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Readers of a certain vintage will recall the infamous “Laffer curve,” popularized during the Reagan administration, which illustrated that governments raise no money when tax rates are zero and also when they are 100 percent (because why would anyone work?). In between, tax revenue rises along with rates, but eventually maxes out and begins to decline as overtaxed people start to ask, “Why bother?”
If we were already past the maximum, it was theoretically possible to cut taxes without cutting spending. Unfortunately, we weren’t; President Ronald Reagan cut taxes and deficits soared. Ever since, the left has tended to treat the Laffer curve as an irrelevant joke, which is a mistake. At some point, tax increases do cost the government money. And before this point, they start costing the rest of us money, as returns to working and saving decline and people place more emphasis on consumption and leisure.
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But where is this point? The frustrating answer is “it’s complicated,” as demonstrated by three new papers in the American Economic Journal: Economic Policy on the effects of changes in state income taxes.
One of these, by Joshua Rauh and Ryan Shyu, looked at the behavior of high-earning households after California passed a 2012 proposition that brought the top marginal tax rate to 13.3 percent on the highest earners. (It’s now over 14 percent if you include the payroll tax for the state disability insurance.) A second, by David R. Agrawal and Kenneth Tester, looked at the behavior of professional golfers who play tournaments and pay taxes all over the country. And a third, by Traviss Cassidy, Mark Dincecco and Ugo Antonio Troiano, examined what happened after states introduced their income taxes at varying times. (Which is how I learned that Wisconsin pioneered the modern income tax.)
All three conclude that when a state starts taking more income, people respond by trying to move income out of the state’s reach, an effect that is most pronounced for the highest earners. High-earning golfers are less likely to participate in tournaments conducted in states that take a bigger share of their prize money. High-earning residents were more likely to leave California after their taxes rose, and those who stayed seem to have earned less income. And overall, states that imposed income taxes for the first time saw out-migration increase.
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Yet these findings don’t tell us what the revenue-maximizing rate is — because there is no one revenue-maximizing rate. It depends on the place, the time and even the individual taxpayer.
For example, the paper on golfers suggests that people make decisions about where they work, as well as where they live, based on taxes — but it would take considerable further research to generalize pro-golfers to more ordinary working stiffs. The paper on the state-by-state introduction of income taxes indicates that they spurred migration, but only after World War II, when states got more efficient at collecting taxes and transportation improvements made it easier to move. And the paper on California taxes suggests strong taxpayer response to higher rates — but the highest earners who responded most strongly probably have more ability to relocate, or structure their income in tax-avoiding ways, than the average wage slave.
Two things do seem clear, however: Tax rates matter, even if exactly how much they matter depends on circumstances — and also, our circumstances are changing. Whatever the revenue maximizing rate was five years ago, it’s probably lower now, thanks to remote work.
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Like the interstate highways, remote work makes it easier for workers to move both home and workplace. Companies might find it easier to recruit employees while headquartered in D.C., which taxes only D.C. residents, than in Massachusetts or New York, which tax incomes based on the employer’s location. So, states are going to have to figure out just how much they can take from a more mobile workforce — and make sure the services they deliver in return are worth the price. Otherwise, they risk losing workers and companies to states that understand their fiscal limits.
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In 1911, Wisconsin enacted the United States’ first modern state income tax — preceding the modern federal income tax by two years. Thus, the Badger State gets credit for inaugurating the eternal debate that still plagues U.S. politics: How much is too much, taxation-wise?
This seemingly simple question is actually two questions, neither of which is simple at all. Both are important for state and federal governments to answer — especially now when remote work is rewriting the possibilities.
First is the moral question of how much society is entitled to take. Unfortunately, there is no definitive answer for this. Team “you didn’t build that” will probably still be duking it out with team “taxation is theft” even as the sun expends the last of its nuclear fuel, bloats into a red giant and absorbs the Earth in its fiery embrace.
Somewhat easier to resolve is the second question, the technical calculation of how much the government can take before tax increases become counterproductive.
Readers of a certain vintage will recall the infamous “Laffer curve,” popularized during the Reagan administration, which illustrated that governments raise no money when tax rates are zero and also when they are 100 percent (because why would anyone work?). In between, tax revenue rises along with rates, but eventually maxes out and begins to decline as overtaxed people start to ask, “Why bother?”
If we were already past the maximum, it was theoretically possible to cut taxes without cutting spending. Unfortunately, we weren’t; President Ronald Reagan cut taxes and deficits soared. Ever since, the left has tended to treat the Laffer curve as an irrelevant joke, which is a mistake. At some point, tax increases do cost the government money. And before this point, they start costing the rest of us money, as returns to working and saving decline and people place more emphasis on consumption and leisure.
But where is this point? The frustrating answer is “it’s complicated,” as demonstrated by three new papers in the American Economic Journal: Economic Policy on the effects of changes in state income taxes.
One of these, by Joshua Rauh and Ryan Shyu, looked at the behavior of high-earning households after California passed a 2012 proposition that brought the top marginal tax rate to 13.3 percent on the highest earners. (It’s now over 14 percent if you include the payroll tax for the state disability insurance.) A second, by David R. Agrawal and Kenneth Tester, looked at the behavior of professional golfers who play tournaments and pay taxes all over the country. And a third, by Traviss Cassidy, Mark Dincecco and Ugo Antonio Troiano, examined what happened after states introduced their income taxes at varying times. (Which is how I learned that Wisconsin pioneered the modern income tax.)
All three conclude that when a state starts taking more income, people respond by trying to move income out of the state’s reach, an effect that is most pronounced for the highest earners. High-earning golfers are less likely to participate in tournaments conducted in states that take a bigger share of their prize money. High-earning residents were more likely to leave California after their taxes rose, and those who stayed seem to have earned less income. And overall, states that imposed income taxes for the first time saw out-migration increase.
Yet these findings don’t tell us what the revenue-maximizing rate is — because there is no one revenue-maximizing rate. It depends on the place, the time and even the individual taxpayer.
For example, the paper on golfers suggests that people make decisions about where they work, as well as where they live, based on taxes — but it would take considerable further research to generalize pro-golfers to more ordinary working stiffs. The paper on the state-by-state introduction of income taxes indicates that they spurred migration, but only after World War II, when states got more efficient at collecting taxes and transportation improvements made it easier to move. And the paper on California taxes suggests strong taxpayer response to higher rates — but the highest earners who responded most strongly probably have more ability to relocate, or structure their income in tax-avoiding ways, than the average wage slave.
Two things do seem clear, however: Tax rates matter, even if exactly how much they matter depends on circumstances — and also, our circumstances are changing. Whatever the revenue maximizing rate was five years ago, it’s probably lower now, thanks to remote work.
Like the interstate highways, remote work makes it easier for workers to move both home and workplace. Companies might find it easier to recruit employees while headquartered in D.C., which taxes only D.C. residents, than in Massachusetts or New York, which tax incomes based on the employer’s location. So, states are going to have to figure out just how much they can take from a more mobile workforce — and make sure the services they deliver in return are worth the price. Otherwise, they risk losing workers and companies to states that understand their fiscal limits.
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