The Laffer Curve and the Flat Tax Paradox

A just nation prospers. Nations built on lies contend with just nations, just laws, and just men. The highest just tax on “the rich” is the flat tax because any law that treats any group or person arbitrarily is unjust. Statistics do show, however, that just laws work far better at taxing the “rich” than lies. How weird is that? Despite the seeming paradox, taxing each person a percentage of his total earnings results in top earners the paying more taxes than when they are unjustly targeted.

Studies of the four key eras in which tax rates on top earners were reduced are conclusive: lower rates for the top income earners increase the total revenue the top earners pay. Even more importantly, the same studies show that narrowing the difference in rates paid by all tax payers results in the top earners paying the lion’s share of the total tax. This paradox cannot be overlooked by those seeking social justice, for the inverse is also the case. The more the government targets the top income brackets the more of the total tax is paid by the poor.

The chart below shows two immense drop offs in rates paid by the top income earners:

What is implicit in the dramatic drop off in tax rates for “the rich” between 1925 and 1931 and between 1980 and 1989 is that the difference between the rates paid by all narrowed. In 1918 the top rate was 77% and the lowest rate was 6%. By the time the five tax cuts of the 1920’s we completed, the top rate was 25% and the lowest rate was 1% (“Fact Sheet on the History of the U.S. tax system” IRS). An untrained eye must conclude that, since the top rate was reduced far more than the lowest rates, the booming economy of the 1920’s was paid for by the poor. Likewise, Marxist demagogues can teach that, despite the fact that everyone’s taxes were reduced, the top earners were given a “pass.” Surely, a college graduate in macro-economics might conclude this was a trade off. The government revenues were increased by the economic boom, but the rich paid less of the total tax burden.

That assumption, however, as the following chart shows, is incorrect:

The truth of the matter is that the narrowing of the income tax rate differential between the rich and the poor resulted in an increase in the total aggregate taxes paid by the rich. Even more telling, while the total of the aggregate taxes paid by the rich increased 100%, the decrease in the rates of total tax paid by the poor was over 1,000%. These figures are especially important because the 1920’s experienced a deflation of about 1% a year (“Deflation Nation.” Newsweek). That means that those making under $5,000 a year were not inflated out of existence.

The other pronounced tax rate valley shown above, the Reagan era, began with a reduction of the top rate from 70% to 50% and a reduction of the lowest rates from 15% to 11% (Economic Recovery Tax Act of 1981). This narrowing of the tax rates culminated with a reduction of the top rate from 50% to 28% and an increase in the lowest rates from 11% to 15% (Tax Reform Act of 1986). These incremental moves towards a flat tax rate did indeed increase growth and, thereby, the total revenue the federal government received from income taxes. However, this increased private sector vitality did not come because the top income earners were let off the hook. No, as the chart below show, the moves towards a flat tax rate increased the total amount of the federal income tax burden shouldered by the rich:

Some defenders of the Reagan era cuts, in a desperate plea for allowing the small businessman to have money to invest in the competitive economy of the future, have pointed to the increased standard deduction for the lowest income earners as both the reason for the rich paying more and as the model for future tax cuts. McKenzie, in What Went Right in the 1980s is quick to trumpet the fact that Reagan’s tax policy was egalitarian precisely because over his decade “… the average effective tax rate for the top 1 percent fell by 30 percent between 1980 and 1992, … by 35 percent for the top 20 percent of income earners, (and)… by 44 percent for the second-highest quintile, 46 percent for the middle quintile, 64 percent for the second-lowest quintile, and 263 percent for the bottom quintile (p. 277).” In the 1920’s the lowest rates fell by as much as five-hundred percent but the total income tax burden fell by over a thousand percent. The egalitarian methods of the Reagan era actually failed to reduce the burden on the poor as much as the simple narrowing of the margins that took place in the Roaring Twenties.

One of the Reagan compromises of the 1980’s, the use of an earned income tax credit, did indeed serve as a model for the Bush tax cuts of twenty-first century. Bush’s 2001 EGTRRA tax cuts actually increased the rate differences between the rich and the poor. They did so directly by reducing the lowest rates from 15% to 10% while reducing the highest rates from 39.6 to 35%. Meanwhile, the middle rates were reduced by as little as 2%. However, secondly, applying the Reagan model, tax credits and standard deductions were accelerated so that the lowest effective rates were actually much smaller than the stated 10%. This complicated attempt at “fairness” may have significantly reduced the growth rates of the economy. Certainly, however, the total income tax burden did not shift to the top earners as much as it should have. As the chart below demonstrates, the shift between top income earners and the lowest earners that actually paid taxes (the middle 20%) is very slight.

 

The negative percents in the second lowest 20 percent and in the lowest 20 percent are the results of “tax credits.” These “refunds” were actually Keynesian stimulus policies. Any tax refund, whether considered a Wal-Mart subsidy, a consumer stimulus, or a welfare payment compromise ought to be “paid for” in accordance with CBO scoring. Whatever these government rebates were, they were not tax cuts. These, like other Keynesian policies, actually have an effect opposite of what is intended. These tax stimulus packages did not forestall the mortgage crisis. They, perhaps, may have accelerated the disaster by providing down payments or savings account rationale for additional imprudent Fannie or Freddie loans.

The American economists of the Bush era had been training themselves in their political ideology since Reagan. They lay in wait for Bush to try his cuts, and the noise of the thunderous herd almost drowned out the moderate success of his policies. One of the weapons the Harvard Nobel Prize types came up with were models that showed who had the most after tax income. Yes, the top wage earners had the most take home pay after the tax rate decrease. This may well be because the middle tax rates were not properly flattened. A tax increase barrier separated the very rich from the very poor.

In every generation, the economy must be remade to be competitive and effective. This process does not require winners and loser, but it does require winners. If we will not allow the winners to become top wage earners, then, by definition the lowest wage earners will be all of us, and the poor will have to bare the lion’s share of the income tax burden.

The Laffer Curve is a paradox. Up to a certain point the more tax rates are reduced, the more tax revenues are raised. Beyond the prosperity that results from finding the correct tax rate, every era of tax reform in the twentieth century has shown that the top earners pay the most when the tax rates are closest to being flat. This flat tax paradox is as significant to governments that seek the prosperity of the private sector as it is to those who seek social justice. The recognition of this paradox is as essential to good governance as the recognition of supply and demand curves are to proper free market pricing.

Here comes the revolutionary free market theory: the best way to discover the optimal Laffer tax rate is with a flat tax, or a tax that is as nearly flat as can be dared. As with pricing goods in a free market, only tests give us certainty. When reducing prices fails to raise demand, prices may be raised. Likewise, when lower taxes on top income earners fails to produce more revenue, the optimal point on the Laffer Curve has been passed. However, to properly test the Laffer Curve, the flattest tax that can be designed should be used.

Certainly, the notions behind the Laffer Curve (that of risk, sweat equity, investment, and return on investment) are notions that apply to those who labor for more than essential needs. Food, housing, and transportation, at bare minimum levels, are largely inelastic demand curves. Laffer motivation will not apply there. However, without actual experimentation no one knows how far down into the middle class the Laffer Curve applies. How rapidly would those currently making $100,000 excel to $175,000 if their tax brackets didn’t change? How much more growth and prosperity would result from lower income brackets not being afraid to work, save and invest? This cannot be known without experiment.

As in the 1920’s, everyone should pay some tax. The top fifty percent, simply because they are the top fifty percent, should not be the only members of a free society paying income tax. The optimal Laffer Curve revenue line will be skewed by a continued practice of man-made egalitarianism. If economic history is to be believed, the flatter the tax the more egalitarian the outcome; targeting top earners actually ends up causing more of the tax burden to be paid by the lowest income earners. In other words, a lower tax rate on only the top 50% of tax payers may result in barely noticeable economic growth and barely noticeable increases in tax revenue. The application of the Laffer Curve in ways that increase the difference in income tax rates may, ultimately, result in mixed evidence that big government fanatics can use to discredit the Reagan-Kennedy revolution. If the Bush tax cuts did far less to stimulate the economy than did the Reagan-Kennedy cuts, it was because these cuts, in practice, moved away from a flatter tax, not towards it.

Tax Language for the Totalitarian State

  • An Employee’s FICA deduction: This is a payroll tax.
  • Earned Income Tax Credit: This is a tax cut. Because FICA is a payroll tax, even those that pay no federal taxes “deserve a refund” of their FICA.
  • Tax Cut: Like military spending and infrastructure spending, this is a federal expenditure also. Therefore, a tax cut must be “paid for.” Every year, the OMB fails in its duties by not calculating the federal expense involved in not levying a 100% tax on every man woman and child.
  • The Rich: Anyone who earns more than a household where both parents are teachers. Axiomatic: All the rich are involved in legalized criminality. They are purveyors of market extortion, wage slavery, or deliberate deception of consumers.
  • The Poor: These are the oppressed victims of the rich. These unwashed masses are often deceived by the malicious agents of capitalism into supporting fiscal conservatives. These people would unionize if they only understood what it meant to be poor.
  • Economic Stimulus: This is spending, preferably deficit spending. That’s why, no matter what the employment rates show, the Obama trillion dollar deficit spending package MUST have stimulated the economy. If it didn’t, it was only because we didn’t spend enough. Hence, the poor ought to receive all the tax cuts and the rich none.
  • Reaganomics: This was voodoo economics: the focus of all evil in the modern world.
  • Bush Era Tax Cuts: This is irresponsibility. These vicious tax cuts caused the oil price spikes of 2007, the real estate market collapse, and the ensuing meltdown of the global financial system.
  • Kennedy Tax Cuts: Kennedy only cut taxes because such cuts would result in Keynesian deficit spending. Deficit spending is always good. That is why Obama is the beloved one.
  • Coolidge-Harding Tax cuts: These NEVER happened. The 1920’s were evil. That’s all you need to know. There were gangsters and there were greedy people, and it all ended in the Great Depression. That is all you will EVER need to know.

As it is a serious rhetorical mistake to use the word “capitalism” when discussing the natural rights of a free people to prosper and to own property, so also it is a serious error to talk about tax policy and allow any of the above to be so defined. Here are the corrections:

  • An Employee’s FICA deductions: While it is true that the employer’s FICA contributions are taxes, the employee’s deductions are contributions to retirement insurance programs. No matter how likely it is that the federal government will renege on its legal obligation to repay with interest, the contributions made to these insurance plans, they are still, legally, employee contributions.
  • Earned Income Tax Credit: When this results in a net payment from the government to a citizen, this is a welfare payment. It may also be defined as disguised subsidy for businesses that provide insufficient wages for labor. This is a blatant redistribution of wealth. While, Reagan and others might argue that paying lower wage workers a small subsidy ultimately saves the genuine tax payers money that might be spend on unemployment, food stamps or other benefits to those that do no work at all, the Earned Income Tax Credit is NOT a tax cut. Hence, unlike any genuine tax cut, these federal distributions of other people’s wealth may be scored by the OMB.
  • Tax Cut: No tax cut is a federal expenditure. Money not taxed does not belong to the government. Hence, it cannot be spent. History is illustrative of the absurdity of trying to have an accounting scheme that accounts for what one does not have. Virtually every projection of revenue increase through increased taxes or of revenue loss for decreased taxes fail, and their failure are cascading ironies. Almost always, revenues, after tax increases, decrease. Revenues, after tax reductions, increase. Additionally, rates meant to target the rich tend to cause the poor to pay more of the overal tax burden. Likewise, evening the rates between the top bracket and the lower brackets tends to result in the rich paying more. It is like God is laughing at us.
  • The Rich:  While, this usually means the top wage-earners, “rich” has become a slur. All the “rich” are hateful, but, when asked, most folks consider those who are “rich” to be those who are only slightly wealthier than they are themselves. Who is to say who is really rich? The riches of abundance in an agricultural society may not involve a great need for the American dollar. Certainly, unless they’ve inherited a rent control penthouse, a family living in Manhattan making $250,000 per year is not rich. They are barely in the upper middle class. The use of “rich” instead of ‘top income earners’ is NOT to promote class warfare; it is used for the purpose of promoting the totalitarian ideal of egalitarianism. Anyone who has anything more than their neighbor is one of the deplorable “rich,” Heck, admit it, you know you yourself hate that fellow down the street. Yea, that one. Still, resist the temptation, for someone down the street hates you too.
  • The Poor: In terms of taxation, these are the lowest income earners. As it is impossible to know who among us are “rich,” except on a case by case basis, it is just as hard to know who the poor are. Why are some people indigent? Is a student working part-time, living in his parents’ house, driving his grandparents’ spare Prius, and being supported by a college grant one of the “poor”? Are there people who, even in a robust economy, would choose to work part-time while pursuing their passion for surfing? What of those who have sacrificed their considerable abilities to become the slaves of narcotics?
  • Economic Stimulus: Since every measurable increase in economic growth is, by definition, taxable, an economic stimulus is one that increases government revenue while decreasing government expenditure. This is called a tax cut. Actually, it is called enlightened tax policy. There is a place between no taxes and no government and totalitarianism where the maximum amount of revenue is collected. However, this number is affected by a number of other government policy vectors. Reducing government while reforming regulation, equality in tax rates, protection of the rights of property, prosecution of governmental corruption, transparency in laws and in government operation all form a nexus around correct tax policy.
  • The Kennedy Tax Cuts: While often defended by the totalitarian democrats of egalitarianism as an effort to employ Keynesian economics, these tax cuts served as a model taken up by Milton Friedman and Ronald Reagan. They were so effective that the Democrats couldn’t stand them. They were ended within four years by Lyndon Johnson.
  • Reganomics: The tax cuts of the 1980’s that resulted in the top income earners paying more of the tax burden than the lowest income earners. These tax cuts doubled federal revenues, ended inflation, and spurred growth at twice the rates of Johnsons’ great society.
  • The Bush Era Tax Cuts: This series of three tax cuts ultimately came close to equaling reduction in rates provided in the Reagan era. The third of these tax cuts was the first failed stimulus package of the American twenty-first century. It relied too heavily on income redistribution policies of increased standardized deductions and tax credits for children. The “simulative” effects went, primarily, to Saudi Arabia. Although it is difficult to disaggregate the data, like the Reagan tax cuts, the first two rate cuts for the top wage earners resulted in the lowest income earners paying less in taxes.
  • Coleridge-Harding tax cuts: These are the purest tax cuts in the last one hundred years. Unlike the Reagan and Bush tax cuts, these were largely simple rate reductions. They did not involve income tax credits, or increased standard deductions. The resulting prosperity in America is still almost beyond description. If it had not been for the prosperity of this age, America may not have survived World War II. This information is NOT difficult to disaggregate. After evening the tax rates, the lowest income earners CLEARLY paid less in taxes than they had under the rates that had previously targeted the top income earners.