Tax the Rich! Fails again.

Taxation with representation ain't so hot either. ~Gerald Barzan

What a topic today - I get to discuss government, sports and mathematics!

Since April, foreign sports stars competing in Britain have been liable for a top income tax rate of 50%. Now this is unpleasant but it gets even worse. Controversially, the tax is charged not just on the money they earn in Britain but on a proportion of their worldwide sponsorship income.

Many sports stars are voting with their feet and refusing to complete in Britain. The impact is being felt in Olympic type sports like track and field as well as tennis and golf. The organizers of UK sports are asking the government to repeal this tax.

A year ago I wrote about the unintended consequences of raising taxes on the rich,
Actions have consequences. The rich either move or declare a house in another state as their primary residence and the net tax revenue collected declines! The Financial Times reports that the number of Americans giving up their citizenship to protect their families from America’s tax system has jumped rapidly.

The idea that people flee from high taxes is captured in the Laffer Curve; a key part of Reganomics and much criticised by opponents who claim it has been discredited. Actually the stories above show exactly the opposite. It is politicians who are discredited by not understanding the Laffer Curve and negatively impacting the revenue collected with over taxation.

The theory goes like this. When the tax rate is 0%, the tax revenue is zero. Now consider the other extreme; when the tax rate is 100% what happens? Why would anyone work when all the money goes to the government? They'll opt out, collect unemployment, work off the books, use barter, leave the country, or find tax shelters. The end result is very few, if any, will choose to work for non-existent pay and the revenue collected is again zero (or very small).

From calculus you learn that a curve that crosses zero at two points must have a high point, a maximum value. (see image above) To the left of the max, raising taxes increases revenue to the government; but on the right side of the max, raising taxes results in less total revenue.

Bottom Line

Sadly the Laffer Curve is much misunderstood. It does not promise that revenue will always go up when the tax rate falls. It depends on which side of the maximum the current tax rate is. And unfortunately the Laffer Curve does not tell us where that max revenue value is. You have to find it by trial and error to get the perfect tax rate - neither too high nor too low.

http://www.vistech.net/users/rsturge/laffercu.html
http://en.wikipedia.org/wiki/Laffer_curve