May 1, 2012  

Lib Idea of the Month: More on the Laffer Curve

…Forget that silly flat tax: it’s about lower tax RATES…as you lower tax rates, revenues and productivity jump…at this review article, see body for useful youtubes as well: http://danieljmitchell.wordpress.com/2011/11/06/a-lesson-on-the-laffer-curve-for-barack-obama/

One of my frustrating missions in life is to educate policy makers on the Laffer Curve.

This means teaching folks on the left that tax policy affects incentives to earn and report taxable income. As such, I try to explain, this means it is wrong to assume a simplistic linear relationship between tax rates and tax revenue. If you double tax rates, for instance, you won’t double tax revenue.

But it also means teaching folks on the right that it is wildly wrong to claim that “all tax cuts pay for themselves” or that “tax increases always mean less revenue.” Those results occur in rare circumstances, but the real lesson of the Laffer Curve is that some types of tax policy changes will result in changes to taxable income, and those shifts in taxable income will partially offset the impact of changes in tax rates.

However, even though both sides may need some education, it seems that the folks on the left are harder to teach – probably because the Laffer Curve is more of a threat to their core beliefs.

If you explain to a conservative politician that a goofy tax cut (such as a new loophole to help housing) won’t boost the economy and that the static revenue estimate from the bureaucrats at the Joint Committee on Taxation is probably right, they usually understand.

But liberal politicians get very agitated if you tell them that higher marginal tax rates on investors, entrepreneurs, and small business owners probably won’t generate much tax revenue because of incentives (and ability) to reduce taxable income.

To be fair, though, some folks on the left are open to real-world evidence. And this IRS data from the 1980s is particularly effective at helping them understand the high cost of class-warfare taxation.

There’s lots of data here, but pay close attention to the columns on the right and see how much income tax was collected from the rich in 1980, when the top tax rate was 70 percent, and how much was collected from the rich in 1988, when the top tax rate was 28 percent.

The key takeaway is that the IRS collected fives times as much income tax from the rich when the tax rate was far lower. This isn’t just an example of the Laffer Curve. It’s the Laffer Curve on steroids and it’s one of those rare examples of a tax cut paying for itself.

Folks on the right, however, should be careful about over-interpreting this data. There were lots of factors that presumably helped generate these results, including inflation, population growth, and some of Reagan’s other policies. So we don’t know whether the lower tax rates on the rich caused revenues to double, triple, or quadruple. Ask five economists and you’ll get nine answers.

But we do know that the rich paid much more when the tax rate was much lower.

This is an important lesson because Obama wants to run this experiment in reverse. He hasn’t proposed to push the top tax rate up to 70 percent, thank goodness, but the combined effect of his class-warfare policies would mean a substantial increase in marginal tax rates.

We don’t know the revenue-maximizing point of the Laffer Curve, but Obama seems determined to push tax rates so high that the government collects less revenue. Not that we should be surprised. During the 2008 campaign, he actually said he would like higher tax rates even if the government collected less revenue.

That’s class warfare on steroids, and it definitely belong on the list of the worst things Obama has ever said.

But I don’t care about the revenue-maximizing point of the Laffer Curve. Policy makers should set tax rates so we’re at the growth-maximizing level instead.

To broaden the understanding of the Laffer Curve, share these three videos with your friends and colleagues.

This first video explains the theory of the Laffer Curve.

This second video reviews some of the real-world evidence.

And this video exposes the biased an inaccurate “static scoring” of the Joint Committee on Taxation.

And once we educate everybody about the Laffer Curve, we can then concentrate on teaching them about the equivalent relationship on the spending side of the fiscal ledger, the Rahn Curve.

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  • crisbd

Posted in Class warfare, Economics, Fiscal Policy, JCT, Joint Committee on Taxation, Laffer Curve, Obama, Supply-side economics, Tax avoidance, Tax Compliance, Tax evasion, Taxation | Tagged , , , , , , , , , , , , , , | 45 Comments

45 Responses

  1. Adam Smith wrote about the Laffer Curve two-hundred years before Laffer: “High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes.”

  2. In discussing the Laffer curve nearly everyone ignores, the most important element: EFFECT ON ECONOMIC GROWTH.
    Given sufficient time the effect of lower economic growth under high tax rates overrides all other factors when it comes to tax revenue (…and also GDP… and also overall prosperity).

    So the Laffer curve CANNOT be presented or discussed without a time horizon.

    The Laffer curve looks different if we are talking about tax revenue tomorrow, in a year, five years or twenty years. This is because it takes some time for people to react to changes in taxation (including the changing of lifetime trajectories towards mediocrity – ex. deciding to not go to college, deciding not to join that startup etc.), but PRIMARILY because it takes some time for the relentless effects of a compounding lower growth to affect GDP and thus also tax revenue.

    In terms of elementary arithmetic:

    If tax revenue in year n is represented as Tn = TR * BGDP0 * (1+GR)^ n where TR is the tax rate, BGDP0 is baseline GDP in baseline year 0, GR is the annual growth rate, and n is the year, then, GR always becomes THE DOMINANT factor given a large enough n.

    In other words, the ratio of tax revenue under a high tax rate TRh over a low tax rate TRl always becomes less than 1 given a large enough time horizon n. In essence, the inequality

    [TRh * BGDP0 * (1+GRh)^ n]/[ TRl * BGDP0 * (1+GRl)^ n] < 1

    Always has a solution for n regardless of TRh,TRl so long as GRh<GRl i.e. so long as higher tax rates result in lower economic growth.

    That is why, the left, in order to also convince anyone who understands intuitive elementary arithmetic (? less than 20% of the population?) to acquiesce to higher tax rates, it must also sell the story that higher tax rates also result in higher growth rates.

    So the postulate that “all tax cuts pay for themselves” or that “tax increases always mean less revenue.” Is likely true if one adds “…after a sufficient number of years” or “… given a long enough time horizon”.
    Hence the problem of the suicidal 60% (American voters that is): “I’m in distress now [because my standard of living is sliding from the top 15% worldwide to 18% worldwide] therefore redistribute NOW, the future be damned, so I rest my Hope that Change to redistribution and central planning will lead to high economic growth and prosperity – I drink the cool aid of delusion for now and we’ll find something later that will propel us back to the top 10% of world prosperity”. Once you’re gone, once you’ve become France, you can’t come back. Absorption into the worldwide average will be your fate.

    In short,
    People in the Democratic Western World want high tax rates because they want a large proportion of the economy to be collectively managed, it gives them control, and hope that they will be disproportionately recipients of tax revenue (at least what is left after waste fraud and abuse) rather than contributors to the inefficient pile.

    The less than one billion citizens of the Western World is embracing the above pernicious delusion at the very time that three billion newly awakened people in the Emerging World are rejecting it. Thus convergence of the western citizen into the world prosperity average is inevitable and will be quick. Things move fast in the 21st century. Declines that used to take centuries will now be complete in a few short decades. That is the story you are now living through dear Americans…

  3. I agree with your larger point on the Laffer Curve but I do have one quibble:

    There must be good examples other than the 1980 – 1988 comparison. The 1980 – 1988 comparison is a bit like comparing apples to oranges. The tax reform act of 1986 allowed for S-Corps, which led to a lot of income previously declared on corporate returns subsequently being declared (and taxed) on individual returns. Just that fact would account for a lot of the increase in individual tax payments.

    Liberals also ignore this fact: I’ve seen them argue that corporate taxes accounted for much more of a percent of GDP in 1970 or 1980 vs 1990 or 2000. So corporations must be taxed more!!! But again, much income that was “corporate” pre-1986 is “individual” post-1986.

    Personally I’d nuke the corporate tax rate altogether, as I suspect you would. Anyway, enjoy your blog, hope you don’t mind my nitpicking! :)

  4. Am I missing something here? According to the chart the IRS collected almost $100 mil in taxes in 1988, five times the $20 mil it collected in 1980, albeit at a much lower tax rate. But taxable income from “rich” people was 10 times greater in 1988 than 1980. Can’t it be argued that the IRS would have (should have?) collected $200 mil in revenue in 1988 had the rate stayed at 70%??????

  5. @truther: no. income is a negative function of tax rates. which is the reason why the laffer curve exists in the first place.

  6. [...] A Lesson on the Laffer Curve for Barack Obama « International Liberty. Share this:TwitterFacebookLinkedInStumbleUponEmailPrintLike this:LikeBe the first to like this [...]

  7. [...] a previous post, I showed how rich people dramatically increased the amount of income they were willing to earn and [...]

  8. [...] a previous post, I showed how rich people dramatically increased the amount of income they were willing to earn and [...]

  9. [...] a previous post, I showed how rich people dramatically increased the amount of income they were willing to earn and [...]

  10. [...] a previous post, I showed how rich people dramatically increased the amount of income they were willing to earn and [...]

  11. [...] say it anyhow) that it would be even better to combine Clinton’s spending levels with Reagan’s tax rates. Rate this: Share this:PrintEmailFacebookTwitterMoredeliciousDiggFarkLinkedInRedditStumbleUponLike [...]

  12. [...] say it anyhow) that it would be even better to combine Clinton’s spending levels with Reagan’s tax rates. jQuery(‘#lazyload_post_0 img’).lazyload({placeholder: [...]

  13. [...] It goes without saying (but I’ll say it anyhow) that it would be even better to combine Clinton’s spending levels with Reagan’s tax rates. [...]

  14. Sorry to come late to party. I’m not in favour of high taxes – largely because I’m not in favour of a large state – but I’m not convinced by the Laffer argument as put forward here.

    Laffer’s idea comes in two flavours, it seems to me. The soft version holds that high tax rates encourage the rich to hide income or otherwise avoid taxation, and that lowering tax rates while closing off loopholes, etc. can lead the rich to declare more income. That is undoubtedly sometimes true, and may be a partial explanation of what happened in the Reagan years.

    The hard version holds (1) that high taxes can suppress growth, (2) that lowering tax rates can stimulate sufficient extra growth to offset the lower rates, and (3) this is actually what happened in the United States in the Reagan period and after.

    Well, did it?

    Here’s real US GDP growth (5 yr averages) versus the marginal income tax rates, since 1970.

    1970-74 – 3.5% – 70%

    1975-79 – 4.7% – 70%

    1980-84 – 3.0% – 70%

    1985-89 – 3.6% – 50%

    1990-94 – 2.5% – 28%

    1995-99 – 4.3% – 40%

    2000-04 – 2.2% – 36%

    2005-09 – 0.2% – 33%

    There’s very little evidence for the Laffer thesis. For one thing, growth did not increase! There was an upward blip in the late 80s (after the first tax cuts), but a bigger increase in the 90s after Clinton raised the margin rate. Bush’s tax cuts produced nothing we can see in these statistics.

    The miserable truth is that growth has steadily fallen for decades, regardless of tax rates. I have my guesses on why this happened, and I don’t think Dr Laffer has much to contribute to the debate, although Dr Hayek certainly does.

    Sources:

    http://www.measuringworth.com/index.php

    http://en.wikipedia.org/wiki/Income_tax_in_the_United_States

  15. [...] liberals are not just hypocrites, but wrong as well, read this post from economist Daniel Mitchell that tries to teach President Obama about the Laffer Curve. GA_googleAddAttr(“AdOpt”, “1″); GA_googleAddAttr(“Origin”, “other”); [...]

  16. Um,
    38.5 / 134.65 = 28.6% —- i.e., the 28% tax rate reported.
    11.1 / 22.7 = 48.9% —– i.e., NOT the 70% tax rate reported.

    I don’t understand how the Laffer Curve or the amount of taxable income changes the rate of taxation OF that taxable income from 70% to 49%.

    The change in tax RATE was 1.71 times. ((48.9% / 28.6%))

    The the tax paid increased 3.47 times ((38.5 / 11.1 = 3.46))
    The taxable income increased 5.93 times ((134.65 / 22.7))

    The RATIO (or rate) of increase in taxable income to increase in tax paid was 1.71 ((5.93 / 3.47 = 1.71)); exactly the change in the tax rate.

    I don’t understand how the Laffer Curve works anymore.

  17. Actually, I think I do understand the Laffer Curve. The same way I understood it before.
    What I don’t understand is the claimed effect that on taxable income, there seems to be none.
    Tax rate DROPS 59 percent (the inverse of 1.71 — i.e., 1 / 1.71 = .59); the ratio of taxes paid as a percentage of taxable income GROWS 71% ((1 + .71 = 1.71 — i.e., the inverse of .59))
    In other words, as the tax rate drops; there is an inversely proportional INCREASE in the amount of tax revenue as a percentage of taxable income. Just what the Laffer Curve (as I had PREVIOUSLY understood it) predicts.

  18. [...] changes can be enormous, as demonstrated in this post showing how rich people paid five times as much federal income tax after Reagan cut the top tax rate from 70 percent to 28 [...]

  19. [...] to the video, beginning around 6:35, I debunk the President’s class-warfare tax agenda by citing IRS data from the 1980s to explain that higher tax rates don’t necessarily mean higher tax [...]

  20. [...] to the video, beginning around 6:35, I debunk the President’s class-warfare tax agenda by citing IRS data from the 1980s to explain that higher tax rates don’t necessarily mean higher tax [...]

  21. [...] video is part of a three-part series, by the way. Click here if you want to see the entire set. Rate this: Share [...]

  22. [...] Here’s the data on the Laffer Curve in the 1980s. [...]

  23. [...] Here’s the data on the Laffer Curve in the 1980s. [...]

  24. [...] When tax rates change, sometimes they choose to alter their levels of work, saving, and investment. [...]

  25. [...] When tax rates change, sometimes they choose to alter their levels of work, saving, and investment. [...]

  26. [...] When tax rates change, sometimes they choose to alter their levels of work, saving, and investment. [...]

  27. [...] little economics lesson for a Tuesday morning: The Laffer Curve, and a double dose of Milton Friedman: 10 of his best economic quotes and the original “Greed [...]

  28. Interesting post but the liberals are going to rip you a new one (or should if they knew what they were doing) for comparing unadjusted 1980 and 1988 numbers. It really is apples and oranges.

    There were many more rich people in 1988, and your own chart shows the tax collected PER RETURN is lower. Not good. Just more data showing that the rich are shifting the burden of taxation to the middle class, under both Democrats and Republicans.

  29. @KYT Not just tax collected per return as a percentage but also on absolute terms. The average income in that group went from $932K in 1980 to over $2 million in 1988, but the average tax paid per return dropped from $155K to $132K.

  30. [...] When tax rates change, sometimes they choose to alter their levels of work, saving, and investment. [...]

  31. [...] Think about that! More than 5 times as much tax REVENUE at a tax RATE of LESS THAN HALF! Just more proof that all these attacks on Millionaires/Billionaires when based on the abstracts of tax RATE are based on little more than smoke bombs in the misguided, unethical, highly immoral Class War! LINK [...]

  32. [...] though there is a wealth of evidence for the Laffer Curve, statists and other big-government advocates routinely claim that incentives don’t [...]

  33. [...] That’s why I wrote about the U.S.-specific evidence from the 1980s, which shows that rich people paid much more to the IRS when tax rates were slashed from 70 percent to 28 percent. [...]

  34. [...] And the same thing happens in reverse. If lower tax rates lead to a big enough increase in taxable income, the government actually collects more revenue – which is exactly what happened when the top tax rate was lowered in the 1980s. [...]

  35. [...] And the same thing happens in reverse. If lower tax rates lead to a big enough increase in taxable income, the government actually collects more revenue – which is exactly what happened when the top tax rate was lowered in the 1980s. [...]

  36. [...] all the talk about budgets in Washington, and given Obama’s support for class warfare, higher tax rates, and double taxation, this image I received seems rather [...]

  37. [...] 5. If you want the rich to pay more tax, keep tax rates reasonable. [...]

  38. [...] When tax rates change, sometimes they choose to alter their levels of work, saving, and investment. [...]

  39. [...] The Laffer Curve is a graphical representation of the relationship between tax rates, tax revenue, and taxable income. It is frequently cited by people who want to explain the common-sense notion that punitive tax rates may not generate much additional revenue if people respond in ways that result in…. [...]

  40. [...] The Laffer Curve is a graphical representation of the relationship between tax rates, tax revenue, and taxable income. It is frequently cited by people who want to explain the common-sense notion that punitive tax rates may not generate much additional revenue if people respond in ways that result in…. [...]

  41. [...] most effective moment (I think) was when I explained that “rich” taxpayers declared much more income and paid much higher taxes after Reagan reduced the top tax rate from 70 percent to 28 [...]

  42. [...] then provide a specific example, looking at how Reagan’s lower tax rates resulted in a lot more revenue from the rich. Unlike the rest of us, the rich have a great ability to alter the timing, amount and composition [...]

  43. [...] then provide a specific example, looking at how Reagan’s lower tax rates resulted in a lot more revenue from the rich. Unlike the rest of us, the rich have a great ability to alter the timing, amount and composition [...]

  44. [...] want the rich to pay more? Dan Mitchell observed:I explained that “rich” taxpayers declared much more income and paid much higher taxes after Reagan reduced the top tax rate from 70 percent to 28 [...]

  45. [...] For what it’s worth, this is why Obama’s proposed tax increases won’t raise nearly as much money as projected. [...]

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