Meta-Blog

SEARCH QandO

Email:
Jon Henke
Bruce "McQ" McQuain
Dale Franks
Bryan Pick
Billy Hollis
Lance Paddock
MichaelW

BLOGROLL QandO

 
 
Recent Posts
The Ayers Resurrection Tour
Special Friends Get Special Breaks
One Hour
The Hope and Change Express - stalled in the slow lane
Michael Steele New RNC Chairman
Things that make you go "hmmmm"...
Oh yeah, that "rule of law" thing ...
Putting Dollar Signs in Front Of The AGW Hoax
Moving toward a 60 vote majority?
Do As I Say ....
 
 
QandO Newsroom

Newsroom Home Page

US News

US National News
Politics
Business
Science
Technology
Health
Entertainment
Sports
Opinion/Editorial

International News

Top World New
Iraq News
Mideast Conflict

Blogging

Blogpulse Daily Highlights
Daypop Top 40 Links

Regional

Regional News

Publications

News Publications

 
Laffer Curve
Posted by: Dale Franks on Thursday, September 13, 2007

Jon's Post below mentions the Laffer Curve, and states we're on the left side of the curve. One commenter takes strong exception to this, stating bluntly, "We’re indisputably operating on the RIGHT side of the Laffer Curve. Not on the left."

Oh, really. Well, let's take a look at that, shall we?

First, for review, let's look at the Laffer Curve itself.

The simple explanation of the Laffer Curve is that there are two tax rates that will yield the same tax revenues. In this case, the tax rate at point A is significantly lower than that at point B, yet they both yield the same rate.

If the tax rate is 0%, you get no tax revenue, because there are no taxes. If the tax rate is 100%, you still get no revenues, because no one will work if everything they make is taken away from them. So, as you raise tax rates from 0%, tax revenues will start to rise, but, once tax rates get too high, i.e., at the right side of the equilibrium point, tax revenues start to fall, because tax rates become a disincentive to produce.

The trouble is that Art Laffer defined the equilibrium point as the rate at which the population consents to be taxed. So, the equilibrium point is quite fluid. If a war occurs like WWII, that rate might be quite high indeed. In peacetime, that rate might be quite low. It may shift about some due to public concerns about the budget deficit or the national debt. Since that point varies with public opinion, it is never really possible to say at what tax rate the equilibrium point is.

Additionally, some people consent to be taxed at different rates than other people, depending on how they view taxation in general, or how much income they have, or any of a number of other reasons. So, in reality, there's no real equilibrium point, rather, there's an equilibrium range.

So, while the Laffer Curve is useful conceptually, it can't really be taken too literally.

With the above in mind, then, it might be possible to gauge where it was in the past, which we shall discuss in due course, but it's pretty difficult to say what it is at any particular point in time.

So, are we on the left or right side of the Laffer Curve?

Let's look at some numbers.

I think pretty much everyone will agree that in 1980, we were on the right side of the curve, with a top statutory rate of 70%.

When we look at IRS collections for the years 1982-1988 (Excel spreadsheet), i.e., the eight years following the initial Reagan tax cut legislation in 1981, we see that personal income tax revenues for 1982 were $352,608,936. By 1989, that had risen to $515,731,504, an increase of 46%.

Now, that seems impressive, until you look at tax revenues that followed the Clinton tax increases of 1993—which were made retroactive for that year, to much wailing and gnashing of supply-sider teeth. In 1993's tax year, revenues for personal income tax were $585,774,159, and in 2000, they were $1,137,077,702. That is an increase of 94%.

Since the above figures use current dollars, the numbers are actually a bit less impressive. Still using constant dollars, we come up with a Reagan increase of 28.4% in Federal revenues, and a Clinton increase of 36%.

Ah, and since 2000, revenues have increased to $1,236,259,371 in the 2006 tax year, an increase of 9% in current dollars, and in constant dollars, an increase of practically nothing.

So, please explain, if we are on the right side of the Laffer Curve, how tax revenues increased after the 1993 tax increases, and why tax revenue increases have been so anemic since 2000.

Hint: tax rates had very little to do with it...but that's another post. In any event, what the Laffer tells is is that major tax policy changes can have quite an impact. Fudging around a few percent at the top rates, when that rate is already historically low, simply doesn't have an outsized effect.
 
TrackBacks
Return to Main Blog Page
 
 

Previous Comments to this Post 

Comments
I would certainly stipulate that we are on the left side of the Laffer curve’s equilibrium point. And I want to move further left, because my goal is not to maximize governmental revenues but to minimize governmental intrusiveness.
 
Written By: Jeff Medcalf
URL: http://www.caerdroia.org/blog
Very good, Jeff. You are making a political point that is completely opaque to Laffer Curve analysts.
 
Written By: Billy Beck
URL: http://www.two—four.net/weblog.php
How does government spending play into the tax returns on the Laffer curve? If at the same time as changing taxes a government were to be increasing spending through expanded borrowing this would in effect be increasing tax returns (generated on that spending) irrespective of underlying economic growth.

How can this distortion be removed from the equation?
 
Written By: unaha-closp
URL: http://warisforwinning.blogspot.com/
John Henke from the post below:
Spending is the issue, taxes is just a symptom.
 
Written By: unaha-closp
URL: http://warisforwinning.blogspot.com/
When we look at IRS collections for the years 1982-1988 (Excel spreadsheet), i.e., the eight years following the initial Reagan tax cut legislation in 1981, we see that personal income tax revenues for 1982 were $352,608,936. By 1989, that had risen to $515,731,504, an increase of 46%.
That’s less impressive that the "cut taxes, increase revenue!" people would have you believe. Reagan (helped to) raise taxes in 6 out of his 8 years.

A growing economy results in higher tax revenues. But the economy almost always grows, whether you have tax cuts or tax hikes. Tax cuts provide some (varying) economic stimulus, but assuming that tax cuts are the cause of growth is just remarkably ignorant.
I would certainly stipulate that we are on the left side of the Laffer curve’s equilibrium point. And I want to move further left, because my goal is not to maximize governmental revenues but to minimize governmental intrusiveness.
Yes, but that’s a separate argument. I support lower taxes, as well, but I don’t wish to advocate them using bad arguments. "Tax cuts increase revenue" is one such bad argument.
 
Written By: Jon Henke
URL: http://www.QandO.net
Ha. That was strong exception. In any case, I still hold that strong position.

Of course, the answer that you’ve asked for has everything to do with growth, recession, and to some extent, the time period you chose.

2000 was the peak of the dot.com bubble; revenues were also "bubbling".

In late 2000 the bubble burst and in March 2001 we entered a recession (according to NBER). The recession lasted until November 2001. At that point the US economy began expanding again, but the expansion (growth) was anemic.

When the 2003 tax cuts were passed growth began again in earnest.

In any case, the Laffer curve maximum will likely occur in the very near vicinity of the rate corresponding to maximum growth of the economy. That isn’t something I was taught, ever, but I believe it to be true as growth will be mirrored in both profit and increased wages, thus, increased revenue.

Further, it is my opinion that the left side of the curve will be nearly proportional to the tax rate (because you’ve already reached "optimum" output) while the right side of the curve will be more tapered as there will always be some minimum output required to maintain a "desirable" standard of living.

So, I hope I answered your question.
 
Written By: NewEnglandDevil
URL: http://
I would certainly stipulate that we are on the left side of the Laffer curve’s equilibrium point. And I want to move further left, because my goal is not to maximize governmental revenues but to minimize governmental intrusiveness.
I do to, but that doesn’t have anything to do with the Laffer Curve.
 
Written By: Dale Franks
URL: http://www.qando.net
But the economy almost always grows, whether you have tax cuts or tax hikes.
Jon, I fundamentally disagree with this premise. Were it accurate, communism, or even French style socialism would be viable. But then observe the massive difference in the Irish economy after their massive tax break, or the huge growth in formerly eastern bloc countries, some of which have adopted flat tax policies.

There are two major issues here. One is profit incentive. If I as an investor am going to be willing to risk capital, then the potential gain must be great enough to warrant the risk. Tax structures which punish risk taking (particularly the confiscatory tax policies prior to Reagan) essentially remove capital that is necessary for growth from the market and put it all in bonds, or moved it completely out of the country or into other currency (to avoid the massive inflation).

As an example, under a Carter era tax policy a private entity might approach an investor and provide their business plan and ask for investment. The investor will look at the business plan and determine the probability of seeing some return, say 40%, on his investment within a fixed period of time, say 5 years. But, when the investor then figures that he will be paying 70% of that 40% in taxes, his return after 5 years will only be 12% (2.3% return, annualized, and about 7-9% below inflation). And that’s assuming that the company he is investing in even makes a profit! There is some fair probability (e.g. restaurants, ~50% failure) that he will lose his entire investment. In other words, there is no incentive to take that risk.

Conversely, tax policies which reward risk taking give investors reason to take risk and put capital into the marketplace which spurs growth.
 
Written By: NewEnglandDevil
URL: http://
And I forgot the other issue. ;) Maybe it will come to me later.
 
Written By: NewEnglandDevil
URL: http://
Of course, the answer that you’ve asked for has everything to do with growth, recession, and to some extent, the time period you chose.
Well, actually, I would have thrown in the massive productivity increases of the 1990’s but you’re not incorrect.

As far as the dates, I used the the only dates that were available, really, the eight years succeeding tax rate changes.
 
Written By: Dale Franks
URL: http://www.qando.net
The Laffer Curve is a big fat generalization, and it works, as a big fat generalization.

It DOES help explain why complete socialism doesn’t work (sitting over near the 100% side of the curve), but does almost nothing to explain why this country has growing tax revenues in every single decade on record except one (Great Depression), whether tax rates were flat, higher, or lower.

I suggest we tax the living crap out of the richest Americans, because those are the people who are best able to affect changes in spending. We ALL know that we are spending too much, but if as we spend, we cut taxes on the wealthiest Americans, who’s really going to complain, and more importantly, who’s going to listen.

Perhaps a modest proposal, but if the gubment were taking 80% of (insert billionaire here)’s income, I’m betting that he (or Oprah) would invest a few bucks in shutting off the spigot.

The people that are going to complain about what we are doing now are going to be the people who are paying 50% of their taxes just to service the debt we’ve rung up for them.

I really do miss the days of the fiscal conservative / social liberal. I subscribe to the school of thought that tells people they can what they want, but government better not do anything that is not cost effective and a prudent use of the taxpayers money.

Does anyone think that if we hit the wealthiest Americans for the shortfalls in Social Security and Medicare that we wouldn’t have a practical reworking of those programs in a New York minute?

Cap

 
Written By: Captin Sarcastic
URL: http://
Additionally, some people consent to be taxed at different rates than other people... So, in reality, there’s no real equilibrium point,

Dale, for the sake of clarification, isn’t this equivalent to saying that there isn’t a "best price" for a service or good?

If so, I would point out that there is, in fact, a point of diminishing returns on the Laffer Curve, just as there really is a "best price". The only catch would be that the point shifts with the times, just as with prices - something you pointed out in the paragraph right before what I quoted. But that point would still exist.

What each of us individually defines as the best tax rate is irrelevant to the Laffer curve, since it’s not a graph of how much the government can squeeze out of a single person.

Maybe I’m overly fixated on that small bit I quoted above, but the problem has never been that the curve doesn’t accurately describe the taxation reality. The only reason it "can’t be taken literally" is that it moves much faster than policy can - which is also why government would be incapable of setting best prices for goods and services.
 
Written By: Wulf
URL: http://www.atlasblogged.com
Jon, I fundamentally disagree with this premise. Were it accurate, communism, or even French style socialism would be viable.
And if we were talking about those systems, instead of the current US system and rates, then you would have an interesting point. Since we are not, your point is irrelevant.
 
Written By: Jon Henke
URL: http://www.QandO.net
So, while the Laffer Curve is useful conceptually, it can’t really be taken too literally.
I think we can, but given that each and every individual is running on their own Laffer Curve, we have to consider that some sort of "Aggregate Laffer Curve" runs society.
 
Written By: Neo
URL: http://
Nit:
In this case, the tax rate at point A is significantly lower than that at point B, yet they both yield the same rate.
They both yield the same revenue.
 
Written By: Tom
URL: http://
Jon, My point is entirely relevant. Do you understand the concept of compare and contrast? I was demonstrating that if your stated premise were true, these other failed and failing systems could have succeeded. Thus, your premise is evidently false.

Unless you’d care to actually offer an argument rather than offering up a non sequitur.
 
Written By: NewEnglandDevil
URL: http://
From the other thread, Jon Henke wrote:
"Revenues would have gone up in the absence of tax cuts, too. Unless you want to argue that the US economy would have crated and remained completely stagnant if we hadn’t lowered rates by a very small amount - that the entire business cycle had been repealed, and growth was impossible without a small tax cut - then tax revenues would have gone up regardless of the tax cut."
Italicized emphasis mine.

We are seeing in the housing lending industry the extent to which economic activity is dependent on an emotional bias—in that case at first in favor of it and then far to restrictive of it.

I doesn’t need to have cratered, only not grown quickly enough that the loss in rates was not made for in bulk economic growth.

I still remember getting my Bush tax cut check, I used it to pay down credit card debt.

Yours, TDP, ml, msl, & pfpp
 
Written By: Tom Perkins
URL: http://tomdperkins.blogspot.com/
In this case, the tax rate at point A is significantly lower than that at point B, yet they both yield the same rate.
They both yield the same revenue.
But point A most likely has a more robust economy.
 
Written By: Neo
URL: http://
I’ll toss my hat in here. Pardon the lengthy post, but there’s much to be said. There are three problems with your analysis: You fail to distinguish between the timing of the tax cuts, the *type* of the tax cut, and where the individual rate cut happens to be. Remember, some of our rates are presently at 5%. This is almost certainly on the left side of the curve. Our rates in the 30% range are more debateable, imho.

But let me just start by saying that I think this is a difficult debate to measure, given that there’s a big ol’ "ceterus paribus" assumption in the Laffer curve that is nearly impossible to measure in real life. I also agree that we’re asking the wrong question here, and that the goal isn’t to maximize government revenue (it’s the same problem to me as the constant utilitarian libertarian arguments I hear, which marginalize the strong moral arguments for freedom and liberty in and of themselves, and place libertarianism on the same materialistic playing field as does socialism). My writing has more certainty in its tone than I actually have because, well, I’m a lawyer (with a background in economics) and that’s just how I write.

That said, there are a couple points in favor of the Laffer curve’s existence in a meaningful sense (by "meaningful" I mean equilibrium may not be at 90% rates). First, as one poster has pointed out, the underlying economy is affected by a lot more than tax rates, especially when we’re just dickering around with top marginal rates somewhere in the 30-40% range. When a tax cut is implemented when the economy is on or about to go on the downslide, tax revenues are likely to fall no matter what policy is implemented. It is difficult to say whether those revenues would have fallen even more (or less) had tax cuts not been implemented.

Its part of the problem for supply siders. Your measurements (1981-1990, 1993-2000, 2001-2004) are from trough to peak for tax hikes, and peak to peak for tax cuts. They also ignore the fact that there was a substantial tax cut in 1997, and a supply side inspired tax reform in 1986, both just as revenues were going through the roof. More on that later.

Now, one could look to the Bush I tax hike from 1990 and make the same argument you are making to favor supply siders — the annual revenue increase from 1990 to 1993 are the slowest from 1983 to 2001. Perhaps the hikes kept revenue from decreasing, as it did in the other two recessions. I don’t know, though the recession of 1990 was not very deep and was brief. I also believe that if you look at tax revenues from the slashed tax cuts of the 1920s (slashed in a time of prosperity), you see significant revenue enhancements. I don’t know enough about tax policy in the 1960s to comment about what happened after the Kennedy tax cuts of 1963(?)

Finally, using your data, individual income tax levels from 2005 and 2006 are two of the five largest increases we’ve had since 1980. The other two annual increases of comparable size come shortly after the 1997 tax cuts and the 1986 tax reform. In other words, compared to where we were at this point in the last recovery, our income tax receipts are growing faster, even after a massive tax hike. This is actually what a supply sider would predict.

The other more serious criticism is that not all tax cuts have supply side effects (if any). Expanding the $500 tax credit for children to $1000? Not so much of a supply side effect, and may even drain revenues more than anticipated inasmuch as it marginally incentivizes bearing children. Lowering the tax rate on the least productive citizens from 15% to 10%, not so much — both in terms of stimulus AND the fact that we’re almost certainly on the left side of the Laffer curve there.

Cutting tax rates for the most productive citizens from 39% to 35%? I’m not so certain that there isn’t a supply side effect there. Cutting capital gains rates?

This is why the 1986 tax reform is considered a major supply side coup — revenues shot up after the bottom tax rate was marginally raised, tax shelters were eliminated, and the top rate was slashed. There is also a *massive* increase in capital gains revenues coming in the late 90s, right after a substantial cut in the capital gains rate. And these tax cuts are exactly the *types* of tax cuts a supply siders would embrace.

That’s the main problem with the Bush tax cuts, especially the first round. There were almost no true supply side cuts there, and even if tax cuts on low incomes can produce supply side effects, we’re almost certainly on the left side of the Laffer curve when we’re in the 10-15% range. The 2002 and 2003 cuts had much more of a supply side base to them.

Again, please don’t label me a supply sider. I think the jury is out, and is likely to remain out. I just think the arguments for at least some of our tax policy still being on the right side of the Laffer Curve are stronger than you imply.
 
Written By: Sean
URL: http://www.myelectionanalysis.com
I personally think trying to quantify this stuff is like trying to measure "sea level" while on rough seas.
 
Written By: anomdebus
URL: http://
I’m not familiar with the original thinking of the Laffer Curve, but as I understood it, the effect that demishes the return on taxes is not consent to being taxes. Even today most people aren’t going to quite working because taxes increased.

The factor that determines whether or not your revenue deminishes is economic health, not consent.

Most taxes are parasitical to a healthy marketplace. As such increasing taxes deminishes the health of economy as a whole. Now the government has a role in keeping the marketplace healthy, but the actual revenue required for that role is miniscule.

Economic health is not an instant responder to almost anything including taxes. And there are other factors that influence economic health. So you can get an improved economy without necessary changing tax rates. For example, the economy just as Clinton took office was coming out of a small recession caused by a bunch of issues including concerns from Gulf War I. So during the course of his presidency, the economy quickly got healthier from bouncing back from that recession. The tax revenues improved.

So basically
1) revenue is impeded by an unhealthy economy (not just taxee consent)
2) taxes are just one factor that affect economic health
3) taxes harm the economy & cutting taxes stimulate it
4) examples of one can be misleading when there are multiple factors and you attempt to assign a single cause and go "a ha!"
 
Written By: jpm100
URL: http://
This whole thing seems to be off-track. No one (that I know of) says that being on the right side of the curve will PREVENT economic growth. Just because Clinton raised taxes in 93 doesn’t mean we would expect less tax revenues in 94 or 95, the argument is that we get less than we would otherwise have had.

The best story I remember on this was Bush Sr.’s luxury tax in 90. Instead of increased collections, rich people decided not to buy things like new yachts, the salespeople and all the other connections to the yacht companies make less money and so people lose jobs and the government doesn’t get income tax or luxury tax. Part of Clinton’s increase in 93 removed the luxury tax as I recall.
 
Written By: abw
URL: http://abw.mee.nu
 
Written By:
URL:

 
Add Your Comment
  NOTICE: While we don't wish to censor your thoughts, we do blacklist certain terms of profanity or obscenity. This is not to muzzle you, but to ensure that the blog remains work-safe for our readers. If you wish to use profanity, simply insert asterisks (*) where the vowels usually go. Your meaning will still be clear, but our readers will be able to view the blog without worrying that content monitoring will get them in trouble when reading it.
Comments for this entry are closed.
Name:
Email:
URL:
HTML Tools:
Bold Italic Blockquote Hyperlink
Comment:
   
 
Vicious Capitalism

Divider

Buy Dale's Book!
Slackernomics by Dale Franks

Divider

Divider