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Beyond the Laffer Curve — the case for confiscatory taxation

Arthur Laffer
Arthur Laffer
Gage Skidmore/Flickr

The Laffer Curve — the idea that tax cuts can sometimes increase tax revenue — is one of the most influential and widely debated ideas in the past two generations of American politics. Beloved by the right and despised by the left, one thing that both sides have tended to agree on is that knowing what side of the curve we're on should be a key driver of tax policy.

But in an era of surging inequality, it's time to revisit that assumption. Maybe at least some taxes should be really high. Maybe even really really high. So high as to useless for revenue-raising purposes — but powerful for achieving other ends.

We already accept this principle for tobacco taxes. If all we wanted to do was raise revenue, we might want to slightly cut cigarette taxes. And since cigarettes are about the most-taxed thing in America, we certainly would want to cut out all our other anti-smoking initiatives. But we don't do that because we care about public health. We tax tobacco not to make money but to discourage smoking.


The same is true of widely discussed proposals to tax carbon dioxide and other greenhouse gas emissions. The goal here wouldn't be to maximize tax revenue, it would be to reduce pollution. The revenue would be a pleasant side effect.

If we take seriously the idea that endlessly growing inequality can have a cancerous effect on our democracy, we should consider it for top incomes as well.

Taxing the boss

With the growing concentration of wealth an increasing subject of public concern, it's time to reconsider whether the application of Laffer-style reasoning to very prosperous individuals is appropriate.

Imposing a marginal tax rate of 90 percent on inheritances worth over $10 million, for example, would probably raise very little revenue. Rather than pay $90 to Uncle Sam for the chance to send $10 more to their kids, rich people would give the money to a tax-exempt charitable institution instead. That wouldn't help balance the budget — in fact, it would hurt those efforts — but it would help break the doom loop of oligarachy whereby concentrated wealth breeds political power breeds greater concentration of wealth.


Even more intriguing would be to apply the same principle of taxation-as-deterrence to very high levels of income.

About twenty years ago, Congress and the Clinton administration took a step that they thought would curb what they thought was excessive CEO pay. They said that salaries of over $1 million wouldn't be deductible from the employer's corporate taxes. Since that time, CEO pay has gone further up. Now the typical S&P 500 CEO earns 311 times more than his median employee. The reason isn't that tax deterrence doesn't work, it's that the authors of the law left a loophole big enough to drive $10 million through — you can deduct whatever payment you want as long as you jigger your compensation scheme to label it "performance based."

Imagine a world in which we not only closed that loophole, but imposed a 90 percent marginal tax rate on salaries above $10 million. This seems unlikely to raise substantial amounts of revenue. If you really really really really desperately wanted to give your CEO a raise, you would have that option. But for every extra $1 you give him, you'd have turn over $9 to the government. Why not use that same $10 to give raises to three or four people lower down the food chain who pay lower taxes?

Of course, the CEO might threaten to quit if he can't get his raise. But what are his realistic options? Every company in the country would be faced with the same dilemma — why waste the salary budget on paying confiscatory tax rates rather than on hiring and retaining front-line workers? That might turn around the deplorable stagnation in earnings that typical households have faced over the past several decades:


It's conceivable that America's executives would respond to their newly reduced wages by retiring en masse. But it seems unlikely that objective need to accumulate more wealth is what's stopping today's captains of industry from choosing early retirement.

Beyond CEOs

Of course not every highly paid person in the United States is an executive at a large company. Some of them manage hedge funds. Some are partners at law firms. A few are "superstars" in the arts or sports. Maybe in these fields we really would see a reduction of effort, or at least a relaxation of the intensity with which the performers pursue money.

But would that be so bad? Imagine the very best hedge fund managers and law firm partners became inclined to quit the field a bit sooner and devote their time to hobbies. What would we lose, as a society? Fancy lawyers overwhelmingly compete against each other in a zero-sum game.

Much of finance has the exact same dynamic. If the average "quality" of the trader on Wall Street declined slightly, nothing of consequence would happen.

As for superstars, would it be so bad if celebrity actors became slightly more inclined to accept low-paying passion projects rather than income-maximizing commercial ones? At the same time, some would presumably just move to Switzerland or the Cayman Islands to avoid taxes. That would be a real hit to local economies, but hardly a disaster.

The false tax dichotomy

Policy discussions of inequality in the United States are too often plagued by a somewhat artificial imperative to distinguish between efforts to "redistribute" income through taxes and transfers and efforts at "predistribution" that would alter the market structure of compensation.

This distinction is crucially important when considering the fate of the poor — many of whom lack full-time jobs — since there is a large and obvious difference between cutting someone a larger welfare check and arranging for her to get a well-paid job.

But when the question is the rich, the distinction largely breaks down. That's because the tax code structures even the "pre tax" incomes of very high earning people. Very high taxation of inheritances would mean fewer big inheritances, not more tax revenue. Very high taxation of labor income would mean fewer huge compensation packages, not more revenue. Precisely as Laffer pointed out decades ago, imposing a 90 percent tax rate on something is not really a way to tax it at all — it's a way to make sure it doesn't happen.

If you believe systematically lower CEO compensation packages would mean a mass withdrawal of talent from the business world and a collapse of American industry, then those smaller pay packages could be an economic disaster. But the more plausible theory is that systematically lower CEO compensation packages would mean systematically higher compensation spending elsewhere in the corporate structure. Either more frontline workers or better-paid ones. The new tax code would redistribute value inside the corporate structure without anyone actually paying the new sky-high taxes.