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:
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth: @ 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.
Their exact definition of "labor tax" may not be identical with "income tax" (I'm not sure), but yes, it sounds like income tax makes up the bulk of it.
or lowering capital taxes (since we're beyond the maximization point for capital taxes)
Yes. Even then it will not be enough.
Makes sense to me.
Jan '11
Re: Do Conservatives Understand the Laffer Curve?
One dimension of the tax rates logic is simple: if you have four businesses taxed at a million per year, that's four million coming in. However, if by lowering rates 10% you can attract an extra business, that's $900,000 multiplied by five, giving you four and a half million coming in. That's why growing the tax base is the key, not just lowering the tax. You need to get some value in return for it. And that's why these proposals are all packaged with other pro-growth policies, such as reduced regulation, simplifying compliance, etc.
No matter what the Laffer Curve's math is, the real message is the attitude and incentive. We want to grow.
The Obama Administration, however, seems to live in a static world. Rich people here, poor people there. They think they're "pro-job" by giving bailouts. But when they make it harder to take risks (by smothering taxes and regulation), they don't seem to realize that instead of helping, they're preventing help from arriving.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Mendel: 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?
Speaking as a Communications Studies graduate who may or may not be consuming a wee bit of alcohol today because I took the day off to do some much-overdue spring cleaning on my home and therefore my head may or may not be a little fuzzy today ... um, uh, yeah. Absolutely. You're exactly right.
[grin]
Or, to put it another way, if we agree with each other, why are we arguing?
(Vodka & Kool-Aid, in case you were curious...)
Edited on March 23, 2012 at 7:21pmApr '11
Re: Do Conservatives Understand the Laffer Curve?
Well here is a graph of a Laffer curve for corporate tax rates. The Y axis is the revenue generated expressed as a percent of GDP, and the X axis is the nations corporate tax rate. I think though there is a lot more going on than just the rate in these figures.
I think on of the problems in figuring out the Laffer Curve is that we have a tax rate and then we undermine it with exemptions and all sorts of gimmicks to make it artificially lower.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
KC Mulville: One dimension of the tax rates logic is simple: if you have four businesses taxed at a million per year, that's four million coming in. However, if by lowering rates 10% you can attract an extra business, that's $900,000 multiplied by five, giving you four and a half million coming in. That's why growing the tax base is the key, not just lowering the tax. You need to get some value in return for it. And that's why these proposals are all packaged with other pro-growth policies, such as reduced regulation, simplifying compliance, etc.
No matter what the Laffer Curve's math is, the real message is the attitude and incentive. We want to grow.
I agree, but maybe we can get the most benefit by just deregulating rather than cutting rates. One of the things Reagan did was also simplify the tax code and stream line regulations. I think we can get more bang for our buck by attacking loop holes and regulations than over all rates. But, the GOP seems unable to articulate this point effectively.
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
Revenues as a % of GDP 1977 vs. 2007
My takeaway here is that we should first and foremost design a tax code that promotes economic growth, because the revenues will flow just fine as long as the economy is healthy.
Also note from the link above that the corporate income tax dropped from 2.7% in 2007 down to 1.0% just two years later in 2009. I don't recall any major corporate tax cuts in that time, but I do recall a significant economic downturn.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
Well here is a graph of a Laffer curve for corporate tax rates. The Y axis is the revenue generated expressed as a percent of GDP, and the X axis is the nations corporate tax rate. I think though there is a lot more going on than just the rate in these figures.
I think on of the problems in figuring out the Laffer Curve is that we have a tax rate and then we undermine it with exemptions and all sorts of gimmicks to make it artificially lower. · 10 minutes ago
I bless you for posting this graph.
Truly.
Sincerely.
Now ... do we have any Norwegian Ricochetoise reading this thread?
If yes, does Norway have fewer-than-average tax loopholes relative to its tax rate?
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
Well here is a graph of a Laffer curve for corporate tax rates. The Y axis is the revenue generated expressed as a percent of GDP, and the X axis is the nations corporate tax rate. I think though there is a lot more going on than just the rate in these figures.
Based on that graph, the rate seems to be the least important determinant of revenue.
For instance, the majority of countries seem to be in the 2-4% of GDP range for revenue, despite having corporate rates ranging from 8-35% (and the distribution is not entirely clustered). At the same time, Germany and Norway have almost the same rate yet see revenues of 1.5% and 10% of GDP, respectively.
In other words, everyone on this thread is right: pro-growth policies and simplified taxes are probably much more important than the nominal rate.
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
Republicans talk about lowering taxes because they believe this will buy them votes. Democrats talk about raising entitlements for the same reason. Both groups tell the voters they are good people trying to do the right thing which is the biggest lie they tell. Understand these are career politicians trying to accumulate power. If they understand the Laffer theory or not is of little import. US debt is at 100% of GDP. People who think good people trying to do the right thing got us in this predicament because they are told that by the people who have caused the problem are naive at best. I would suggest the only logical explanation for the current fiscal situation is that both parties populated by self serving individuals have consistently put their well-being before the good of the country. That is the primary problem, not who understands the Laffer Curve.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
So why stress the tax rate so much? Which is what the GOP is doing. I say it is because they for the most part aren't bothering to understand what is going on or explain it to people. This though strikes me as a bad way to do business and convince people we have real solutions. If the GOP is simply reciting "We need to lower rates to raise revenues" as a kind of prayer their position will be quickly undermined by any journalist or Democrat (redundant I know).
May '11
Re: Do Conservatives Understand the Laffer Curve?
Let us have the classic Laffer curve from Heritage
http://www.heritage.org/research/reports/2004/06/the-laffer-curve-past-present-and-future
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
But if more conservative understood the Laffer Curve we could better hold our politicians to the fire for telling us "sweet little lies". GOP politicians get away with this because too much of the base is actually ignorant of what the theories on which our economic policies are built upon mean. I think we here on Ricochet are not very representative of the average GOP voter and their level of understanding...
Jul '10
Re: Do Conservatives Understand the Laffer Curve?
This discussion is beautiful. Oh Masters of the Rico-verse, this is why we need a serious, established economist regularly contributing to Ricochet! We need more intelligent discussions of taxing and spending patterns based on empirical economics, not just political-economic theory, which is generally where most Ricochet conversations on economic issues end up.
Mar '12
Re: Do Conservatives Understand the Laffer Curve?
Clearly those in different tax brackets are on different points on the curve. The degree to which economic activity is stimulated by tax cuts varies from group to group, but I suspect those in the upper tax brackets are on the right side of the curve and those in the lower brackets are just to the left of peak. An honest discussion would evaluate the effect on economic activity when (1) tax rates are varied for each income group, and (2) when tax brackets are shifted left (i.e., lowering the level at which income is taxed at a higher rate).
The Laffer Curve is not hard to understand philosophically unless you're a liberal.
Feb '11
Re: Do Conservatives Understand the Laffer Curve?
To complicate matters more, why should that peak point (if the equation really is parabolic and thus only one peak) be time invariant? i.e., why doesn't it shift around because it is highly correlated with other factors that are themselves changing?
Edited on March 23, 2012 at 8:22pmMay '10
Re: Do Conservatives Understand the Laffer Curve?
Another question that I have never seen addressed anywhere, but which seems intuitively very significant to me, is, Is the Laffer Curve static over time or is it dynamic? I strongly suspect that it is not static; that if we are on the right side of the curve and cut taxes and get the predicted increase in revenues, then people will accommodate their expectations to the new situation and will begin taking steps to reduce their tax hit, which will shift the curve to the left. I know that, even though I am most assuredly not part of the 1%, after taking a big tax hit in 2010, I restructured our income so that for 2011, our income increased by about 10% but our tax hit dropped about 30%. I have no doubt that people smarter and richer than me -- think Mitt, Warren, Bill, Barack, etc. -- are making full use of these opportunities.
Re: Do Conservatives Understand the Laffer Curve?
Hey. Glad to have helped spark a very interesting discussion. I don't buy for a second that line about the optimum being 48 per cent.
Feb '11
Re: Do Conservatives Understand the Laffer Curve?
James Delingpole, the real stimulus package!
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Misthiocracy
If yes, does Norway have fewer-than-average taxloopholesrelative to its taxrate?
Mendel
Based on that graph, the rate seems to be the least important determinant of revenue.
In other words, everyone on this thread is right: pro-growth policies and simplified taxes are probably much more important than the nominal rate.
Yes. Tax brackets and marginal rates, loopholes, how costly it is to comply with Byzantine tax laws, all add to the complexity. Plus the fact that differing forms of taxation have differing effects...
I think the Laffer curve is a useful basic model, but we'd be foolish to overlook its many limitations.
As our astronomy professor said once, "Today, we're figuring out what it would take to get a cow to jump over the moon. First step: Assume a spherical cow."
Simplicity is both a strength and weakness.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
Right so if the curve is always shifting then all tax rates could be a crap shoot. This though would argue for having a much simpler tax system with very few exceptions, as it would make it easier for the government to know where on the Laffer Curve its taxes fall.
I would also like to ask if we are certain that the Laffer Curve has only one peak? It could be more complicated where there are local peaks in certain ranges but maybe only one overall maximum. This would create really confusing situations, where one tax cut generated revenue, but a further tax cut just lost us revenue.