Do Conservatives Understand the Laffer Curve?
I was listening to the fantastic Radio Free Delingpole podcast, when Mr. Delingpole (if memory serves me right) made the assertion that cutting taxes will generate more tax revenue. The basis for this statement was the "Laffer Curve." I have heard this sentiment expressed by many conservatives and Republican politicians. The iron clad mantra of the GOP is that lowering taxes will generate more revenue. Like Mr. Delingpole, they will all cite the Laffer Curve as the basis of their belief. But does the Laffer Curve actually support the claim that lowering taxes will generate more government revenue?
Here is an idealized version of the Laffer Curve:
Simply looking at the graph will let any one who knows how to read graphs see right away that the statement, "Lowering tax rates will always yield more revenue," is false. Clearly the implications of the Laffer Curve are twofold.
First, government revenue and tax rates do not have a linear relationship. Second, there is an optimal tax rate at which the government can generate maximum revenue. Conservatives and GOP politicians always seem to ignore the fact that the Laffer curve is a curve. They will point to Thatcher and Reagan and Kennedy and say, "They lowered tax rates and revenues went up," and then they will point to California or Illinois and say they raised tax rates and failed to draw in extra revenue. All of these being true, they are nevertheless still missing the point of the Laffer Curve.
To understand what government tax increases or decreases will do, you have to know what the actual Laffer curve for your particular government (federal or state) looks like and where you are on that curve. The GOP always seems to think we are on the right side of the optimum, and the Democrats don't even understand what the Laffer curve is.
Why am I harping on this? Well, if, like me, you believe that that our national debt problem is real and serious and must be confronted, knowing what the Laffer Curve is and how to read it is vital to fixing the mess we are in. Our government is running serious deficits. To handle these, we will surely have to not only cut programs and spending but also look to maximizing tax revenue. What I hear regularly from the GOP is a blatant ignorance of their own economic theories. How are they supposed to solve this problem when all they seem to know is a political chant, rather than actual theory?
So I pose these questions to the Ricochet audience at large. What does the US federal government's Laffer Curve look like, and where are we now on that curve? If we are below the optimum should we then not consider raising taxes, or at the very least drop the notion that lowering them will yield us more revenue?
PS: Mr. Delingpole and his guest did later make mention that the Laffer Curve has an optimum. They just seemed rather disappointed that the optimum places at 48% for the UK, and seemed rather inclined to doubt that figure as true. I think that if we are to be rational and empirical we must accept that the optimum may be higher than we would philosophically like it to be.
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Comments:
Dec '10
Re: Do Conservatives Understand the Laffer Curve?
I haven't heard anyone claim that lowering taxes will "always yield more revenue".
But you ask an interesting question. Do conservatives understand the Laffer curve. The answer is; many do, and many do not.
For instance, in order to increase tax revenue by lowering taxes, the current condition would need to be to the right of the peak. On the truly horribly drawn curve you presented, the tax rate would need to be north of 50%.
The argument about Laffer curves is not based on whether it works or not. Of course it does. The argument is based on the location of the peak. You show it to be at 50%. It certainly should be lower than that. I would guess that it's lower than 20%.
So your excellent question begs another. Do you understand the Laffer curve?
Dec '10
Re: Do Conservatives Understand the Laffer Curve?
I haven't listened to the Delingpole podcast. Who placed the UK optimum at 48%, and how did they decide on this number?
My guess is that the people that came up with this number have a dog in the fight.
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
For whatever it is worth, Art Laffer endorsed a 15% flat income tax just a couple of months ago.
At the end of his piece, he appears to admit that 15% flat tax is on the left side of the curve, but that this is a feature and not a bug. He seems to fall into the "starve the beast" camp.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
I never claimed that the The US Federal Governments Laffer Curve is the one I showed above. That is just an idealized representation of the Laffer Curve. I don't know where the true peak is. I think we can probably say it is not above 50% considering the Reagan years. My fear is that we are currently hovering very close to the peak, and the marginal benefits of new tax cuts on government revenue will be much smaller than we expect, if even there.
The GOP wants us to be on the right side of the peak because that would fit with their political strategy. I fear though that many of them being politicians will mistake their own hopes and dreams for what is really happening, much like Democrats do.
Dec '10
Re: Do Conservatives Understand the Laffer Curve?
I'm sorry, I reread my comment. I wasn't trying to be quite so abrasive.
But you do understand the problem. Nobody knows where the peak is. The only way to establish the peak is by changing the rate, and determining what happens to revenue. So far, in my lifetime, I don't think a reduction in marginal rates has caused any long term reduction in revenue. This would indicate that we are still to the right of the peak.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
Jerry Broaddus: I haven't listened to the Delingpole podcast. Who placed the UK optimum at 48%, and how did they decide on this number?
My guess is that the people that came up with this number have a dog in the fight. · 9 minutes ago
It was Her Majesties Revenue and Customs Report that set the optimal rate for the UK at 48%.
@Mark
I don't think there is any obligation for the Government to try to raise maximum revenue all the time. In fact I would argue the prudent thing is to keep your Government taxing and spending half way between the peak and the base on the left side of the peak. You want some flexibility to be able to raise more money if needed. Spending at peak levels all the time is foolish of course. It forces the need for debt when any emergency come about.
Dec '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
It was Her Majesties Revenue and Customs Report that set the optimal rate for the UK at 48%.
...
That would certainly qualify them as having a dog in the fight. They picked a number that will allow them to accomplish political goals.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
Jerry Broaddus: I'm sorry, I reread my comment. I wasn't trying to be quite so abrasive.
But you do understand the problem. Nobody knows where the peak is. The only way to establish the peak is by changing the rate, and determining what happens to revenue. So far, in my lifetime, I don't think a reduction in marginal rates has caused any long term reduction in revenue. This would indicate that we are still to the right of the peak. · 4 minutes ago
On the other hand if you look at Clinton years he raised taxes but also kept generating a lot of revenue. In fact both under Clinton and Reagan the total government revenues doubled, under Bush 43 though they did not.
The problem is many fold, because the location of the peak is probably also based on over all economic growth rate, and the efficiency of collection is also impacted by exemptions, deductions, and all the other loop holes. So in a roaring economy the peak may slide to the right and be broader, in a bad economy maybe it slides to the left or just narrows...
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
I have always seen the take-home message of the Laffer curve to be "lowering taxes can increase revenues," which may not sound very powerful, but is still earth-shattering to about 30% of Americans.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
I have heard several embarrassing speeches/interviews by prominent conservatives who claim that we need to lower taxes from their current rates in order to decrease the revenues available to the government (aka starve the beast). They then stated later in the speech that a further benefit of cutting taxes is that they raise revenues ala the Laffer curve. Oops.
Dec '10
Re: Do Conservatives Understand the Laffer Curve?
It is definitely based on the growth rate. The growth rate is an intermediate function of the tax rate which in turn drives the level of revenues.
But there's a lot more involved in growth rate function than there is in the simple collection of revenue. Other factors would be industrial utilization, savings and investment rates, the cost of borrowing money, recent inventions, etc. Most of these factors are also affected by the marginal rate. And, certainly there is financial momentum involved.
There's simply no way to accurately predict what will happen without actual changes in the marginal rate, and changes made today won't effect the economy in the same way as identical changes tomorrow or next year.
Edited on March 23, 2012 at 6:00pmMar '11
Re: Do Conservatives Understand the Laffer Curve?
Has a method to determine/approximate the peak of the Laffer curve ever been proposed, or does history seem to be the only guide?
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Well, since different forms of taxation create differing incentives, the best model may not be a curve at all, but a surface with more dimensions, such as this pretty-looking Laffer hill in two dimensions:
Valiuth
I don't think there is any obligation for the Government to try to raise maximum revenue all the time.
Totally agree. There is no obligation. The government exists to serve the populace, not to extract maximum revenue from them.
It's better to think of revenues in terms of how much is needed to efficiently support optimal size of government. A certain amount of government is necessary to enforce rule of law. Too much is stifling, as we know. Many estimates of the optimal size of government are between 15% and 30% of GDP, with a 95% chance of the size being below 25%.
I would guess that the amount of revenue needed to sustain a government of optimal size would be considerably less than what a government whose main goal was maximizing revenue would collect.
Edited on March 23, 2012 at 6:37pmApr '11
Re: Do Conservatives Understand the Laffer Curve?
Mendel
I have heard several embarrassing speeches/interviews by prominent conservatives who claim that we need to lower taxes from their current rates in order to decrease the revenues available to the government (aka starve the beast). They then stated later in the speech that a further benefit of cutting taxes is that they raise revenues ala the Laffer curve. Oops. · 12 minutes ago
And these are the people that have to synthesize this theory to solve our fiscal problems. You can see why I am worried. Politicians for the post part just want something to claim as supporting their views which are for the most part derived not from earnest analysis but rather political needs. Thus I fear the GOP currently is doing what Democrats do which is living on wishful thinking rather than sound ideas.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
The best available methodology, it seems to me, is to compare one's tax rates to those of other jurisdictions. On a graph, tracks which jurisdictions have the most efficient levels of revenue relative to their tax rates.
Using this methodology, I hypothesize that one would conclude that the USA's corporate tax rates are too high on the Laffer Curve.
(Incidentally, this is another good counter-argument to OneWorld government. After all, to whom would you compare your metrics to see if you're doing things right?)
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
The Laffer curve also has regions that have properties we can understand. In my look at the properties of the curve, the peak is defined by where you either cut or increase rates, the revenue decreases. On the high side of the curve, decreases in rates lead to greater revenue (for example the capital gains tax cut under Pres Clinton - the ones that Pres Obama wants to increase because of "fairness", despite the demonstrated increase in revenue at the lower rate).
Since there has never been a tax decrease that results in less revenue (in both the total income tax and capital gains tax), you can safely say we are on the high side of the Laffer curve.
Ann Coulter mentioned in one of her books that Democrats will never let us cut taxes to see where revenue decreases - therefore we will never be on the good side of the curve.
There are a couple of other places on the curve as well (the rate of maximum growth - and the region of tax avoidance).
I have always thought of the Laffer curve as akin to L/D curve in aerodynamics. the regions fit better.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Misthiocracy: The best available methodology, it seems to me, is to compare one's tax rates to those of other jurisdictions. On a graph, tracks which jurisdictions have the most efficient levels of revenue relative to their tax rates.
Using this methodology, I hypothesize that one would conclude that the USA's corporate tax rates are too high on the Laffer Curve.
As a scientist, this methodology appears to me too flawed, since it does not take the myriad other variables between jurisdictions into account. Not that I have any doubt but that our corporate rate is too high.
I imagine Jonah Goldberg and James Lileks could spend a whole podcast comparing the tax rates on Earth to those on Triskelion.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
@ Midget Faded Rattlesnake
Now that is a graph! Of course if I read it right we are on the left side of the curve for income tax rates. Which means that the GOP claims of extracting more revenue by lowering income taxes are bunk. It also means that the Dems are wrong about capital gains and only taxing the rich they would have to tax everyone....
But, see if the GOP congress people and candidates actually understood this they could make a strong case for the need to cut government spending. Reagan did a lot by explaining the principle of the Laffer Curve and arguing (correctly I believe) that we were to the right of the peak. Now it is time for us to argue we are to the left of the peak and the only way to raise more money is massive tax increases on the middle class, and even then they will not be enough. So the American people must choose. Try to pay for all this or cut back.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Note that I wrote best available methodology.
I will now define that to mean available to my little brain, at this particular moment, and at my current particular blood-alcohol level.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Misthiocracy
Note that I wrote bestavailablemethodology.
I will now define that to mean available tomylittle brain, atthis particular moment, and at mycurrentparticular blood-alcohol level.
Sorry, the haughtiness of my comment didn't appear to me until after re-reading a few minutes later. This is what happens when I decide to hold off on the first cup of coffee until after 10 AM. Apologies.
What I meant to say is that most natural sciences would not accept a methodology that fails to take into account large differences in other variables which could have a large influence on the ratio of tax rate:government revenue, but I'm not familiar with economic sciences so I don't know if there are good explanations. Perhaps the other differences between countries balance out when large groups are taken together?
Edited on March 23, 2012 at 7:08pm