The U.S.: Still Well To The Left Side Of The Laffer Curve
Yglesias pulls a quote out from a recent paper by Peter Diamond and Emmanuel Saez that all Progressives should read if they really want to understand the economic case for progressive taxation, rather than relying solely on valid-yet-vague ideas about social justice and fairness:
When a tax system offers tax avoidance or evasion opportunities, the tax base in a given year is quite sensitive to tax rates, so that the elasticity e is large, and the optimal top tax rate is correspondingly low. Two important qualifications must be made. First, as mentioned above, many of the tax avoidance channels such as re-timing or income shifting produce changes in tax revenue in other periods or other tax bases—called “tax externalities”—and hence do not decrease the optimal tax rate. Saez, Slemrod, Giertz (2011) provide formulas showing how the optimal top tax rate should be modified in such cases. Second, and most important, the tax avoidance or evasion component of the elasticity e is not an immutable parameter and can be reduced through base broadening and tax enforcement (Slemrod and Kopczuk, 2002; Kopczuk, 2005). Thus, the distinction between real responses and tax avoidance responses is critical for tax policy. 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. Although considerable uncertainty remains in the estimation of the long-run behavioral responses to top tax rates (Saez, Slemrod, Giertz, 2011), the elasticity e=0.57 is a conservative upper bound estimate of the distortion of top U.S. tax rates. Therefore, the case for higher rates at the top appears robust in the context of this model.
For those unfamiliar with the Laffer Curve and its impact on tax policy, see my post on the subject here.