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:
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
But if more conservative understood the Laffer Curve
The curve is a pictorial representation of an incentive theory. Basically the theory holds that if you cut tax rates from 90 - 70% (22%) you will get more incentive and all things being equal -more growth than when you cut tax rates from 70 - 50% (28%). If the incentive provided is great enough enough growth will occur to provide more revenue. When rates are at 90 or 70% the Laffer principle is of significance. When rates are at 30% it is of little importance.
Tax rate is only one of the factors that effect growth. Right now debt and the burden of servicing that debt far exceeds any incentive that can be provided by cutting taxes. You can't by votes by telling people we need to tighten their belts.
Bush calling on people to continue shopping instead of calling for shared sacrifice after 9/11 was in my opinion one of the most unpatriotic things that a President has done in my life time. But it looks like Obama may out do him. Corruption not poor economic theory is the problem.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
It is, indeed, precisely the same fallacy; the Laffer curve is a subset of Keynesian multipliers, which can come through tax cuts or spending. The math is totally subjective, as there are plenty of important and relatively unguided guesses to put into the equations, but the "science" helps to persuade people who want to agree with you that they should.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
As Mr Ryan often points out, we have a spending problem, not a tax problem. So it doesn't really matter which side of the Laffer curve we are on - we can never raise or lower the tax rates to pay off the debt - it's too, um, high.
This is what Dr Laffer means, I think, when he proposes a lower tax rate and lower spending.
So, the question should be "do conservatives understand the spending problem"?
Btw, the UK is the place to took if you want to see why high tax rates don't work, irrespective of which side of the Laffer curve they are on - they have a 40-50% top rate, 20% VAT (worse than a sales tax), high gas taxes (Mr Obama is envious) and the country is still bankrupt.
Edited on March 23, 2012 at 10:26pmSep '10
Re: Do Conservatives Understand the Laffer Curve?
First: Laffer drew his curve to help his students, and dumies like me understand his incentive theory. He nor anyone else maintians it is anything but an aid.
Reading all of the comments it strikes me as odd that most everyone would agree the government is at least 30% too big ( I would go for 60%) and yet we still talk as if a given tax scheme is going to make a significant difference. I would suggest it won't.
Few politicians dare to talk of cutting government, they offer instead talk of taxes and it appears their are a lot of people willing to take the bait.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
Dan Hanson:
Finally, I totally reject the 'starve the beast' argument. I used to believe in it, but I don't know how anyone can still buy into that argument in an era when the government is borrowing more than 40% of all the money it spends. It has an endless appetite. · 11 minutes ago
This is where I am trending to as well. We need to start ending the deficit. I don't just want it to stop rising I want to see that number start dropping. So I think that to achieve this we may have to accept higher taxes on top of spending cuts. The new taxes just have to be allocated to debt reduction. The beauty of paying of your debts is that at some point they will be paid off.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
You can increase taxes without increasing top marginal rates. The U.S. in an outrageous situation where nearly 50% of the population pays no federal income tax at all. Republicans and Democrats have long pandered to the middle class by giving them increasing numbers of tax breaks and credits until today many of them pay no federal tax at all.
This is not just poor tax policy, it's poor social policy. It's destabilizing when almost half your voters know they will not pay the price for the goodies they vote for.
Corporate tax revenue could be increased while lowering marginal rates by closing the myriad loopholes and exemptions the big corporations have carved out for themselves, while leaving small corporations and entrepreneurs to pick up the check.
Responsible policy should include an increase in taxes through broadening the tax base, eliminating special exemptions and credits, and lowering corporate tax rates. This should be accompanied by even larger cuts in spending - say, 2:1 spending cuts to tax increases, with the spending cuts coming first. This situation should remain until the deficit is below the rate of GDP growth, then taxes should be cut.
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Midget Faded Rattlesnake
The government exists to serve the populace, not to extract maximum revenue from them.
Oh, that your statement was carved onto every wall of every building in Washington DC, and read aloud every morning in every classroom in America.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
You have my vote Dan.
Oct '10
Re: Do Conservatives Understand the Laffer Curve?
A few points. Republicans have been burned many times by broken promises on tax deals that purportedly balance spending cuts and tax hikes. Thus, there is a credibility and a trust issue.
But, obviously the math dictates a balanced approach. Neither tax hikes nor spending cuts can alone reduce the deficit; it has to be a mix. Myself, I prefer front-loaded spending cuts and back-loaded tax hikes. That way, the cuts happen first.
Of course, all of this may be moot. Most of our fiscal problems stems from our over-subsidized lightly-taxed middle class, who are too powerful to allow change. In truth, we probably can't afford most of our middle-class entitlements, or the current low rate of middle-class taxation. I suspect that in 10 years, Social Security and Medicare will no longer exist, though ObamaCare (hopefully repealed/replaced by RyanCare) may still be around.
Nov '10
Re: Do Conservatives Understand the Laffer Curve?
Of course I understand the Laffer curve.
However, the the real issue here is not about revenue, it is about spending. The question that should be asked is not what the optimal tax rate should be but rather what should the optimal government spending be as a percentage of GDP. Then you can as the revenue question and where we are on the Laffer curve.
Sequencing matters!
Edited on March 23, 2012 at 11:15pmDec '11
Re: Do Conservatives Understand the Laffer Curve?
The Laffer curve is really about marginal tax rates, and the outsized impact on after-tax income that high marginal tax rates have.
Re: Do Conservatives Understand the Laffer Curve?
The most important, often overlooked means of maximizing tax revenues over time is to maximize wealth creation. This is accomplished by establishing secure property rights, a stable rule of law, and adjusting regulatory, tax and legal policy to promote individual initiative and the associated economic growth.
Under a pro-growth regime, low tax rates mint money over time due to the mathematical miracle of compounding. Narrowly focusing on short-run Laffer Curve effects In a low-to-no-growth economy like today's rather misses the point.
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
The results for the simulation shown above were obtained using using "a neoclassical growth model featuring 'constant Frisch elasticity' (CFE) preferences."
Are these models even close to being accurate? Or would the actual real life results be wildly different due to a host of factors already discussed? There is no way to test the actual data points in the real world.
I just finished "Basic Economics" by Dr. Sowell and I got the impression that he was favorably disposed to the idea that additional tax revenues in a lot of circumstances could be raised by lowering rates (Laffer curve), but the whole enterprise was "empirical".
These economic models will probably get more accurate as time goes on and maybe tax policy can then be based on a kind of science instead of politics and handwaving as they largely are now. Then again, one day they will be able to predict the weather accurately as well.
Jan '12
Re: Do Conservatives Understand the Laffer Curve?
I would also hypothesize that the Laffer Curve is very likely to be "size", "societal" and without question "government efficacy" dependent. The optimal tax rate is likely to be higher in a smaller and tighter knight community/country that is more homogeneous and socially cohesive. Given that a large portion of taxes in modern economies are for redistributive purposes, populations at large will be more willing to pay a higher rate as it is perceived to be helping their fellow citizens. On the other hand, in very large countries with more diverse populations, I would guess that citizens view higher redistributive taxes as incredibly impersonal and wasted on anonymous people and programs.
Further, I think it is certainly the case that if citizens perceive their governments putting tax receipts to good use by an efficient government (oxymoron, I know) , they are more willing to accept higher tax rates. Interesting, I am not sure I have ever seen a comprehensive study attempting to measure efficiency across governments although I am sure some exist.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Actually very few people due understand the Laffer curve. If the policy goal was to increase revenues then lower and mid-income families should pay higher effective tax rates (mid to upper teens)than they currently do and the top income earned need to be lowered to the high 20%.
Or at least that is what I remember from an old Nation Review online comment I can't find. So Republicans should actually agree with the Democrats and say your right raising taxes will increase revenues but its the poor and middle-class who should pay not the rich. You will just decreases taxes if you tax the rich more.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Actually very few people due understand the Laffer curve. If the policy goal was to increase revenues then lower and mid-income families should pay higher effective tax rates (mid to upper teens)than they currently do and the top income earned need to be lowered to the high 20%.
Or at least that is what I remember from an old Nation Review online comment I can't find.
So Republicans should actually agree with the Democrats and say your right raising taxes will increase revenues but your taxing the wrong people.
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
Dan Hanson:
The U.S. is in an outrageous situation where nearly 50% of the population pays no federal income tax at all.... This is not just poor tax policy, it's poor social policy. It's destabilizing when almost half your voters know they will not pay the price for the goodies they vote for.
Truly, the point of the day.
Oct '10
Re: Do Conservatives Understand the Laffer Curve?
EThompson
Dan Hanson:
The U.S. is in an outrageous situation where nearly 50% of the population pays no federal income tax at all.... This is not just poor tax policy, it's poor social policy. It's destabilizing when almost half your voters know they will not pay the price for the goodies they vote for.
Truly, thepoint of the day. · 34 minutes ago
I don't know, they still pay payroll taxes, don't they?
Aug '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
Midget Faded Rattlesnake
...But I don't know how you'd make tax increases permanently surprising. People catch on quick to a pattern of raising taxes, financially, if not politically.
Well one way may be to have a tax policy that is due to change every 2 years and only gets settled 5 hours before the dead line. I mean dose anyone know what the tax rates will be in 3 years? I don't. Maybe this is showing Obama's inadvertent brilliance.
True, people don't know exactly what's coming, tax-wise. But they'll infer from a history of capricious tax policy that something nasty's on the way. People then divert resources from happier economic pursuits to bracing for the next blow from Uncle Sam, which slows growth, reducing the revenue that "surprise" taxation can collect.
You don't need to know exactly what the school bully is gonna do next, beat you up or flush your head, to have an incentive to avoid him. In fact, the less you know, the more you have to fear, and bullies exploit that fact.
Not that I would ever compare Uncle Sam to a bully or anything...
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
Joseph Eagar
EThompson
Dan Hanson:
The U.S. is in an outrageous situation where nearly 50% of the population pays no federal income tax at all.... This is not just poor tax policy, it's poor social policy. It's destabilizing when almost half your voters know they will not pay the price for the goodies they vote for.
Truly, thepoint of the day. · 34 minutes ago
I don't know, they still pay payroll taxes, don't they? · 3 minutes ago
Payroll taxes don't fund the military, foreign aid, Veterans benefits, Intelligence agencies, the interstates, national parks, Pell Grants, the DEA and salaries of the legislative/judicial/executive branches.