Hauser's law, the Laffer curve and pissed-off taxpayers
The debate over Laffer's theoretical insight hotted-up this week after the Wall Street Journal published a column by David Ranson touting economist Kurt Hauser's claim (Hauser's Law) that tax revenue sticks pretty close to 19.5% of GDP no matter where the government sets marginal tax rates.
What makes Hauser's Law work? For supply-siders there is no mystery. As Mr. Hauser said: "Raising taxes encourages taxpayers to shift, hide and underreport income. . . . Higher taxes reduce the incentives to work, produce, invest and save, thereby dampening overall economic activity and job creation."Several tax-happy critics promptly set out to debunk Ranson and Hauser -- inadvertently reaffirming Hauser's Law in at least one case. But the biggest criticism of Hauser's Law seems to be the 100-mile-high view he takes of the economy. What's actually going on there and how can we know that it really prevents taxes from increasing as a share of the GDP?
Putting it a different way, capital migrates away from regimes in which it is treated harshly, and toward regimes in which it is free to be invested profitably and safely. In this regard, the capital controlled by our richest citizens is especially tax-intolerant.
Fortunately, Hauser's take on the matter isn't the only one out there. A 2006 report (PDF) by Louis Levy-Garboua, David Masclet and Claude Montmarquette for Quebec's Centre Interuniversitaire de Recherche en Analyse des Organisations (CIRANO) looked at the behavior of individuals subject to varying tax rates. What they found is that the Laffer curve doesn't kick in when tax rates are perceived to be "exogenous" -- dispassionate and impersonal, like gravity. But when tax rates are experienced as unfair products of human calculation, the Laffer curve kicks in in spades.
We do not observe the Laffer curve phenomenon in our simplified setting when tax rates are randomly imposed on working taxpayers. However, we observe it in a Leviathan state condition in which an experimental tax setter in flesh and blood is given the power to maximize tax rates to his own benefit. ...What constitutes "unfair" taxation? Whatever the taxpayers say it is. In the study, the maximum rate before revolt kicked in was 50% (this is a Canadian study, after all). Ultimately, though, it seems obvious that the trigger point will depend on the expectations of the specific taxpayers who are affected.
The fact that tax responsiveness of work is substantially greater when tax rates are set by another subject in flesh and blood than by nature is taken as evidence that workers respond strongly and emotionally to unfair taxation, which is consistent with the history of tax revolts. To be more specific, taxpayers want to punish the tax setters who intentionally violated the norm of fair taxation. ... We also find evidence of affective responses (Zajonc 1980) to unfair taxation by angry taxpayers who lost their temper and were ready to incur a net cost to hurt norm violators, and these turn out to be the ultimate cause for the Laffer curve phenomenon.
The researchers conclude that "fiscal policies that serve macroeconomic purposes" are unlikely to trigger a revolt, but that "[i]n order to produce a Laffer effect, fiscal policies need to be felt as intentional, discriminatory and especially hurtful by a group of taxpayers."
So, if we can get God or Plato's philosopher-kings to take over tax policy, taxes might be raised nearly forever without consequence. But we live in a world in which taxes are inherently political, and tax rates are often used to reward or punish. Does anybody really experience changes in tax rates as dispassionate acts of nature? Or are they understood, more or less universally, as the arbitrary choices of whoever happens to be in power?
The currently popular craze to increase taxes on people considered wealthy is especially problematic since, say Levy-Garboua, Masclet and Montmarquette, "The initiators of tax revolts are usually found among the most productive, high-earning, and hard-working group of taxpayers." This point squares, of course, with Hauser's and Ranson's insight that "the capital controlled by our richest citizens is especially tax-intolerant." Try to soak the rich too much and, more than any other group, they'll skate their money out of the country, drop into the underground economy or stop being productive even if it hurts them to do so.
This, then, is likely why Hauser's Law seems to hold true. Taxpayers view tax rates as the outcomes of political decisions by human beings with axes to grind. Taxpayers will tolerate tax hikes up to a certain point -- but then, no more. In the modern-day United States, with expectations as they are, that has confined tax revenues in recent decades to roughly 19.5% of GDP.
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