Yglesias highlights a paper from Diamond and Saez on optimal taxation.
As an illustration using the different elasticity estimates of Gruber and Saez (2002) for high income earners mentioned above, the optimal top tax rate using the current taxable income base (and ignoring tax externalities) would be τ*=1/(1+1.5 x 0.57)=54 percent while the optimal top tax rate using a broader income base with no deductions would be τ=1/(1+1.5 x 0.17)=80 percent. Taking as fixed state and payroll tax rates, such rates correspond to top federal income tax rates equal to 48 and 76 percent, respectively.
I see some confusion on this issue so I just want to point out the following. The optimal tax rate, the peak of the Laffer Curve, and the tax rate that maximizes GDP are all different things. Moreover, they can have almost any relationship to one another.
That is it could be that the optimal tax rate is 20%, the Laffer Curve could peak at 40% and GDP be maximized at 60%.
To get GDP maximization higher than the Laffer Peak and the optimal tax rate requires unusual set up, but if – similar to China – you are using the tax rate to perform financial repression on households, it is possible.
1 comment
Comments feed for this article
Tuesday ~ August 16th, 2011 at 9:09 pm
happyjuggler0
People get batty when the subject of the Laffer Curve is brought up, so I will hit and run here.
The long run Laffer Curve is lower than the short run Laffer Curve…it matters which one that is under consideration.
Mankiw has mentioned on his blog more than once that Germany takes in essentially the same amount of tax dollars *in absolute amounts* (PPP adjusted I am pretty sure) per capita that the US does, despite Germany having much higher tax rates of pretty much every type. Sounds like the long term Laffer Curve at work to me, and to Mankiw too, which probably matters more to whoever reads this….