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:
Apr '11
Re: Do Conservatives Understand the Laffer Curve?
EThompson
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. · 1 minute ago
but they still fun the most expensive part of the federal budget and do represent a not insignificant tax burden on people. In truth there should just be one tax on income from which all government spending is funded. Again leading us back to the idea that the current rates aren't really the issue. We just need a new, simpler, and more transparent tax code.
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
EThompson
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, the point of the day.
I don't know, they still pay payroll taxes, don't they?
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.
but they still fund the most expensive part of the federal budget and do represent a not insignificant tax burden on people.
And it's the most expensive part because many social security/medicare recipients are taking out more than they've put in. Ponzi scheme. Prime example of the destructive effects of income redistribution.
I supported George W.'s 2-4 % privatization plan; remarkable (?) that it was such an extremely unpopular idea.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
Tom Lindholtz:
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. · 6 hours ago
I found this very interesting and more significant than tax rates per se.
I assume the tax hit in 2010 was not the result of a lack of either intelligence or common sense. I assume Tom Lindholtz is not confessing to anything illegal. I also assume he needed expert help to restructure, and had to pay for it.
I think the case for a flat tax is irrefutable.
I have never thought of the Laffer Curve as a precise tool for determining an optimum tax rate but simply as a visual presentation of the implications of the observation that zero tax will produce zero revenue and 100% tax will also produce zero revenue.
May '10
Re: Do Conservatives Understand the Laffer Curve?
Dan Hanson: It's wrong to say (as so many conservatives do) that "half the voters pay for the other half". Such a statement commits the fallacy of "mistaking statistical categories for actual flesh and blood human beings", as Sowell would word it. As our tax code is structured, most Americans start out their working lives paying little or no income taxes (especially if they have child deductions, which, btw, Santorum wants to triple) and then rise through the tax brackets as they age and gain in income and wealth (and set the kids free). Notwithstanding the small, permanent underclass, this perception of a "net-taker half" and a "net-provider half" is a canard. The typical American spends time in each half.
Oct '10
Re: Do Conservatives Understand the Laffer Curve?
Valiuth
but they still fun the most expensive part of the federal budget and do represent a not insignificant tax burden on people. In truth there should just be one tax on income from which all government spending is funded. Again leading us back to the idea that the current rates aren't really the issue. We just need a new, simpler, and more transparent tax code. · 1 hour ago
I don't know, I do agree with the Democrats that social insurance programs need their own funding sources, though I'd much rather we privatized most of 'em (which may happen in ten or fifteen years).
Also if we ever want to partially swap labor taxes with a consumption tax, we might have an easier time selling it to the public if it was done within the SS system (since payroll taxes are flat anyway, people may not mind if they're swapped with a flat consumption tax).
Nov '10
Re: Do Conservatives Understand the Laffer Curve?
I'm no economist I don't think the peak of the Laffer curve is fixed. The general existence of the curve, and it's basic shape, is simply a matter of common sense. A bit more common sense shows that outside influences can affect the shape of the curve. Revenue is not elevated or lowered by a single stick like an old WWI Sopwith Camel. The curve gives a particular relation between revenue and tax rate "with all other factors held constant". There is also the question of which tax rate one ought to place on the horizontal axis.
If one concentrates only on the corporate tax rate, without a glance at the curve I can say with confidence that the U.S. is to the right of the "bump", for the U.S. has the highest corporate tax rate in the industrialized world right now. Therefore raising the rate will drive dollars overseas, out of taxable enterprise in the U.S.; lowering it will bring dollars home. Lowering the rate makes sense, at minimum until the U.S. rate lies comfortably among that of its chief economic competitors.
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
Sorry to be late to the conversation but, in my judgment, the Laffer Curve misleads and aims at the wrong end. It seems to suggest that the first priority is maximizing government revenue. Rather, the first priority should be maximizing everyone's prosperity. The more government takes from the wealth-producing sector to feed the parasitic government sector, the less wealth is produced and thus fewer goods and services are divided among more people which include non-productive but well-paid government workers.
For example, if government employs a hundred thousand healthcare bureaucrats then there will be about that much less money and less wealth-producing employees available to provide services that people need--such as actual healthcare services. But these bureaucrats will be paid in goods and services produced by the wealth-producing sector whose members would rather be receiving healthcare services than being told what to do by healthcare bureaucrats.
May '10
Re: Do Conservatives Understand the Laffer Curve?
This cannot be repeated enough.
Maximizing government revenue is not a worthy goal.
Figure out what the government ought be be doing, figure out how much that will cost, and then figure out how to raise that amount of revenue and no more.
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
Mark Wilson
This cannot be repeated enough.
Maximizing government revenue is not a worthy goal.
Figure out what the government ought be be doing, figure out how much that will cost, and then figure out how to raise that amount of revenue andno more.
I'm sorry to quibble where we are in basic agreement but your first consideration still seems to be providing for government.
The primary and first aim should be to maximize everyone's prosperity. When everything is ordered to that end, the "rising tide" will help the poor, unskilled and unlucky to become self-reliant and prosperous more than any government program. Ideally, government is ordered to promote, protect and defend the general prosperity.
The maxim that best summarizes the understanding of the Founders is: "The purpose of government is to protect the industrious and rational from the quarrelsome and contentions."
I would add that it can be seen that the work of the "industrious and rational" is to help their fellow citizens become industrious and rational self-reliant ladies and gentlemen because these are the qualities that good businessmen need in their employees.
Dec '11
Re: Do Conservatives Understand the Laffer Curve?
(continued from comment #89)
But I have skipped a couple of steps in the argument.
It is in the self-interest of the "industrious and rational" as well as all human being, to be, to the extent they are able, true ladies and gentlemen because being a good and noble human being is the superior way of living. It is the only way to be truly happy.
Clearly, true ladies and gentlemen would lead and help their fellows citizens to live better lives even when it is not in their immediate self-interest.
Edited on March 24, 2012 at 1:51pmMay '10
Re: Do Conservatives Understand the Laffer Curve?
Mark: In a debt-free Year Zero, yes. But in Year 2012, we've managed to accumulate trillions in debt that we're dumping on my kids and yours. It'll be little consolation (not to mention immoral) to shrug and say, "Sorry, guys, we were trying to starve the beast but it didn't work." In our situation, I'm afraid, the only moral thing to do is to cut spending AND maximize revenue. Fortunately, it's likely that maximizing revenue and maximizing growth mean pretty much the same thing.
Jan '12
Re: Do Conservatives Understand the Laffer Curve?
I would add in one factor I do believe needs to be computed with this curve. The regulatory costs of doing business. Taxes are all good and fine but if my tax on my business are cut but cost from regulations and health care etc go up I have still not gained any ability to do business, or incentive for that matter. Where does that "cost of doing business" get computed on this curve?
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
George Savage:
Under a pro-growth regime, low tax rates mint money over time due to the mathematical miracle of compounding.
When a country needs to borrow money to pay the interest on their debt and continues to do so for a period of time, like the US has, the mathematical miracle of compounding takes over. In addition the Treasury under both Bush and Obama has shortened the duration of debt instruments making servicing costs more sensitive to interest rates. We could grow our way out of debt through the early Bush years, but that is no longer the case. Growth will cause interest rates to rise which will worsen the deficit/debt not improve it. As you pointed out it is a matter of math. The GOP lacks the courage to propose the drastic cuts that are the only way out and therefore they cling to their mantra of growth that is now more foolishness than sound policy. The tipping point has been reached, unless Keynes was right, in which case you should be signing the praises of Obama.
Feb '12
Re: Do Conservatives Understand the Laffer Curve?
I have often decried -- in private until now (thank you, Ricochet) -- the kind of magical thinking about tax rates that grips some in the Republican party, the way magical thinking about gun control laws or Social Security trust funds grips those on the left. I have heard it asserted countless times that cutting tax rates will yield an increase in revenues, always!
Well, maybe, and sometimes, but not always.
The source of this confusion is precisely the misunderstanding of the Laffer curve that you identify here. But your question shows another misunderstanding. In the 1980s I received a review copy of a self-published book arguing that the solution to our debt problem was to plant the tax rates firmly atop the Laffer curve and leave them there. Your question indicates some support for the same idea.
The problem is that we don't know and cannot know where the peak is. It is constantly changing with economic and social conditions. Do you doubt the peak was higher in 1943 that it was in 1961?
Also, the optimal tax rate for immediate revenue generation is not necessarily the optimal rate for economic growth, which determines revenues in the long term.
Sep '10
Re: Do Conservatives Understand the Laffer Curve?
Idahoklahoman:
Also, the optimal tax rate for immediate revenue generation is not necessarily the optimal rate for economic growth, which determines revenues in the long term. · 18 minutes ago
It would seem to me that the ideal would be understand the minimum amount of government needed to have a well functioning country which should cost less than the maximum amount of capital that government could extract from a free market economy. That I realize is of little or no interest to either party. Which explains why we are in the mess we are in.
Mar '11
Re: Do Conservatives Understand the Laffer Curve?
A great metaphor, but perhaps lost on people who are not aircraft buffs. The reason the Camel killed a lot of pilots was that the huge torque generated by it's large rotary engine meant that the result of a control input was unpredictable. It could turn on a dime in one direction but had to be wrestled to turn in the other at all, and a small mistake could put it into a fatal stall.