the ULTIMATUM GAME: The Laffer Curve doesn't depend upon what you think is a fair tax rate | Adam Smith Institute

The Laffer Curve doesn't depend upon what you think is a fair tax rate | Adam Smith Institute

The Laffer Curve doesn't depend upon what you think is a fair tax rate

Written by Tim Worstall | Monday 24 December 2012

While scribbling elsewhere on Gerard Depardieu and his fleeing of the extortionate tax rates in France it occured to me that there's something rarely mentioned in this whole thing about where the peak of the Laffer Curve is. It's that that peak isn't determined by what you think is a fair rate of tax that they should pay is. Nor what the community in general, or democracy, politicians, think is a fair rate. It's determined by what those who have to pay the tax rate think is a fair rate.

And there's a lot of very interesting economics been done on what people do think is fair: take theultimatum game for example. Two people, $100. One of them gets to decide how the two will split it. The other one can accept the split or reject it: on rejection neither of them get anything.

The logical policy is to accept any split at all from 1:99 on up. Hey, at least you'll get a whole dollar! But as it turns out people just don't react that way. As soon as the split starts getting worse than $40:$60 the rejection rate goes way up. The conclusion is that we're so tied up, we weird humans, about fairness that we will even punish ourselves in order to punish someone else we think is acting unfairly. There have also been experiments with both monkeys and apes (although with lovely pieces of fruit rather than useless pieces of paper) that lead to the same conclusion. All of us higher primates seem to be wired pretty much the same way: you try and rip me off and I'll take you down with me fella.

I've not seen this point explicitly made anywhere: although I assume that's to do with my lack of reading more than anything else. But if that sense of fairness is hard wired, then obviously it's also going to apply to those we're trying to tax. Which will mean that that peak of the Laffer Curve, that rate at which people bunk off, leave the country, reduce their work loads, lie or cheat the taxman, isn't determined by what we think is a fair rate to tax them. It's a result of what they think is a fair rate to tax them. Which, of course, could be a very different rate indeed from what we think is a fair rate.

Indeed, when we look at the family fortunes and incomes of those who advocate much higher tax rates we do indeed see all sorts of shenanigans going on to avoid those higher rates. The list of wills altered, trusts to hide from inheritance tax, personal service companies, dividend splitting and all the rest: even those who propose those higher taxes rates wriggle as if they think they are unfair when applied to themselves. That revealed preferences thing again: those who face those rates don't think they're fair.

And as I say, adding that unltimatum game into the mix does tell us something very interesting. It's not what we, or the left, think is a fair tax rate that matters. It's what the people paying the tax think is a fair rate that does. And as that game tells us, people start getting very unhappy with anything less than a 40:60 split. To the point where they will indeed give up income themselves in order to punish those offering such a measly share.

Rupert Darwall: Britain's Great Stagnation - WSJ.com

Rupert Darwall: Britain's Great Stagnation - WSJ.com

comments from other reader:
"...exploiting a weak regulatory environment...The UK was, and to many extent still is, an example writ large of the Bush-era folly of combining laissez-faire with tax cuts, ...An inadequately regulated financial market generated false signals about future returns, ..."

response:


What you may be benignly choosing to ignore is the role of government in the US setting up the liberal idea that everyone should be able to own a home (e.g. not reining in Fannie and Freddie and all that lending - after all, if people don't qualify but should, then the qualifications have to be unfair, etc.); and, in a broader bank regulatory environment, the idea of replacing bank-determined risk-based lending with the substitution of regulatory insight (e.g. Basel xxxx almost requiring banks to fund feckless governments).

And, as baby Obama is now lamenting like the parent who wants to keep charging things to the credit card (i.e. how can you want to limit my government credit line) vs. the parent (Republicans) saying you are spending more than you have and effectively proscribing the assets to be used for investment to support current consumption.

Your comments perfectly highlight the ability of all-too-many people to ignore common sense and somehow see government and its programs and regulations as only benefiting them (or those they think deserve the benefits) without being willing or able to recognize there are consequences and tradeoffs.

Somehow what they would do in their own family life with respect to credit card debt is seen as not applicable to government.

And, the use of debt to encourage consumption rather than to invest for retirement, a rainy day or a worthwhile something-or-other is also seen as something individuals might consider; but, instead something governments can ignore (or at least only charge a few citizens or businesses to pay for).

Somehow, the old saying about "the blind leading the blind" seems more applicable to your reading of economic affairs than the opposite:

See; http://online.wsj.com/article/SB10001424127887323320404578215873697800166.html?mod=opinion_newsreel

David Malpass: Nothing Is Certain Except More Debt and Taxes - WSJ.com

David Malpass: Nothing Is Certain Except More Debt and Taxes - WSJ.com

• OPINION
• January 1, 2013, 6:53 p.m. ET

David Malpass: Nothing Is Certain Except More Debt and Taxes

The Senate fiscal-cliff bill still means higher taxes on every working American. So much for just going after 'the rich.'

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By DAVID MALPASS

Whatever ultimately emerges from the fiscal-cliff negotiations over the past 48 hours, the country will survive. But the damage can't be undone. Taxes are going up for all working Americans. And so is the size of government.

Businesses have been waiting to see whether a second Obama administration will encourage the economy. During the fiscal-cliff negotiations, however, the president made clear that his goal isn't to get business going again but instead to expand government and redistribute income. He offered no real spending cuts and instead used the year-end deadline to divide America into classes—to the point of campaigning on New Year's Eve against higher earners. Though the president talks about fairness, his policies penalize profit and investment. This hurts aspiring Americans more than it hurts those who have already made it.

The deal that emerged from the Senate early Tuesday morning is being sold as a tax cut for the middle class, but the expiration of the two-percentage-point payroll tax holiday means that working Americans' take-home pay will drop. The bill reduces the value of tax deductions for upper incomes and, with the new open-ended 3.8% Medicare tax that was enacted under ObamaCare, income-tax rates on families and small business owners earning over $450,000 have been pushed above 44%.

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The Senate bill makes the tax code more complex, provides for no spending cuts and creates four deadlines—for the debt-limit increase within weeks, the March 1 automatic spending cuts known as the sequester, a second sequester on March 27 (to make up for overspending since the first sequester) and the March 30 expiration of government spending authority. These deadlines will keep Washington negotiations on the front page for months but with little likelihood that government will cut programs, sell assets or downsize the 1,300 federal agencies and commissions.

No wonder many House Republicans balked at what was presented. The New Year's Day legislation is breathtaking in its largess. The Senate bill extends 52 tax credits, mostly for one year, ensuring huge annual lobbying fees and political contributions. Section 206 provides a juicy capital-gains tax exemption for contributions of property for conservation, meaning wealthy environmentalists with extra acreage will be able to take a tax deduction for the appreciated property and have the environmental organization preserve it, adding to the value of the primary property. Section 312 provides faster tax deductions for "motorsports entertainment complexes." Section 317 allows expensing of film and television productions, meaning lower taxes for Hollywood.

The bill devotes much space to tax credits for government-approved energy schemes, providing taxpayer subsidies for energy-efficient new homes, existing homes, appliances, cellulosic biofuel and "Indian coal facilities." Underscoring the complexity of the tax code, the bill takes seven pages to index the alternative minimum tax for inflation because it takes side trips to curry favor with the owners of plug-in electric vehicles and with first-time home-buyers in the District of Columbia.

The pattern across the developed world is for politicians to negotiate with each other and, after much drama, make the brave decision to downsize jobs through taxes and mandates rather than downsizing government. This country is no different: Whatever tax and spending decisions Washington makes over the next few months, the likelihood is that government will be bigger in 2013 and the fiscal problems even more urgent.

There has emerged from the budget negotiations no process to cut government programs, limit the debt or reform the tax code. Many tax rates have now gone up and almost no spending restraint has been implemented, hurting 2013 investment and hiring. Even if the spending sequester is allowed to proceed on March 1 or substitutes are found, the cuts will be a small fraction of the spending binge in recent years that left a string of $1 trillion deficits.

The Congressional Budget Office scores the Senate bill as adding $4 trillion to the national debt by 2022. That assumes the sequester or equivalent spending cuts are fully implemented in March, which seems unlikely. Some are hoping that during the coming confrontation over the debt-limit increase fiscal conservatives will be able to recover lost ground on spending. That won't work, because the debt limit doesn't provide much leverage.

The debt-limit statute was written specifically to make it easier to increase the debt, not as a way to limit the debt. It should be repealed and replaced with a law that cuts spending when there is too much debt. While Republicans rightly want to stop the unending growth in debt, the current debt-limit statute gives most of the power to the president, allowing him to shut down parts of the government and blame holdouts until he gets enough votes for more debt.

Rather than rejecting an increase in the debt limit, fiscal conservatives should offer a lasting remedy. This would be a debt-to-GDP limit that, when exceeded, would give the president the power to underspend congressional appropriations and to propose fast-track reductions in entitlements—but would also require him to make monthly reports to the public on excess spending and prohibit raises for government employees making over $100,000.

Fighting under the current rules isn't working and leaves government inexorably bigger. The country can't afford this approach. Demographics are making it harder each year to restrain spending or win elections on the platform of limited government. The rules pit fiscal conservatives against themselves, leading to bigger government.

Regardless of how the current crisis is ultimately resolved, there is sure to be another. Republicans and fiscally conservative Democrats should use every opportunity to strengthen the framework for limited government, in order to restrain federal spending and allow the private economy to grow.

Mr. Malpass, a deputy assistant Treasury secretary and legislative manager for the 1986 Tax Reform Act in the Reagan administration, is president of Encima Global LLC.