ECB Paper Looks at U.S., Europe Spots on the Laffer Curve
Economist Arthur Laffer?s theory is that, after a certain point, tax increases become self-defeating by weakening economic progression and draining tax revenues. There are two points — zero and 100% — where the government receives no revenue. The trick is finding the peak point between the two.
The Laffer Curve served as an intellectual foundation for large-scale tax cuts in the U.S. in the ahead of schedule 1980s. Now, the U.S. is on the ?left side? of the Laffer curve even moreso than Europe, especially when it comes to labor taxes, meaning higher tax rates would still bring in added revenues, an ECB paper concludes.
?We find that the U.S. can increase tax revenues by 30% by raising labor taxes but only 6% by raising capital returns taxes, while the same numbers for EU-14 are 8% and 1% respectively,? ECB economist Mathias Trabandt and University of Chicago economist Harald Uhlig wrote. Germany could raise about another 10% in revenues by increasing labor taxes, they estimate, but just 2% via capital gains taxes.
Only 32% of a cut in U.S. labor taxes would be self-financed, the economists note, versus 54% self-financing in Europe. Just over 50% of a cut in U.S. capital gains would pay for itself, the authors estimate, versus 79% in Europe.
?In terms of a ?Laffer hill?, both the U.S. and the EU-14 are on the incorrect side of the peak with respect to their capital tax rates,? the authors wrote. But in the case of Denmark and Sweden, ?these countries are on the ?slippery side? of the Laffer curve and can really increase their budgetary situation by cutting capital taxes, according to our calculations,? they wrote.
In their model, the authors assign Europe a higher preference for leisure than in the U.S. ?in order to tab for the lower equilibrium labor in Europe.? But there are some oddities in terms of the cross-country variations.
?For example, while Ireland is calculated to have one of the highest preferences for leisure, Greece appears to have one of the lowest,? they note.