It's No Laff-ing Matter

I was intrigued by the graph I included in my "Poverty is Unaffordable" post that showed the amount of U.S. income going to the top decile earners. Yes, I amuse myself rather easily, but I decided to investigate a bit further. It turns out that the shape of this graph looks exactly like the inverse of the graph of the top marginal tax rates in the U.S.
Remember the Laffer curve? Laffer warned that once tax rates exceed a certain level, total tax revenues will fall because people no longer think it’s worthwhile to work for additional income. Liberals, me included, greeted his theory with a resounding pooh (or substitute your own less polite word), because it also holds that the wealth of the rich will trickle down to all of the rest of us. Even Papa Bush called it “voodoo economics.”
Laffer saw only one side of the equation. Why keep working for that next $100 million if the government is going to take 70% of it? Of course if you’re one of the trickle down beneficiaries making only $35,000 a year, the choice to stop working isn’t exactly the same. But I’m wondering, based on the latest round of financial scandals and malfeasance, from Enron to predatory lending to the lawsuit announced today against Goldmann Sachs, if perhaps Laffer had a point. Maybe we’d be better off if indeed these guys stopped working so hard to make the next $100 million.

There are a couple of interesting things about the graph above of the top federal marginal income tax rate —the rate the wealthiest pay on the portion of their income that puts them in the most wealthy category. The rates were astronomically high during the war—imagine actually raising money to pay for your spending! The economy crashed when these rates were at their lowest—in the 1930’s and again, starting in the 1980’s in a series of bubbles—from the savings and loans scandal; followed by the dotcom bubble, and the housing bubble today.

Laffer seems to have gotten it both tragically wrong and maybe tragically right. The higher the tax rates, the more trickle down seemed to have occurred. Family incomes were increasing and the income distribution was less polarized when tax rates were higher. And GDP capita has increased irrespective of the tax rates after the Great Depression.

Why would family incomes increase when marginal tax rates are higher for the wealthy? Who knows? I imagine that economists have all sorts of explanations. I’m sure there are even some who will say that what appears to be so in the graphs isn’t actually so. I prefer to think that maybe Laffer was right about the incentives for the wealthy. Maybe companies put in place different earnings policies because they know they can’t keep it anyway. Maybe the uber-wealthy do work less at concocting the latest get-mind-blowing-rich schemes that implode in foreclosure, bank failures and stock scandals. Maybe higher tax rates simply create a different expectation for what type of society we want to be.