The Laffer Curve

Marginally Useful Material Launcher ^ | 30 January 2004 | Robert Sturgeon

[SierraWasp]

"What do you think is "known" about that?"

"Fascinating!" God only knows!!!

[Wumpus Hunter]

Wait a minute! Aren't we talking about Larry Laffer?

[GigaDittos]

I'm a dittohead, I know what the Laffer Curve is.

[stylin_geek]

How about the fact that an electron has a mass approaching zero (for all practical purposes it is zero, but due to limitations in the equipment used to measure such things it still shows some mass) yet has "spin?"

[GigaDittos]

You mean it has less mass than a photon?

[Hawkeye's Girl]

How about the fact that an electron has a mass approaching zero (for all practical purposes it is zero, but due to limitations in the equipment used to measure such things it still shows some mass)

No. Electron mass = 9.10938188 × 10-31 kilograms. That's not zero, practically or theoretically.

yet has "spin?"

They spin because electrons have intrinsic angular momentum. Moreover, photons have no mass, but they have a lot of interesting properties, don't they?

[Hawkeye's Girl]

Yes.

Proton mass = 1.67262158 × 10-27 kilograms.
Electron mass = 9.10938188 × 10-31 kilograms.

[GigaDittos]

I had a little chemistry once. I sorta knew that.

[Hawkeye's Girl]

I'm sure you did :-)

[Pitchfork]

That is the truth. Laffer persists (like Keynesian theory persists and monetary theory persists) because it can't be falsified.

[Pelham]

It is a testament to effective self-publicity that a simple Elasticity Curve, when applied to tax rates, received the name of "Laffer Curve". Laffer hardly "invented" the curve, but because most people have no reason to study academic economics they are easily buffaloed into believing that nonsense.

The Laffer Curve doesn't provide any useful predictive information, because there is no way to apply numbers to the curve, or in fact know what its shape is. You have two problems: you have no way of knowing where you are on a curve whose shape you also can't draw.

The closest thing to an actual "Laffer Curve" is the study of the effect the Reagan tax cuts, an exhaustive regression analysis done by Larry Lindsey, Dubya's first economic advisor. The finding of Lindsey's study is that the Reagan tax cuts generated enough growth to recoup 2/3 of each dollar cut. The tax cuts didn't pay for themselves, as many supply-side journalists like to claim, but they also only cost the Treasury one-third of the amount that static analysis predicted.

[GigaDittos]

I didn't realize we had so many geniuses on this board. So many people that know so many things. Amazing. Truly amazing.

[Torie]

What is the tradeoff when you cut the highest marginal rates, not from 50% for earned income, and 70% for unearned income, to around 30%, but rather from 40% to around 35%, or or somewhat more than 35%, given the AMT kicking in? And of course, the regression analysis, with only one data set, is suspect to begin with. What co-variables, correlated with the tax cuts perhaps by the accidentally and coterminously, might have been at play? Maybe the regression analysis has a bit of GIGO in it, and maybe if honestly rendered, as a low T stat confidence level.

[Pelham]

I'm a dittohead, I know what the Laffer Curve is.

One thing Rush doesn't get right is Reaganomics. You'd be much better served by reading what Reagan's economists have written, than to take Rush's accounts seriously. He's often 180 degrees out from what they have to say. I sometimes wonder where he gets his information, as it's certainly not from the economists who worked for President Reagan.

[cookcounty]

All I can tell you is that the fast-growing economies of Asia in 1970-1990 had one thing is n common: Tax rates of 15% or less. Those with higher tax rates had significantly slower growth.

[Pelham]

Lol. Piece of cake, I'll have the answer for you in a jiffy.

Lindsey's study was published as "The Growth Experiment", and includes all the variables that he used for his study. As I recall they were about as eye-glazing as that list you just made.

[Pelham]

I dunno about genius. But by reading a few too many obscure books on economics and politics, with a view to the "supply-side" movement, you end up knowing a lot of mostly useless information. For an intro you could read

Reaganomics- Niskanen
Revolution- Anderson
The Growth Experiment- Lindsey
The Supply Side Revolution- Roberts
Reaganomics- Bartlett
Wealth and Poverty- Gilder
The Way the World Works- Wanniski
The Seven Fat Years- Bartley

[Swordmaker]

(Yes, this is a devil's advocate question, so please refrain from your Adam Smith/Milton Friedman retorts. I'm already a member of the choir). Yours in Capitalism,

How about the take that the liberal website Economist.com takes on the Laffer Curve . . .

The Laffer Curve

Legend has it that in November 1974 Arthur Laffer, a young economist, drew a curve on a napkin in a Washington bar, linking AVERAGE tax rates to total tax revenue. Initially, higher tax rates would increase revenue, but at some point further increases in tax rates would cause revenue to fall, for instance by discouraging people from working. The curve became an icon of supply-side ECONOMICS. Some economists said that it proved that most governments could raise more revenue by cutting tax rates, an argument that was often cited in the 1980s by the tax-cutting governments of Ronald Reagan and Margaret Thatcher. Other economists reckoned that most countries were still at a point on the curve at which raising tax rates would increase revenue. The lack of empirical evidence meant that nobody could really be sure where the United States and other countries were on the Laffer curve. However, after the Reagan administration cut tax rates revenue fell. American tax rates were already low compared with some countries, especially in continental Europe, and it remains possible that these countries are at a point on the Laffer curve where cutting tax rates would pay.

If the truth is inconvenient for your world view... LIE.

All of this obfuscates the REAL point of the Laffer Curve.

On the graph above, the Y axis represents Tax Revenues and the X axis represents Tax Rates (0-100%), "T" is the optimal revenue return to the government and the point of beginning discouragement by the public to working more to produce more. Although it may look like a 50% tax rate, it is not necessarily so, that is merely an artifact of the drawing.

Finding "T" is not the point of the Laffer Curve nor was it Laffer's observation that he was illustrating on that napkin. If that were the case the graph would be merely a reverse price/demand curve that any economist would recognize.

The point that Laffer was illustrating is that for ANY given revenue, there are TWO tax rates that will produce the same revenue for the taxing agency. Draw a horizontal line across the curve from the revenue axis and you will see that the line intersects the curve both on the increasing and on the decreasing arcs of the curve. In other words a return of 100 units of revenue can be received from a 25% and a 75% tax rate (just examples, we really don't know what the rates for equal return are... sort of an economic Uncertainty Principle).

The liberal economists at Economics.com fail to realize the other effect of selecting the lower of the two equal revenue return tax rates. Supply siders noticed the duality of the curve and, being greedy capitalists that they are, not to mention hardheaded business oriented people, realized that the LOWER tax rate left more money in the hands of said greedy capitalistss while STILL giving the government the same revenues. They knew that money left in private hands could and WOULD be invested in making more income, which also could be taxed, resulting in HIGHER revenues to the taxing agency. It was this phenomenon that DID, in fact, increase government revenues in the Reagan years, despite drastically lower tax rates!

[tortoise]

What is the proper balance of taxation and maximum revenue?

I seem to recall some very recent studies that put it right around the 5% range, plus or minus a couple percent, for the general case that we have now. Interestingly this pretty much describes the US up into the 20th century before taxation became all the rage.

There are some additional factors in the model that make the specifics more complicated but as a ballpark rule, the optimal number is ALWAYS less than 10%. At least in theoretical literature.

[Fishing-guy]

Of course those Asian countries do not need high tax rates, because they don't have all these entitlement programs to pay for.

You can also argue that those European countries, with all their entitlement programs and high tax rates, have done fairly well too. They have maintained fairly high standard of living for their citizens.