Sinclair Davidson has written a CIS policy brief arguing that Australians pay too much tax. On its face, this is about as surprising as Richard Neville telling us that George Bush isn’t his favourite President. But Sinclair also throws in a new argument – that we’re on the wrong side of the Laffer Curve. In other words, the government could get more tax revenue if it cut top tax rates.
It’s a novel argument, and Sinclair carefully discusses all the evidence. But from everything I’ve read, I reckon it’s just got to be wrong. As he points out, the only convincing instance in which a Laffer Curve has been shown to exist is Sweden in the 1960s and 1970s, and Australian tax rates aren’t anything like that high. He suggests that we might learn something from falling top tax rates and rising top income shares – but the income share (and hence the tax share) of the top 1% is also going up because of other factors, such as changing norms about inequality and the internationalisation of the market for english-speaking CEOs.
Ultimately, as the University of Chicago’s Austen Goolsbee has put it:
The notion that governments could raise more money by cutting rates is, indeed, a glorious idea. It would permit a Pareto improvement of the most enjoyable kind. Unfortunately for all of us, the data from the historical record suggest that it is unlikely to be true at anything like todayâ€™s marginal tax rates. It seems that, for now at least, we will have to keep paying for our tax cuts the old fashioned way.
Still, the nice thing about this debate is that we’re about to have a very clean policy experiment, thanks to JWH pushing up the top tax brackets in 2005-06 and again in 2006-07 in a way that disproportionately favours the rich. So perhaps Sinclair and I can revisit this issue in a few years’ time, and see what happened. I expect we’ll see an increase in earnings for those whose tax rates fall – what I don’t expect is that the total tax take from the rich will be higher in real terms.