Thursday, June 15, 2006
I first learned of it during his lecture to the Food Service Industry (Speakers included me, Laffer, Galbraith, Lionel Tiger, and a whole bunch of people you've heard of) back in the 80's.
The Laffer Curve starts with the obvious: at zero tax rate you get zero revenue. At 100% tax rate you get some revenue but not much, and less productivity since a great deal of effort goes into measures to avoid (not evade but that too) the tax. I recall a Swedish friend who had a tax rate of 104% in his bracket: if he could spend money deductively he made money so he attended overseas conferences.
So: maximum revenue comes at tax rates somewhere between zero and 100%. The exact point depends on a number of factors, and can be empirically determine: it seems to be well under 50%. The lower rates have several effects: people work harder if they get to keep more than half of what they earn; at lower rates more goes into investments intended to raise production rather than into tax avoidance; and more jobs are created, there's more production and thus more revenue to tax.
Reagan's sustained economic boom was one demonstration of that, but Kennedy had paved the way with his tax cuts and resulting economic growth. The "Reagan Deficit" didn't come from lower revenue: revenue went higher and higher during his term. The deficit came from great expenditures, not merely the Reagan defense buildup that bankrupted the USSR and brought down the evil empire, but the far greater entitlements expenditures. Reagan's balanced budget submissions were notoriously "Dead on Arrival" (the Democratic House Majority Leader's term) and the deficits grew, but not because of a lack of revenue.
Determining the optimum taxation point is a bit tricky, but there's a lot of data, and nearly all of it indicates that "soak the rich" taxes produce lower revenue.
If you fine people for speeding they tend to drive slower, or buy radar detectors. If you fine people for making money they tend to make less, hire lawyers and accountants to protect it, or move somewhere else. Fining people for making money is not a great way to raise revenue, just as subsidizing people for not working is not a great way to get them out finding jobs.
I would only add that if a tax rate of well under 50% produces the optimum revenue a rate of roughly half that would be likely to produce a somewhat reduced revenue but a substantially higher GNP growth rate.
UPDATE - post on jerry's site:
Subject: Laffer Curve
You probably already know this, but your readers may find it useful. Regarding the Laffer Curver, Jude Wanniski (Former editor of the Wall Street Journal) wrote an excellent book about the topic: "The Way the World Works".
IIRC, the optimum tax rate is around 15 %. By the time you get to 25% you are on the downward side of the curve, and productivity begins to be negatively effected dramatically.
"Indeed. Wanniski's book is very much worth reading" (Jerry said)