Laffer Curve

Congress has once again reduced the taxes for the wealthiest people of the nation. Before Dubya was in office, long term capital gains were taxed at 20%. As part of the first tax cuts implemented by this administration the rates were reduced to 15%. These tax cuts were scheduled to expire, which was merely a gimmick to keep the total tax cost at a specific number. This week, however, Congress extended the tax rate until 2010.

The GOP claims that reducing taxes increases tax revenue for the government. The principal has been called the Laffer Curve, which states that there is a point whereby tax rates will create a peak revenue and increasing or decreasing the tax rate from there will decrease the amount of tax revenue. The trick is determining where the peak is and determining whether the government needs to maintain peak revenue.

It is unclear how reducing the taxes for the rich will increase the tax revenues. The people who are buying and selling stocks the most are the people who can afford major investments - thus people that have significant amounts of disposable income. Many of these people obtain a majority of their income through the sale of stocks. For instance, at the outer most reaches of the economic spectrum, Bill Gates makes less than $1 million per year in actual compensation from Microsoft; however, he is worth over $25 billion. What Gates declares on his income tax form is likely significantly more than $1 million per year; thus, every dollar over that initial $1 million is money gained from capital gains, not wages.

While Gates, who is the richest man in the world, is the extreme case, it is true that the majority of the people at the top of the economic scale are in a similar situation whereby they obtain most of their income from stocks in their companies rather than actual wages paid to them. Thus, the majority of their income is taxed at 15% whereby the majority of the average American’s income is taxed at approximately 30%, plus they are taxed 6% for social security and taxed for medicare and state taxes. Social security, medicare and state taxes are not assessed on capital gains.

In other words, the people at the top of the economic scale are getting the majority of their income at a discounted rate compared to what the average Americans have to pay. Further, the people at the top of the income have more disposable income than the average person does, which is shown by their having money tied up in the market opposed to paying their bills month to month. Since the wealthiest of Americans have greater amounts of disposable income, it is not unreasonable to expect them to pay greater amounts of money than those in the middle and bottom of the economic spectrum.

There is no indication that the US is at the peak of the Laffer Curve or to the right of it, assuming that the theory is accurate. Further, reducing taxes disproportionately for the rich is not the kind of tax rate reduction that would be necessary to move the rate toward the peak of the curve. Rather, if the goal is to attempt to achieve the peak, then greater tax rate changes need to be made on the payroll tax, the primary tax paid by all Americans. Further, whether this amount needs to go up or down needs to be determined based upon where the US is on the curve. The GOP just assumes that the US is toward the right side of the curve, and such an assumption is likely flawed.

It is time the US stops blindly reducing taxes and starts acting responsibly with its revenue especially in this time of extreme debt: $8 trillion and counting.