, not a function of the Laffer curve, but simply basic self interest.

The fact that a composite graph will have different data than individual graphs is...obvious. This is a basic element of economics. Looking at the overal supply/demand for a market is not the same as looking at graphs for submarkets, and optimal price points, etc are likely different. I'm not sure why you consider this to be important.

Zamfir wrote:
duckshirt wrote:I don't think he is dismissing the principle, he is dismissing it in practice, at least as it is used in US political discussions.

Yeah this. I don't mean the general point that tax increases tend to yield less than you would expect from simple extrapolation. It's the specific Laffer-curve argument where someone draws a curve with zeros at 0% and 100% and a maximum in between. That pretty much always shows up as political chaff. If its political uses are irrelevant, then the whole concept doesn't have much relevance.


Determining optimal tax rate seems like a valid and reasonable use, and one in which real numbers/data can be used. Discarding it solely because it's shown up in bullshit political discussions is literally throwing away the principle. It's relevance to tax rates is obvious, and it is not really different from any number of other optimization exercises.

Zamfir wrote:From a theoretical point, it's no more than a funny idea. After all, we have a lot of data and knowledge about economic effects in the neighbourhood of the current tax schedules, while we can't say much about near-100% tax rates. The latter are pretty much restricted to Pigouvian taxes, or side effects of a quasi-nationalization. Oil companies that pay out most of their profits in return for a right to drill, or the Federal Reserve banks that give all of their profits to the US treasury.


Yes, data is usually always best about doing things the way we usually do them. So? Does the available data contradict the existence of such a curve? If not, why the resistance to it as just a "funny idea"? Why is it strange to consider that taxes are subject to similar economic laws to everything else?

Zamfir wrote:So, someone talks about a rough global curve based on a fuzzy argument about 0% revenue at 100%, instead of the deeply studied (but still debatable) local effects near the present situation. It's the equivalent of a magician waving their white-gloved hands.


Why do you think tax rates at 100% are so very rare? Random chance? And such a thing would really be a good idea?

What is the best explanation for why 100% tax rates are avoided? Something supported by some data? Or should we just ignore it very hard?

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Re: The Laffer Curve

Postby leady » Tue Jun 09, 2015 7:08 pm UTC

Zamfir wrote:How could that be done while putting politics aside? Who to tax and how much is surely one of the most political topics there is.


with great difficulty !

I'm thinking say shifting the how away from the what and why, for example a government can say it wants a new hospital and where the money should come from, but the implementation is outside the political discussion (civil servant economists etc). A pipe dream - but it might force a bit of honesty :)

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Re: The Laffer Curve

Postby Tyndmyr » Tue Jun 09, 2015 8:53 pm UTC

leady wrote:
Zamfir wrote:How could that be done while putting politics aside? Who to tax and how much is surely one of the most political topics there is.


with great difficulty !

I'm thinking say shifting the how away from the what and why, for example a government can say it wants a new hospital and where the money should come from, but the implementation is outside the political discussion (civil servant economists etc). A pipe dream - but it might force a bit of honesty :)


Well, often the great plans and the budgeting for them are not even done at the same time. The US isn't even particularly good about passing a budget on time, let alone good at matching up budgetary measures with their great plans.

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Re: The Laffer Curve

Postby AndyG314 » Fri Jun 12, 2015 9:25 pm UTC

From the 10,000 foot view the Laffer Curve makes a reasonable argument. That a sufficiently high tax rate can depress the economy enough that the economic contraction will outpace the increase in tax rate resulting in lower net income for the government. Assuming that the curve was continuous then there exists an "Optimum" tax point that maximizes the governments income. This doesn't mean that the Laffer Curve is an effective argument for lowering taxes.

So, taking some liberties with the math, the test for whether you think the Laffer Curve works is to think about 'What would happen if the tax rate werer 99%?' and if you wish to be more 'proper' with the math, you should think about whether the underlying assumptions in the curve make sense and whether it works with real world examples.

I think that at 99% tax society as we know it breaks down. The idea of a 0 percent or 100% are silly. What happens at these endpoints doesn't tell us anything useful.

What if the graph of Tax Rate vs. Income is a polynomial of order 4 or more? Polynomials like these can have more than one 'maximums' and each can have a different value. One could be at 5 and another at 142654. If your starting point is close to the lower maximum, then you will mistakenly conclude that it is at the best tax rate.

If two tax rates generate the same amount of income, then I can't think of any good reason to prefer the lower one. I'd rather not pay more in taxes than I have to.

Here is another VERY obvious flaw with the Laffer Curve that I forgot to mention. Laffer says you should keep lowering taxes until you reach the maximum. However, let's say that as the tax rate lowered, so did revenue. Then next step would be to start raising the tax rate until you reach the maximum. It is basically the Goldilocks Method, which requires that you try both extremes.

If the current tax rate is sufficient to meet the government's expenditures, there is no reason to raise taxes. Again I'd rather not pay more in taxes than I have to.

The flaw in the argument has nothing to do with the curve itself. It has to do with the fact that it's proponents give us no good reason to assume that we are taxing at a greater than optimal rate. If good reason to think this can be shown, then lowering taxes is a no brainier, we're essentially getting something for nothing. But nothing in the analysis given shows that this is true, or even gives us any idea what the shape of the curve looks like.
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Re: The Laffer Curve

Postby Tyndmyr » Mon Jun 15, 2015 4:12 pm UTC

AndyG314 wrote:From the 10,000 foot view the Laffer Curve makes a reasonable argument. That a sufficiently high tax rate can depress the economy enough that the economic contraction will outpace the increase in tax rate resulting in lower net income for the government. Assuming that the curve was continuous then there exists an "Optimum" tax point that maximizes the governments income. This doesn't mean that the Laffer Curve is an effective argument for lowering taxes.


Yeah, everyone here's pretty much there.

It's only an argument for lower taxes by itself if you've demonstrated that the current taxation rate is higher than the optimal point. Otherwise, it's just a curve for showing one cost/benefit of increasing/decreasing taxes by x as part of a much broader assessment. This is already routinely done, and it's fairly trivial to discover that US taxation rates are generally lower than the optimal collection point. In fact, the same is true pretty much everywhere.

I think that at 99% tax society as we know it breaks down. The idea of a 0 percent or 100% are silly. What happens at these endpoints doesn't tell us anything useful.


0% tax rates do actually come up with some frequency. A number of states, for instance, do not have a sales tax, which is identical to a 0% tax. 100% tax rates are much more rare, and are generally avoided. So yeah, it isn't going to come up much in practice...but it still has theoretical value. For instance, if you're testing models against reality, you would likely want to discard anything that predicts 100% tax rates are wonderful for all concerned as trivially incorrect. This is only one tiny example of how economic models are tested, as economic reality is complicated, but how models handle the extremes can still be interesting.

If two tax rates generate the same amount of income, then I can't think of any good reason to prefer the lower one. I'd rather not pay more in taxes than I have to.


Usually other factors are considered. The laffer curve is only considering a single factor, and in reality, tax rate affects other things as well. You're probably not even optimizing for maximum tax take at the present time. Perhaps a lower rate enables stronger growth, and results in a better tax take over a longer span of time, perhaps.

At least, this would be the sort of discussion we'd have if tax rates were set by more objective criteria than often exists in politics. Data often become weapons in service of ideologies, not the basis for decision making.

I think *most* of the people in this thread are actually fairly close in agreement on most of this. People just keep pulling in the historical political errors to argue against rather than the idea itself.


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