From Mark Thoma, via Brad DeLong, comes what will henceforth be my absolutely favorite example of twisting data to fit your theories. Observe the following graph of corporate tax rates vs. revenue in units of GDP:
Pretty straightforward, really. As you raise taxes, the government collects more revenue. Norway seems to collect more than its fair share, which might be interesting to dig into, but the trend seems clear. But there’s something nagging at the back of your mind — aren’t there people out there in the world who believe that raising taxes actually decreases revenue past some certain not-very-high tax rate? “Supply-side economists,” or something like that? People who exert a wildly disproportionate influence on U.S. tax policy? What would they make of such a graph?
Yes, Virginia, there is such a thing as supply-side economics, and you can find its practitioners in such out-of-the way places as the American Enterprise Institute and the editorial pages of the Wall Street Journal. Here is how such people view these data:
No, I am not being unfair. I did not draw the “Laffer Curve” on top of those data in order to embarrass the WSJ or AEI. They did it themselves; the second graph is how the plot was actually published by the Journal, while the first one was Mark Thoma’s subsequent reality-based-community version of the plot. As Kevin Drum says, it’s “like those people who find an outline of the Virgin Mary in a potato chip.”
Among other features, we note with amusement that the plotted curve implies that tax revenues hit zero at a corporate tax rate of about 33%, and become dramatically negative thereafter. As of this writing, it is unclear what advanced statistical software package was used to fit the Laffer Curve to the data; the smart money seems to be on MS Paint.
AJ points out correctly that the article does not justify the curve as a fit to the data, and only points out whether some countries are on the “right” or “wrong” side of their curves in terms of getting more bang for their tax buck.
Nonetheless the plot makes it very obvious that this curve has no relationship to these data, and the WSJ should rightly be ridiculed for that. I accept that the Laffer curve must be correct in one form or another, but this data set offers no support to that shape or choice of maximum. Without strong justification of that particular curve from other evidence, the data even argue against that choice of curve.
It’s apparent that whatever variation there is in this data set has little correlation with that choice of curve, and the use of that plot to justify the articles taxation conclusions is insulting.
It’s called the abysmal science for a reason. The more one tries to say, “It is so,” the less likely one is to be correct. Sending the tax line through 0,0 isn’t accurate for this reason. The government earns revenues on rents for things such as oil and grazing land leases. Compared to total GDP, they are insignificant I’m certain (I don’t care to look it up) but it proves what some are saying. It seems the only answer to questions like “Which school of thought is correct, the Free-Market economists or Post-Keynesian economists?” (feel free to enter your own school here) is “Yes.”
Aside from what taxation percentages are optimal as such, how about a graduated corporate income tax? I mean, the percent levied on the profit would rise with profit margin (after a deduction, to avoid punishing little companies that have to markup higher to make enough money at all.) Then we reward the industries that serve the public by selling by volume at low profit margin, and penalize the “gougers” without having to directly regulate prices.
Chi^2 for different types of curves is even more meaningless than the measure itself.
Laffer is merely simplistic, i.e. silly. It assumes a mutally exclusive dichotomy between private profit and government revenue. Reality is that gov revenue when appropriately spent increases private profit. Corporations use the “commons” of society as much as (if not more than) individuals.
Yea there are many feedback mechanisms and so forth inherent in the Laffer curve. Which is why it makes talking about where the optimal point is, extremely difficult and academic. Economists talk about being on the left or right of the curve and so forth, but really thats model specific
Soviet Union in the first years of perestroyca and later Russia experimented with summary 70-90% taxes (there were several types of taxes). The result was not only near zero tax revenue, but also complete criminalization of economy – instead of paying taxes enterprises payed protection money to gangs. Eventually about half of Russian economy become property of organized criminals and that become a main obstacle to Russian economic growth.
My memory from economics is that the Laffer curve is a long-term relationship; whatever short-term results Reagan and Clinton had, the Laffer curve was not involved.
“I have an office building. I raise the rents, I get more revenue.”
Not if you raise them to four times the going rate in the market. If you do that, all your tenants will move out, and new ones will not move in.
In the early 90’s, there was a suggestion that the solar neutrino flux was changing in time, and was anti-correlated with the sunspot cycle (leading to much discussion about neutrino magnetic moments). But it was only based on 15 years of data, and the sunspot cycle, of course, is 11 years. Someone at a conference then showed that the fit was even better if you compared the solar neutrino flux with the number of Republicans in the US Senate….
One thing that can be said about these data is that they lie in a plane.
It seems that Bush did some creative curve fitting on the data on progress in Iraq too 🙂
Throw out Norway as an outlier.
Throw out UAE as an outlier.
Result: a random cloud of point showing nothing.
That’s what this really shows, but it’s hard to get a publication out of that.
The Laffer Curve is a joke. At its most basic, it relies on two assumptions:
1 — that a tax rate of 0% will bring in $0 revenue
2 — that a tax rate of 100% will bring in $0 revenue
Assumption 1 is indisputable. But Assumption 2 is simply false.
In a society in which all income earned from business is taken by the government in taxes there will still be business activity. The tax revenue is not simply taken by the government and then burned. It is presumably used (at least to some non-trivial extent) for goods or services for the benefit of the country’s people. That benefit is shared at least in very small part by the businesses being taxed (or more specifically the individuals that make up the businesses). That slight benefit is sure to provide enough of an incentive for some business activity.
I think it is clear that at some point the tax rate reaches a level that is higher than optimal to maximize revenue because of the negative incentives on some businesses. But it is simply not plausible to argue, as the Laffer Curve does, that 100% tax rate will result in $0 revenue.
at least all the datapoints are on the same plane… (von Neumann)
B said: If the people in country X want more (public transport? social security? health insurance? unemployment insurance?) to be shared responsibility, the thing to do so is to use taxes.
And if the people in country R want to hack a minority group to pieces, the thing to do is to use machetes.
What you are suggesting is that we ought to rip off the rich in order to buy the votes of the poor. Dear B: you are in the wrong field. You ought to be a politician.
Hi Habyarimana,
No, you are mistaken. Democracy doesn’t mean you ignore minorities to the benefit of the majority, but it gives you a powerful tool to find the best compromise. The notion of ‘ripping someone off’ is very vague, and not worth discussing at all. If you ask me, my personal opinion is that not too much money should be in the hands of too little people since unfortunately we live in a society where money weights influence, and such a distribution of wealth counteracts the very basis of a democratic opinion making process.
And if the people in country R want to hack a minority group to pieces, the thing to do is to use machetes.
You should try to find out what a constitution is good for, and why it can’t be changed from one day to the other by a people’s vote. There are places where a direct feedback can be useful, and places where it is completely inappropriate. In economics the feedback given by the customer works very efficiently and very direct, and allows to take this into account in further decisions. This works fairly well to optimize over short time periods, and neglects what might become important only on global distances or long time scales. The political system to outbalance these shortcomings is presently extremely inflexible and unscientific (not to mention not globally functional), it’s a problem that will become more and more serious the more important it will become to correct the outcomes of capitalistic developments. It’s the capitalistic system that, if left unattended, works towards a one-fits-all mediocrity, it optimizes economical growth on the expenses of variables that can’t be easily measured in financial values.
I choose more than a decade ago not to go into politics but finish my BD in maths, and I have no regrets about where it lead me. As much as I am interested in politics and sociology, it’s an interest that is far too theoretical to be useful for a career in this field, and I not into all these games that are being played there: all the networking, all the decisions that are made behind the scenes, all the senior people that just keep doing things as they have always been done, for no other reason because they have always been done so… wait… does this just remind me of my actual job?
Best,
B.
ZBicyclist:
Throw out Norway as an outlier.
Throw out UAE as an outlier.
Result: a random cloud of point showing nothing.
That’s what this really shows, but it’s hard to get a publication out of that.
One could try a random distribution. It seems either the UK or Canada is the most average of all states in this plot, EH? Alternatively, I suggest to normalize both scales to the average coffee consume of each country, double log the plot, and see whether it correlates with the local climate change impact.
I agree with B #42.
I think that more scientists should go into politics, clearly politics is much too hard for politicians 🙂
Economics is indeed a science.
My comments as a Fortune 100 employee and taxpayer are on the Good Math, Bad Math scienceblog.
My comments as a published Mathematical Economist are as follows.
Economics is indeed a science, at least since its first great quantitative book defining the key variables:
Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations, 1776.
http://www.econlib.org/Library/Smith/smWN.html
Economics uses (and abuses) Math. In recent decades, LOTS of math. In serious imitation of and envy of Physics. I’ll skip the sidebar on whether “Econophysics” is or is not a valid approach, except to admit that I admire the best work of the Santa Fe Institute, and go on the record here in predicting a “Nobel Prize” in Economics to one or more at that venue.
John Forbes Nash, Jr., is the Albert Einstein of Economics. Based on my breakfasts and lunches with him and his family, and the new work he’s doing, he is still doing important research. The Nash Equilibrium thesis that he wrote is one of the great results of the 20th century, far more reobust than he could have imagined, applicable in the context of, for example, Quantum Computing and entangled players.
I have a few refereed papers in the field, mostly with senior author prof. Philip V. Fellman, which can be found (for instance) on the arXiv recently.
The Wall Street Journal is not a refereed scientific journal. They have recently made fools of themselves. I regret that I could not have refereed that article and graph.
But don’t throw the baby out with the very biocontaminated bathwater.
Mathematical Physicists have managed to earn as much as $1.3 x 10^9 last year, to cite the conspicuous outlier.
Just as Astrophysics equations suddenly got repurposed in Mathematical Population Biology when I was in grad school (1970s) so are Critical Phenomena, power laws, wavelets, differential equations (cf Black-Scholes), asymptotics of random graphs, and subtle analysis of 100s of gigabytes of time series data being used right now in studying actual markets.
Habyarimana wrote:
And if the people in country R want to hack a minority group to pieces, the thing to do is to use machetes.
What you are suggesting is that we ought to rip off the rich in order to buy the votes of the poor. Dear B: you are in the wrong field. You ought to be a politician.
Just who is it that opposes the reduction of the agricultural subsidies in the United States and Europe that are ripping off taxpayers in those countries and depressing the incomes of farmers in third world countries? (Hint – large corporations).
Which two industries have seen both the most US government subsidies and tax breaks and record profits in the last 6 years? Defense and oil.
It is the f***ing rich who are the most willing and most able to feed off the public trough. It is the whole juvenile ideology that the Habyarimanas of this world spout that keeps anything effective from being done about it.
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B:
are prejudices part of the phenomenologists’ doctrine ?
Clearly we should just raise taxes to INFINITE. Clearly that would provide INFINITE income for everybody ! Just look at your curve ! Call washington, we have found the solution to all their income problems !
*ahem*
Obviously the graph will hit zero at some point of taxation (because obviously at a tax rate of 101% the graph will hit zero within a year or so). And clearly 0% tax generates 0% GDP income from tax.
So the curve CANNOT be linear. It has to be at least second degree. Or third. Dunno what will fit best. But it seems to me the economist is much closer on the money than you are.
And btw, I’m a mathematician.
Discount Norway as a statistical outlier for the moment. The UAE stays, because it is empirical proof (as if such were needed!) that governments which don’t levy taxes don’t get money. Now look at Ireland, Luxembourg, Australia, France and the US, and tell me if they (and the others which are unlabelled) don’t form a beautiful Laffer curve, dropping quite steeply at about 35%. The Laffer curve is the maximum theoretical tax revenue, note, so it’s the boundary of the region of taxation.
Interestingly, the data suggest that my own country, the UK, needs to focus not on changing tax rates (which look like they’re just under the peak) but on improving tax-collection efficiency (which moves us up towards the peak without sacrificing significant portions of domestic product).
The danger of producing such rotten arguments in favour of your position is that people spot them as such, and mistake “bad argument” for “no argument”. They then conclude that your position is fundamentally flawed, and you succeed in winning critical thinkers for the opposition.