California Tests the Laffer Curve Hypothesis

As California raises its marginal tax rate on the rich, will tax revenue rise or fall?    France is running another tax field experiment.  Geographic areas with exceptional quality of life are more likely to be able to raise taxes without experiencing sharp out-migration.   David Beckham lives near UCLA.   What marginal tax rate would nudge him to move back to the UK?  For some evidence on this question, read this paper.  

Author: Matthew E. Kahn

Professor of Economics at UCLA.

17 thoughts on “California Tests the Laffer Curve Hypothesis”

  1. Is there any reason we should regard the movements of top-class football (soccer) players and rock musicians as a matter of concern? Scientists, possibly. But they are in much lower tax brackets. Fans are attached to clubs, not players. See Nick Hornby´s perceptive and funny autobiography as an Arsenal supporter, Fever Pitch.

  2. Does anyone not crippled by right-wing ideology believe that higher tax rates *routinely* reduce total revenue? Perhaps they do in a few isolated situations where rates were previously so high as to depress activity severely, or push it out to the official economy. In the vast majority of situations, arithmetic works just fine and higher rates produce higher revenue. It is a triumph of cynical propaganda that the “higher rates/lower revenue” meme is taken as seriously as it is.

  3. This is what Daily Finance said ( about LeBron when he moved:
    “Assuming that James took just under $17 million from the Heat (which is probably pretty close to accurate), he would pay no state income tax, leaving him with the same $17 million. If he had gone to New York, even if he nabbed an additional $1.5 million (as the salary difference has been speculated), he would shell out close to $1.7 million in New York state taxes. That doesn’t count James’ endorsements with companies like Nike, Sprint and McDonald’s. Those deals are said to bring in $40 million per year for James, landing him at #19 on the Forbes list of the 100 most powerful celebrities of 2009 (just behind his idol, Michael Jordan).

    The total bill? Over five years, that means James could save more than $25 million in state taxes alone by relocating to Miami over New York. And that doesn’t count other taxes such as local taxes (New York has a bunch) or property taxes (on average, New Yorkers pay a bigger percentage of their income for property taxes than Floridians). In fact, overall, Florida has a fairly attractive tax picture. Compared to other states, it is ranked by the Tax Foundation as 47th in terms of state and local tax burdens; New York, on the other hand, is 2nd (just behind New Jersey, the home of the Nets, also desperate to sign James).

    Is the lure of lower taxes enough to have convinced James to make the switch? Not on its own: James is too smart for that. But you can bet it figured into the equation. He would not be the first mega-star lured down to Florida for tax reasons. Prior to his legal and marital woes, Tiger Woods was said to have relocated from California to Florida primarily in order to save on taxes.”

    Johny Halyday moved from France to Switzerland when the taxes were less punitive than now. You can argue that Switzerland and Belgium are reasonably close substitutes for France, and there IS NO SUBSTITUTE FOR CALIFORNIA. Maybe so.

    1. JFTR, I think that analysis much overstate James’ tax savings.

      He is still liable, I think, for income tax on money earned in New York, which includes the portion of his salary earned from games played in the state. That applies to every other state he plays in as well. True, he’ll save by playing his home games in FL, but that covers only half his salary. (I once knew an accountant who did work for musicians who toured a lot. Accounting for their state taxes was a nightmare.)

      I don’t know how state tax on endorsement income works, though I presume it’s taxed in the state in which it’s earned. Could that be NY in some cases as well?

      Not to say he didn’t save a bundle, but the article is pretty careless.

      1. there has been some speculation whether the baseball players recently traded from Miami to Toronto will have to be compensated for their extra tax – whether the impact of the taxation treaty between Canada and the US was factored in, I don’t know.

        A more important barrier to the trade may be that one of the Miami players has a pit bull, and Ontario does not allow them to be brought into the province. But that’s not a wealth effect, just a lifestyle choice.

        1. I had not heard of that issue arising in that misbegotten trade, though I do know that, in the past, tax rates discouraged free agents from signing with Toronto or the Montreal Expos (now the Washington Nationals).

  4. FWIW, the paper states that analyzing soccer players is meant to set a ceiling on the effect of the Laffer Curve, since they are an unusually mobile population that would be much more willing to relocate for any purpose, including minimizing taxes. So it’s not meant to be demonstrative of the population at large.

  5. Once he hit his peak earning years in the late 90’s Michael Schumacher settled in Switzerland (a reasonable proxy for Germany if you’re in the Schweizerdeutsch section, I suppose), and pretty much every other Formula 1 driver maintains a residence in Monaco for tax purposes. Again, though, these are a pretty mobile lot, flying hither and yon every other week for a race, and testing in either Spain or Italy during the winter months. Country of residence doesn’t really matter much, so long as it’s a place one is comfortable in.

    Might there be some movement of professionals who aren’t tied to one place from CA? Probably. Consultants, in particular, can operate out of any place. I’m guessing, though, that most successful doctors, attorneys, businessmen, etc., who will be affected by the higher tax, won’t want to re-establish themselves in a new place.

    1. Soccer players and Formula 1 drivers and consultants and such don’t really have any need for a domicile in the sense that the rest of us do. They need a place to get their mail for legal purposes, and a place to relax during the off season(s), and a place to park their spouse and offspring should they be that way inclined, but none of those need coincide. I’m betting, though, that the Manhattan and Silicon Valley effects trump the tax issues: at the upper levels, fast face-to-face access is still fairly crucial, as are the things you never thought of as amenities until you couldn’t get them with a local phone call or a few minutes’ drive.

      What I do wonder about is professionals who attempt to change their legal domicile without actually changing their primary workplace or residence. I expect there will be a few very costly and publicly humiliating legal battles about that.

  6. “exceptional quality of lie etc”. Good point. I just want to add that this applies to areas with exceptionally low quality of life as well as areas with exceptionally high quality of life. The key is non monetary features which different people value different amounts. Take nice weather. If everyone cared equally about it, there would be an equilibrium in which people pay for nice weather with low real income (maybe via the high cost of housing). We would all be indifferent (note cared equally) and people would leave if their taxes were raised. That which helps California is that some people love it and won’t leave and others don’t love it and aren’t willing to buy a house (or pay high rent).

    France is in better shape. For one thing they are very different from other French speaking countries. Where are rich French people going to go — Belgium, Quebec, Ivory Coast ?

    If the English speaking world raised taxes on rich people, they wouldn’t leave. Even rich people in English speaking countries are mostly monolingual.

    Hey wow I’m flashing on something. Maybe Californians are trapped. Like wow, could they speak normal American English if they like had to ?

    OK I admit that my Californian is straight from a 35 year old Doonesbury cartoon, and that Californian bloggers here demonstrate an ability to write standard American English well beyond my wildest dreams (which tend quite frankly not to have much dialog).

    1. France is in better shape. For one thing they are very different from other French speaking countries. Where are rich French people going to go — Belgium, Quebec, Ivory Coast ?

      The Borough of Kensington and Chelsea, beautiful neighborhood, great French restaurants and an upscale Francophone community of 200,000 people. Whenever we took our kids to Holland Park the dominant language spoken was French, they have quite a foothold in that part of London.

  7. If you believe in the diminishing marginal utility of wealth, the Laffer Curve is logically inevitable, and the only interesting question is at what marginal income tax rate does the slope turn negative. Given the absence of any evidence that significant numbers of Americans went Galt when the top marginal rate was in the 90s, it seems safe to assume that the inflection point is at a rate sufficiently close to 100 percent as to be irrelevant.

    In other words, shtup Grover Norquist and the mule he rode in on.

  8. Now wait a minute. The Laffer curve idea was that people would work less at higher tax rates, not that they would move to lower-tax areas. Variations in tax rates have always existed, yet there we are with all those people in CA and NY. Moving is an entirely different matter than cutting back on work hours, because when you move, obviously, you give up whatever local conditions, personal or social, caused you to live there in the first place. You also give up possibly superior government benefits in exchange for lower taxes. Have you ever heard of anyone buying a home specifically in a high-property tax jurisdiction because it had very good schools? I have, often.

    I’m no great believer in the Laffer curve as a guide to policy to begin with. To start with, I don’t understand what the independent variable actually is.The highest marginal rate? Why the highest? Note that for the extremely wealthy the marginal rate is often 15%. How would Wall Street react if the top rate on earned income were cut to 30%, and the CG and dividend rates were also set at that level? And it seems to me that if tax rates affect work level then changes in the rates paid by workers below the top level might matter as well. After all, those rates are marginal to the people paying them.

    Second, even if we can define “tax rate” well enough to get some sort of idea about a curve, I don’t see why the curve has to be stable. Lots of things affect tax revenues. There’s no reason a very poorly defined relationship between rates and revenues won’t change as economic conditions change.

    Finally, of course, there is Martin Gardner’s criticism that knowing two points on a curve doesn’t really tell you what the curve does in between. He famously illustarted that with a tangled scribble, but the point holds. Suppose there is more than one maximum, for example.

  9. Once again, more evidence that we should listen to Republicans and return to the tax rates of the 1950s and early 1960s when our country and economy were strong…


  10. Many variables make up the motivations of outbound migration as well as inbound migration patterns. Taxes are just one variable. Some are motivated by intangible issues such as weather and climate. Over time the mix of motivating patterns can change, for better or for worse. Shifting the tax burden onto a small segment of population causes distortions in that segment in their decisions of where some will choose to live. For the ultra rich, maybe the tax rate does not matter. For the marginal “rich”, the tax rate can be a deciding factor. The killer for the economy are not the people who choose to leave; it is the people who will not come.

    Increasing the distribution of people who consume services at the same time of decreasing the revenue to support those services causes misery.

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