Living Laffer

Tonight, I flew into New York for business. On the way to my hotel, I had a long, illuminating conversation with my taxi driver, who also happened to be a small business owner.

It wasn’t long before John (not his real name) started complaining about the costs of running his business in a city as expensive as New York. For example, my 30 minute ride from JFK was over $60. He was particularly upset about New York’s taxes and revenue enhancement programs like traffic cameras. To him, the city seems to have installed traffic cameras at nearly every corner, in order to squeeze as many dollars from its citizens as possible.

He also complained about high regulatory costs. To operate a cab in New York, the city requires taxi owners to purchase a medallion. The city limits the number of medallion holders to 13,000 (according to John). This limit prevents the market for taxis from collapsing. Otherwise, the barriers to entry are so low that prices would drop to a point where few would find it profitable to run a taxi business. Or so the city would have people believe. Of course, consumers would likely pay far less without the rationing. However, this point is an argument for another day.

According to John, medallions are going for $705,000 apiece – more than the cost of most residences.

Curious, I asked him how much revenue he earned a month. He said about $9,000. I then asked him how he could afford a $705,000 medallion. He responded that he only paid $335,000 when he bought his several years ago. To pay for it, he took out a loan. He now pays $3,600 each month in principal and interest – more than most Americans pay for their mortgages.

I quickly did the math in my head. If New York is remotely as bad as California, he would lose about half his revenue to state, local, and federal taxes. So, he would have about $900 each month for food, gas, and rent, after taxes and debt service.

I asked him how he managed to keep his business from collapsing. His answer was priceless:

“If you had paid me in cash, I wouldn’t have reported the transaction.”

It appears there is something to the Laffer curve after all. If government taxes people too highly, revenue will start to decline as people exploit more loopholes or bypass the system altogether.

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About Sean Patrick Hazlett

Conservative clean energy crusader, national security hawk, financial analyst, engineer, and former military officer.
This entry was posted in Business, Finance and Economics, Policy, Politics, Taxes and tagged , , , . Bookmark the permalink.

9 Responses to Living Laffer

  1. joe says:

    Wow, I never would have guessed taxi drivers in New York make six figures!

  2. Jules says:

    Yep, pretty much jives with my talk with a NYC cabbie few years ago. He was white but noted that the immigrant cabbies have a much harder time than when he had started out way back in the day, when the barriers to entry were lower and cab drivers could eventually become business owners of cab companies which is definitely not the case today.
    Dana White was on Opie and Anthony a couple of times in the past months, talked about how NYC unions prevented UFC from coming to NYC because of Dana’s non-union backers so all the millions of dollars generated by UFC went across the river to New Jersey. He gave the breakdown too, hotels restaurants etc. who missed out on revenue from UFC fans.

  3. The Laffer Curve is primarily about economic growth, I think, not tax avoidance.

    The Laffer theory is, you cut taxes, people invest, growth happens, thereby raising government revenues even though the rates have been cut. By contrast, the taxi experience, if we take the cab driver’s story as gospel, is about tax avoidance– unsurprising when stakes are high and risk of being caught are low.

    There’s no evidence that the US is anywhere near the “cutting taxes raises revenues” side of the Laffer curve. Empirical studies suggest that that point would be somewhere around 70%, as opposed to the 35% where our highest marginal income rate is today.

    • That’s not a completely accurate description of Laffer’s theory. The theory is that if you have a zero percent tax rate, you get no revenue. As you raise the tax rate, revenues steadily increase. At some point, the system earns maximum revenue, after which revenue starts to decrease as people change behavior in response to tax increases. Revenue again reaches zero at a tax rate of 100%, since no rational human being would work if 100% of their income went to the government.

      In this example, I am talking about the cumulative effect of state, local, and federal taxes + regulatory costs. Since revenue enhancements and regulatory costs are after tax, they increase the tax burden at a higher rate than regular income taxes. In this example, government consumes 90% of this taxi drivers income (if he reported all his income) well above the 70% you argue is the optimum.

      • I didn’t mean to argue that 70% “is the optimum.” Studies suggest that is where the Laffer curve bends. I don’t want taxes at 70%, and neither does anyone else. Pretty much no one in the US pays over 40-45 percent in taxes. So the Laffer curve isn’t relevant in this country.

        It is true that high taxes, and low likelihood of getting caught for noncompliance, makes avoidance likely.

        Here’s a little discussion about the Laffer curve (which is, in my view, absurd at the extremes, worth taking into consideration in theory, and not relevant in the US). Jon Chait:

        The Laffer Curve is a concept that says a 0% tax rate and a 100% tax rate will both produce zero revenue. Therefore it’s possible to cut taxes and raise revenue. Most economists agree that this is true in theory, but ridicule the notion (put forth by leading Republicans) that current U.S. tax rates are high enough that tax cuts can raise revenues.

        I think it’s also true, in theory, that some tax rates could be high enough that a rate cut could produce higher revenue. I have not disagreed with that idea anywhere in my book. What I took exception to is the idea that a 100% tax rate would produce zero revenue. I know for a fact that this is false. How could I know that? Because if tax rates were 100% I would still work anyway. Why not? It beats sitting home all day. I wouldn’t work as hard, but I’d work. The government would get revenue from me. There, that’s above zero. I’m also highly confident that other people would work, too. Not nearly as many as do work, and again not very hard, but work they would.

        The point here is that the supply-side model, which holds that all human activity takes the form of calculating the marginal return on our work, is wrong. People work for all sorts of reasons other than income — intellectual stimulation, pride in their craft, feeling productive, etc.

        • Fair enough. I think if tax rates were at 100%, most people would likely resort to bartering, since no one would have money for food. My chief occupation would likely also change from financial analyst to rebel, because any system like that would be worth tearing down. 😉

          I also think if you layer on revenue enhancements and regulatory costs, the effective tax rate is much higher in certain parts of the country than 40-45%.

    • Also, in the article to which you linked, tax evasion is one of the explanations cited for why revenues decline at high tax rates. What makes the tax discussion more complicated is that some states have found more creative ways to bilk their citizens to raise revenue in tough times. These revenue enhancements and regulatory costs tend to impact people above and beyond the standard 35% marginal tax rate. The bottom line is that government is taxing people (when you include state and local government) more than a look at marginal tax rates would suggest.

    • Andrew Roberts says:

      The Cato Institute has proven that cutting taxes has led to increased revenues multiple times in the 20th century, at points much lower than 70%. http://www.cato.org/pub_display.php?pub_id=13204

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