The Laffer Curve

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

[MegaSilver]

Bueller?

"This is very controversial. Does anyone know what Vice President Bush called this in 1980? Class, anyone? Something... d-o-o economics... voodoo economics."

[MegaSilver]

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.

Yep; remember, the media has a conservative bias. ;)

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.

That doesn't mean the concept itself is useless; in mathematics, when you have the shape of a curve, you at least know whether or not you have a bleeding chance at recouping revenue if you significantly lower taxes.

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.

Just how much, if at all, did the income tax rate "flatten out" under Reagan? Is there a table of income tax brackets in various years last century?

[tort_feasor]

The real problem is marginal rates. For example: a couple a nurse and a lawyer one child under 17,are married the nurse makes $70,000, the lawyer $50,000.

Now if only nurse works, after child tax credit, standard deduction and exemptions, the federal income tax is about 10 percent ($7,000).
However if the lawyer works each dollar he earns the 27 percent rate applies. For $120,000 combined gross income the FICA due is $21,000, the effective rate is 17.5%
Now lets add in state and Social Security and Medicare.

SS and Medicare are 7.5%, assume 2.5% state income tax = 10%
The nurse alone pays $7,000 in FICA and $7,000 in state & ss and medicare. $14,000 is 20% of the nurse's gross income.
If the lawyer is added.
The lawyer pays $5,000 state, ss & medicare, and the couple pays $14,000 in additional federal income tax. $19,000 is 38% of the lawyer's income. Together they would pay $33,000 in FICA, State, SS & Medicare which is 27.5%

This is why the middle class is getting F***ed by the system

[Freebird Forever]

bump for later read

[stylin_geek]

Wow, I really crashed and burned on that one. Obviously I have the wrong particle. I will have to dig up my book and get the correct answer. That's what I get when I try going from memory, and not checking my facts. Of course, this is why I am interested in politics, 'cause as a politician, I would never let the facts get in the way.

[Nevermore]

Even these percentages leave out the hidden taxes payed by employers for the privilege of paying someone. They are essentially a hidden withholding that doesn't even seen by the average worker. Unfortunately, I myself don't really know what those percentages are. My expectation is that they add at least another 10%.

[expatpat]

Yeah, the Laffer curve is valid. But this article is based on a bad assumption: that it is right for the government to take in the highest revenues it can.

[teeman8r]

i do not find the laffer curve funny at all...

and yet, its smile seems to mock me wherever i go...

[MegaSilver]

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.

Don't they have, like, double-digit unemployment rates? And their efficiency's pretty low, too... not to mention that prescription drug programs like Canada's are leeching off of U.S. consumers.

[Tribune7]

Save Ferris.

[Pelham]

Yep; remember, the media has a conservative bias. ;)

In this case it did, as the media in question was mainly the Wall St Journal editorial page. Robert Bartley, Jude Wanniski, George Gilder, Paul Craig Roberts.

Wanniski was a great fan of Art Laffer and probably invented the napkin story. Wanniski and Gilder were a bit too enthusiastic about promoting the virtues of tax cuts, and helped create the idea that they generate enough new revenue to prevent deficits. None of the Reagan economists claimed this, nor believed it, and the results bore out their actual prediction, which is that tax cuts would not lose as much revenue as one might expect. The real goal of the tax cuts wasn't to generate more revenue for the Treasury, but to try to get the American economy to grow after the years of stagnation that we had endured in the 70s.

That doesn't mean the concept itself is useless; in mathematics, when you have the shape of a curve, you at least know whether or not you have a bleeding chance at recouping revenue if you significantly lower taxes.

The Laffer curve does have some value as a didactic device, but there is no way to assign quantities to it. The problem is that there is no way to know what the shape of this curve is. There is one tax cut that actually did generate more revenue at the lowered rate, and that was the capital gains tax cut. Oddly enough I think that passed under Jimmy Carter.

Just how much, if at all, did the income tax rate "flatten out" under Reagan? Is there a table of income tax brackets in various years last century?

There are charts in Lindsey's "The Growth Experiment" that should give you that information. There were two Reagan tax reforms, with the '86 bill being the 'flatter' of the two. Personally I liked some of the features of the earlier bill, which had investment tax credits to encourage domestic investment. And I'm not sure that stripping out the write-offs benefited the average taxpayer.

[Pelham]

The only tax cut that resulted in higher revenues at the lower rate was the capital gains tax cut. All the others brought in lower revenue, but not nearly as low as static analysis predicted. The goal of the Reagan program was to break the stagflation of the '70s and grow the economy, not to generate new revenues for the Treasury. Reagan's program included matching spending cuts which Tip O'Neill agreed to, and then reneged on.