Where Does the Laffer Curve Bend?
For the economics geek in all of us.
With the Bush tax cuts due to expire soon and debates about raising top rates further to cut the budget deficit soon to follow, the Laffer curve is bound to come up again. The idea, popularized by economist Arthur Laffer and writer Jude Wanninski in the 1970s and ‘80s, is simple. Tax rates of zero percent produce no revenue, for obvious reasons. Rates of 100 percent should produce no revenue either, as no one would bother making the money that falls into that bracket knowing it would all be taken away. Thus, presumably, there is some rate in between the two that maximizes revenue.
Mr. Klein goes on to ask various economists, tax experts, and politicians where that point is.
Via Greg Mankiw, whose opinion is included.
What we really need is a BIG across the board tax cut for the middle class to kick start some spending. With the increase spending power of the majority, the demand for goods will increase as well as demand for labor. Giving a tax cut the upper class isn’t going to do much of anything for the economy.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 1729 hrs
Thanks for linking to this. I saw this myself earlier today and thought it was interesting - if only because there always seems to be a flawed assumption by so many conservatives and liberals that wherever we’re at on the Laffer curve, we’re on the wrong side of it relative to one’s political persuasion. And that speaks more to their own political ambitions than the practical realities of economics.
I thought it was hilarious that the Republican politicians wouldn’t go near the question with a ten-foot pole. Also interesting that the people who actually study economics for a living have very different answers than most of the talking heads and columnists, who all want to offer numbers but fail to offer any substantive justification for their rationale (e.g. Buchanan, Luskin, Kudlow).
Posted by Recess Supervisor on August 10, 2010 at 1803 hrs
The part of Laffer that’s so contentious is not the two far ends of the curve, but the points in between, where there are theoretically two matching pairs of tax rates which bring in the same amounts of revenue (and yes, a point in between that maximizes revenue). Supply siders argue the lower rate should always be used, allowing the tax payers to keep more, and, again, theoretically, spend more, invest more and lend more, thus driving the economy forward. The problem with this is, people demonstrably do not act this way consistently across economic circumstances. We can see this now; there is money out there, but it sure isn’t getting lent, spent or invested. That’s why it’s necessary for the government to prime the pump with stimulus money.
Keep in mind, THIS IS THE CONSERVATIVE POSITION!!! Deficit spending is called for in certain circumstances. When the economy rebounds, there is time to make up the difference. To do so, you can’t always offer that lowest rate on the Laffer curve, but must opt for some point between the two, more closely approximating the maximizing value.
But the theory has been widely debunked by economists both left and right. There are simply too many complicating factors to apply it in any consistent manner. That, and the fact historical data have shown no support for it, leaves us with little more than an interesting thought experiment.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 1804 hrs
“...there is some rate in between the two that maximizes revenue”
That sums up the problem nicely. The government does not exist to maximize its’ revenue.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 1805 hrs
“The government does not exist to maximize its’ revenue. “
I wasn’t suggesting it was. You first identify how much you need to cover costs of budgeted items, then identify the rates that meet that need. Of course it’s not that simple, as there are multiple rates over various income levels. If anywhere, this is where left and right most obviously conflict: flat versus progressive tax structures.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 1816 hrs
I wasn’t suggesting you were, jimspice, but the original article.
I will take issue with your position on stimulus, however, as it is in part the cause of money not being spent, but that discussion has been had ad nauseum on this blog.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 1820 hrs
I’ve previously read that it was around 70%. But in any event, it’s nowhere near where we are now. Which is why it bugs the shit out of me that many people here will chime in to say that if we cut taxes it’ll increase tax revenue. Even Ron Johnson was saying it on NPR a couple of weeks ago—and naturally didn’t get called on it.
Posted by scott on August 10, 2010 at 2140 hrs
Clinton raised taxes and we had a balanced budget following a great cycle of growth. Bush slashed taxes (mostly for the wealthy), the middle class has been stagnant or sliding backwards and the country is essentially bankrupt.
It is laughable to think continuing tax cuts for the wealthy will put us on the right side of the curve.
Posted by .(JavaScript must be enabled to view this email address) on August 10, 2010 at 2323 hrs
We can see this now; there is money out there, but it sure isn’t getting lent, spent or invested. That’s why it’s necessary for the government to prime the pump with stimulus money.
Are you implying that the problem is people are hoarding money? Really?
The major problem is a lack of confidence and uncertainty. No one wants to take any risks right now because they have no clue what will be coming down the pike next. Obamacare is a huge unknown too… we all know that there will be massive costs and upheaval associated with it, but no one is really sure what’s in the whole package or how it will be implemented. Same goes for taxes, and for cap & trade. Businesses are being quite timid, especially with all the signs out there pointing to a second dip.
What we need is a sane fiscal policy… something that does not involve budget busting deficits or major overhauls of society. We need a leader who can promise businesses that success will not lead to them being labeled as enemies of the state. We need a Congress that understands that reading the bill before voting on it will give people a lot more confidence than saying we must pass it to see what’s in it.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0038 hrs
“Are you implying that the problem is people are hoarding money? Really?”
Oh jeez, the “really” thing. Almost as bad as “I know, right?”
Yes, really. Tried to get a small business loan lately? Checked the bond market?
“The major problem” is a small part of society crying chicken little with “taking the country back” and sucking a disproportionate amount of attention from the media. Yes, the “lame stream” media too. United States politics is a centrist game. Always has been. Always will be. Unless we adopt proportional representation, which aint gonna happen.
The vocal far right needs to drop the dramatics , check in with the intellectual far right. and get on board in getting the economy working again.
Mm hmm. Good luck with that.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0206 hrs
And if Buffet and Gates REALLY want to make an impact, instead of waiting ‘til they’re dead and setting aside half of their net worth to charitable trusts, they should buy up the foundering roads and bridges, put people to work to fix them, and sell them back. That’s what the stimulus should have done in the first place. History won’t remember charitable trusts, but it sure would note a private bailout.
By the way, that 50% should have been in the pockets of the workers that actually produced the profit, and thus my progressive tendencies.
Sorry, completely off topic, but I’ve been sitting in the back yard fuming.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0236 hrs
The only thing I took away from that article is that no one really knows…
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0622 hrs
I’m a little bit more concerned with when the debt curve is going to start increasing exponentially. Compound interest works both ways.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0653 hrs
I’m not a fan of the Laffer Curve. Government revenue is a function of significantly more than just tax rate. And it seems to put the focus on finding this tipping point, implying that government is in the business of maximizing tax revenue from it’s citizens. And this tipping point is a moving target and it’s effects of other inputs are not immediate. Ronald Reagan and Bill Clinton both impacted the gov’t revenue with opposite results…..
Posted by Smeety on August 11, 2010 at 0851 hrs
But you never hear liberals citing Laffer’s work in an effort to “maximize” government revenue. When you hear about it it’s always conservatives trying to defend their tax cuts, saying that they’ll increase revenue—when clearly they won’t.
Posted by scott on August 11, 2010 at 0903 hrs
Ronald Reagan was a simple man- and an economic theory you could write on a napkin made a lot of sense to a “keep it simple” guy.
The old joke is that if you stack economists end to end, they still would point in different directions.
My guy is Volker because he never told anyone you could eat as much candy as you like and still lose weight (my analysis of the L Curve)
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 0908 hrs
Except of course the actual article, scott, which refernces maximizing revenue.
What you never hear are you Keynesians advocating smaller government when times are good.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1002 hrs
When you hear about it it’s always conservatives trying to defend their tax cuts, saying that they’ll increase revenue—when clearly they won’t.
Because Scott doesn’t believe in supply and demand.
What you never hear are you Keynesians advocating smaller government when times are good.
I tried making that inherent case once and was laughed out of the blog chat. Keynesians don’t believe in ‘racheting down’ in good times…
Posted by Smeety on August 11, 2010 at 1006 hrs
The Laffer curve would be valid if, and only if, we only paid one single tax, and that tax was the sole source of revenue for the government - and there was only one “government” operating a single gigantic budget that included everything the government does.
But the Federal government gets its revenue from a multitude of sources, the budget is split up between various entitlements and sacred cows, and then there is the whole issue of state and local taxes and budgets. The complexity of it all renders a Laffer analysis of only taxes-to-revenue at the Federal general budget level completely without context and invalid. I don’t know why people even bother citing it when arguing about U.S. income taxes.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1124 hrs
The curve is valid. Tthe determination of the effect of a particular action on where we are on the curve may be impossible, but complexity rendering analyses invalid has never been an impediment to central planners seeking to expand taxes and government.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1147 hrs
The curve is valid.
If the curve were valid, we could plug 500,000 data points (cities all over the world) and determine a point at which we should not be taxed beyond.
Posted by Smeety on August 11, 2010 at 1220 hrs
Tax cuts will only result in increased revenue when they are applied to a healthy free market economy during a time of stability. Once you’ve blown a hole in the budget too big to fill and loaded up on a double dose of uncertainty for the future… all bets are off. The economy is not only a mathematical animal… it is also a psychological one. If people don’t trust the direction they are being led in, folks will tend to avoid economic risk, so the incentive of a tax cut will not cause the desired expenditure of new discretionary income.
Under more normal circumstance (in an up or down economy) people and businesses tend to spend their discretionary income. Every time this money changes hands, it generates tax revenue and generates some new wealth.
A business gets a tax cut. The owner may use the extra profit margin to lower prices and increase sales… or spend it himself. The consumer has extra cash as well. Say it’s a mens clothing store for an example. The consumer uses the extra discretionary income to buy a sale priced suit. Taxes are levied on the purchase and a new suit needs to be ordered to replace the one that was sold. More cloth needs to be bought to make that suit, a truck driver needs to deliver the cloth to the suit manufacturer and also the new suit to the seller. The cloth manufacturer, the suit manufacturer, and the trucker all make more money (and it all generates tax revenue). Other axillary wealth is also created… fuel is sold for the truck, a mechanic repairs the truck, new sewing machines and needles are bought, employees are hired by the textile mill… in every case taxes are generated, and with the money that is passed down the chain, more people have a little extra cash for a new suit as well, or a TV, or a new blender… or whatever. That tax cut has just generated a huge creation of tangible material wealth and it has also created many instances of new tax revenue. Simple as that.
It’s not all that complicated. Keynsians like to cloud the simple facts and the human nature of the economy with smoky formulas and arcane theories… but the economy is fueled by people… people whose motivations and habits can often be quite simply explained on the back of a napkin.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1222 hrs
The point, smeety, is that the complexity of the data collection means you could not collect the data points. The curve, though, still exists.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1317 hrs
I’m sure the curve is a valid theoretical model, even given the complexity of the real economy.
Tax cuts will only result in increased revenue when they are applied to a healthy free market economy during a time of stability. Once you’ve blown a hole in the budget too big to fill and
Way to insert your own pet issues into it. No, tax cuts increase revenue when they are very high to begin with. Opinions vary, but it seems as if nobody thinks we’re anywhere near that point right now. Some say the top marginal tax rate would have to double in order for us to be at such a point.
What bugs me, again, is when Republicans say “its’ been proven!” that tax cuts increase tax revenue, as if we’re there now, or as if it’s true under all circumstances. Like when Ron Johnson said it on the radio (I mentioned above).
What would really be refreshing is if people on the right would get real and stop tolerating this kind of bullshit. Then men like Johnson would be too embarrassed to say things that stupid. We might even have a real conversation about tax policy in lieu of this nonsense.
Another thing about Laffer’s curve. It’s true that it doesn’t imply that taxation should be at a point where tax revenues are “maximized,” but neither does it imply that they should never go above the revenue loss point. Ultimately what really matters is quality of life afforded by a particular tradeoff point—something Laffer’s curve does not address at all.
Posted by scott on August 11, 2010 at 1333 hrs
What bugs me, again, is when Republicans say “its’ been proven!” that tax cuts increase tax revenue, as if we’re there now, or as if it’s true under all circumstances. Like when Ron Johnson said it on the radio (I mentioned above).
What would really be refreshing is if people on the right would get real and stop tolerating this kind of bullshit. Then men like Johnson would be too embarrassed to say things that stupid. We might even have a real conversation about tax policy in lieu of this nonsense.
Man, it’s hard to take you seriously.
Posted by Smeety on August 11, 2010 at 1345 hrs
What exactly is the issue with what I just wrote? It’s true that Republican candidates and officeholders invoke Laffer’s curve to justify lowering the top marginal tax rate all the time. Like I said, Johnson did it on public radio a couple of weeks ago. I even have the audio recording to prove it. And yes, it would be nice if it wasn’t just people on the left who were the ones calling it out as nonsense, as maybe they’d stop doing it if nobody was buying it.
Posted by scott on August 11, 2010 at 1348 hrs
What bugs me, again, is when Republicans say “its’ been proven!” that tax cuts increase tax revenue, as if we’re there now, or as if it’s true under all circumstances.
I believe I described circumstances where I felt cuts would be a success. I think I offered a very real example of why it’s not “bullshit” (to use your word)... an example that you ignored. If you find fault with what I said, then show me. Hurling out the word “bullshit” really does nothing for your argument. It might work for Penn and Teller, but not for you.
Clearly even tax cuts would find a point of diminishing returns. We are not at that point, but until the federal government offers people something they feel secure with, I suspect that tax cuts alone won’t bring back the economy or reverse our new European norm of 9-11% unemployment.
What would be really refreshing would be to find a liberal who would come out in favor of some real cuts to the governmental behemoth… all you ever get from the left is “cut defense”, as if that is the only area of the budget that could be trimmed by 20%. Reducing spending would definitely be a good way of restoring some confidence… maybe you could even argue that we could forgo any new tax cuts and reduce spending till we balance the budget. Might do wonders for national confidence…. won’t ever happen though.Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1402 hrs
What an interesting article. I’ve often thought about the rate of taxation that would finally discourage me from being productive and I’ve always figured it would be somewhere in the high 60/low 70 percents. I currently pay a decent amount in one of the higher brackets and I don’t even think about taxes. I live comfortably and enjoy working, so it would take an awful lot to get me to consider quitting, or even cutting back on my productivity.
Also agree with the tangent about consumer confidence (or lack thereof) being one of the biggest drags on our present economy. The same uninformed, amateur, partisan hacks who spent a year denying the existence of the recession back in 2007 have now spent the last 12 months denying that any recovery has taken place. That should qualify as treason in my opinion.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1422 hrs
I fail to see how anything you’ve written negates the opinions of the economists cited in the article above: If there’s a point at which tax cuts increase tax revenue we’re nowhere near it right now.
Posted by scott on August 11, 2010 at 1437 hrs
I fail to see how anything you’ve written negates the opinions of the economists cited in the article above: If there’s a point at which tax cuts increase tax revenue we’re nowhere near it right now.
That’s not what the article spouted. The article presented a mixed bag of opinions.
Posted by Smeety on August 11, 2010 at 1441 hrs
Which people had the opinion that extending the Bush tax cuts on $250k earners this year would increase tax revenue?
The opinion wasn’t that mixed.
Posted by scott on August 11, 2010 at 1443 hrs
Incidentally, I just read this morning about how a majority of small businesses were not planning to expand/hire in the near future. The number one reason they cited? I’ll give you a hint. It wasn’t that they were worried about government regulation. It wasn’t that they couldn’t get financing. It was lack of demand.
Giving wealthy people tax cuts may well increase their investment levels. But that will do nothing to increase demand. Making more money available to businesses who can’t sell their current inventory does not spur them to hire new people.
Posted by scott on August 11, 2010 at 1448 hrs
How many of the people thought the Brewers would win the pennant this year?
None. Because none were asked that question either…
Posted by Smeety on August 11, 2010 at 1449 hrs
Let’s bring it on home. How many commenters here think that leaving the Bush tax cuts on rich people in place will result in an increase in government tax revenue over where it would be if we let those tax cuts expire?
An of those, which of you believes you have some backup from something in the article above? Cite it please.
And of those who don’t believe it would do so, do you believe we Ron Johnson should be saying it?
Posted by scott on August 11, 2010 at 1451 hrs
Ultimately what really matters is quality of life afforded by a particular tradeoff point—something Laffer’s curve does not address at all.
Let’s bring it on home. How many commenters here think that leaving the Bush tax cuts on rich people in place will result in an increase in government tax revenue over where it would be if we let those tax cuts expire?
Which is it? Quality of life or government tax revenue?
Posted by Smeety on August 11, 2010 at 1459 hrs
What evidence do you cite, scott, that the “lack of demand” is irrational, or do you believe we should be propping up the prices of say, luxury homes?
“Lack of demand” cited by small (or large) businesses does not indicate the economy lacks demand, it indicates those businesses are not capable of supplying what is being demanded. To suggest otherwise is to suggest we are in a recession for no reason.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1500 hrs
it’s nice to see that there’s a universal condemnation of the zyklon b reference. Makes me feel all warm inside.
Demand is lacking because a lot of people are out of work or otherwise don’t have as much money to spend.
Smeety, your question makes no sense to me. Restate?
Posted by scott on August 11, 2010 at 1544 hrs
it’s nice to see that there’s a universal condemnation of the zyklon b reference. Makes me feel all warm inside.
Sometimes you can be a real pill, Scott. As I write this that comment is less than one hour old and you are whining that no one has come to your defense yet? Oh please.
The last several times that same pustule made similar derisive comments, I made perfectly clear mention that it was a pin head maneuver. He should be put in a blender.
That said, I think you are a bit premature in implying that no one has condemned the actions of that mental midget.
——-
At this point in the Obama recession, I think that new cuts would be ineffective. I also think that a large tax increase would do far more to harm the economy than leaving things as they are. It would be akin to tossing a drowning man an anchor.Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 1555 hrs
if I were king I’d let all tax cuts ride for another year, deficit be damned. But things being what they are, the fate of these tax cuts will be decided now, this year, not some future time. That being the case, I definitely support letting the cuts for the wealthiest expire. The impact on the economic recovery will be negligible in that the problem isn’t financing, it’s demand, and wealthy people are unlikely to change their spending habits based on the fate of this cut. Meanwhile if they expire the projected deficit over the next few years will start to look a lot better.
Posted by scott on August 11, 2010 at 1603 hrs
If people are out of work and don’t have as much money to spend then why have savings rates increased since the recession began and why do they remain high, scott? People lack the money to spend but somehow possess the money to save?
Demand is not and never has been the problem. Just because the only tool you wish to use is a hammer doesn’t mean everything is a nail.
Posted by .(JavaScript must be enabled to view this email address) on August 11, 2010 at 2237 hrs
If people are out of work and don’t have as much money to spend then why have savings rates increased since the recession began and why do they remain high, scott?
Perhaps it’s because we gave tax cuts to people who don’t need them.
Posted by scott on August 11, 2010 at 2251 hrs
Scott has changed my mind. Perhaps it’s because we gave tax cuts to people… http://www.theatlantic.com/business/archive/2010/08/the-facts-about-small-business-and-the-bush-tax-cut/61023/ who don’t need them. Because the money we earn doesn’t belong to us. It belongs to the government. And the more money you earn, the less you should be allowed to keep.
Posted by Smeety on August 12, 2010 at 0818 hrs
Perhaps not. The “cut” in spending was a middle class rebate check. Did they choose to spend their money or save it, scott?
The concept of someone “needing” a tax cut runs counter to yoru claim in another post here of not claiming set tax rates to maximize revenue. Your default position appears to be that income belongs to the state.
Posted by .(JavaScript must be enabled to view this email address) on August 12, 2010 at 0823 hrs
Because the money we earn doesn’t belong to us. It belongs to the government.
Your default position appears to be that income belongs to the state.
It’s funny how you guys bust this one out whenever you feel cornered. Someone points out that tax cuts aren’t magically deficit neutral? No problem! Just get all angry and ranty about how it’s not the governments money. (As if that’s some kind of answer.) It’s like once you realize you have no rational argument against what I’m saying you resort to arguing with things that I’m not saying.
Posted by scott on August 12, 2010 at 0837 hrs
Hit the showers, hebe.
Posted by .(JavaScript must be enabled to view this email address) on August 12, 2010 at 0855 hrs
It’s funny how you guys bust this one out whenever you feel cornered. Someone points out that tax cuts aren’t magically deficit neutral? No problem! Just get all angry and ranty about how it’s not the governments money. (As if that’s some kind of answer.) It’s like once you realize you have no rational argument against what I’m saying you resort to arguing with things that I’m not saying.
Earth to Scott!!! It’s exactly what you said:
Perhaps it’s because we gave tax cuts to people who don’t need them.
Who is to determine what amount each person pays in taxes? Your contention is the government....
But I digress. You are completely missing the conservative argument here. You inadverdently
referenced it in your ‘quality of life’ statement, though.You can make the case (wrongly) that removing the Bush Tax Cuts to small businesses
(and please don’t throw that ‘bullshit’ out here that 2% of businesses will be affected
by the repeal of the cuts because it’s just not true and we can trade links if you really
want) won’t produce more government revenue, but the point is really irrelevant in
the grand scheme.The grand scheme… most Americans nowadays (as shown by BHO’s approval rating
among other things) believe their quality of life would be better if they kept more of their
money than send it to the government.But, by all means, keep making the case for higher taxes. You aren’t doing your cause any favors.
Posted by Smeety on August 12, 2010 at 0936 hrs
Hey Wendy:
Any chance you could look at your server stats and see if’s Zog’s info matches that of any known visitors? My guess is they would. Of course, he might have been employing some cloaking technique, but the intelligence levels of these types don’t generally lend themselves to grasping proxy configs.
Posted by .(JavaScript must be enabled to view this email address) on August 12, 2010 at 1521 hrs
I’d love to have someone in the B&S clan look into it. But my guess is it’s the same person who’s been impersonating capper and tossing around threatening and anti-semitic comments on other blogs including my own. And that person does use an anonymizer.
Posted by scott on August 12, 2010 at 1614 hrs
I am starting to suspect that the dimwit sometimes known as zog is getting a charge out of the reaction to what he posts. He wants attention. Perhaps just quickly deleting his childish commentary in the future will deny him what he seeks and he can go back to playing Warcraft in his mother’s basement.
Posted by .(JavaScript must be enabled to view this email address) on August 12, 2010 at 1638 hrs
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