The Laffer Curve explains why an increase in the tax rate doesn't always lead to an increase in revenue. For example, in a world without taxes, the government would have no revenue. And in a parallel universe in which the tax rate was 100%, the government would be equally poor. People would not work if all their earnings were completely taxed away from them.
Now envision a graph. The tax rate is the x-axis and revenue is the y-axis. The two points described above lie on the x-axis, one at the beginning of the curve, the other at the end of it. This means that somewhere between these two points lies a third point that is higher than any other point on the curve. At this particular tax rate, more revenue will be collected than from any other tax rate.
If you believe, as I do, that our current tax rate is to the right of the "maximum revenue generating tax rate," then you will also believe that raising taxes will lower revenue. If, on the other hand, you believe that our current tax rate is to the left of the "maximum revenue generating tax rate," then by all means, raise taxes and see revenue go up. If revenue is the goal and there are no hidden agendas, the key issue is to discover where we are on the Laffer Curve.
I was pleasantly surprised when the first article I read from yesterday's Wall Street Journal was about the Laffer curve. The authors accept the premise behind the curve, but draw very different conclusions from mine. The opinion piece was written by Peter Diamond and Emmanuel Saez, two award-winning professors of economics.
They begin their discussion of the Laffer Curve as follows:
The Laffer Curve is used to illustrate the concept of taxable income "elasticity," --i.e., that taxable income will change in response to a change in the rate of taxation. Top earners can, of course, move taxable income between years to subject them to lower tax rates, for example, by changing the timing of charitable donations and realized capital gains. And some can convert earned income into capital gains, and avoid higher taxes in other ways.
So far so good. But then, one paragraph later, they wrote:
According to our analysis of current tax rates and their elasticity, the revenue-maximizing top federal marginal income tax rate would be in or near the range of 50%-70% (taking into account that individuals face additional taxes from Medicare and state and local taxes). Thus we conclude that raising the top tax rate is very likely to result in revenue increases at least until we reach the 50% rate that held during the first Reagan administration, and possibly until the 70% rate of the 1970s. To reduce tax avoidance opportunities, tax rates on capital gains and dividends should increase along with the basic rate. Closing loopholes and stepping up enforcement would further limit tax avoidance and evasion.
The authors do not explain how they arrived at the 50%-70% rate, which is the crux of their argument. (That's research for another day.)
The other issue that Diamond and Saez address is whether higher tax rates lead to lower economic growth. They emphatically believe the reverse is true.
Indeed, according to the U.S. Department of Commerce's Bureau of Economic Analysis, GDP annual growth per capita (to adjust for population growth) averaged 1.68% between 1980 and 2010 when top tax rates were relatively low, while growth averaged 2.23% between 1950 and 1980 when top tax rates were at or above 70%.
I find it hard to believe that an economy grows more when its taxpayers have less money to work with...unless one believes that the government is able to spend that money more wisely and more effectively than we are.
I think everyone can be unanimous that lower taxes are better.
We need to curb our spending and reduce the cost of financing our debt. This will involve cutting programs and increasing revenue. Without both we are just a frog in a pot that is slowly heating up and we refuse to stop it by kicking the can into the future. Nobody in politics seems to understand that.
Tax breaks aren't tax breaks if you steal from one group and to tax another group higher.
Economists at the conservative Heritage institute actually concede that the JFK tax cuts increased tax revenues, but Reagan's probably didn't and the Bush tax cuts almost certainly didn't.
You contend that we are on to the right of the revenue-maximizing point on the curve. Any support for this or do you just feel like it is true? I ask because nearly every economist I have read believes we are to the left of that inflection point. Do you have any evidence or reputable authority to point to that supports your contention?
Thank you for your feedback. I'm going to address your comments later tonight. I'll be able to put more time and energy into what I have to say if I wait until then.
I apologize for taking so long to respond to your comments. I want to address the two issues that were raised: Did the Reagan and Bush tax cuts reduce revenue? And was economic growth stimulated by the tax cuts?
As a first step in exploring these questions, please visit the White House website: http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/… and review Table 1.1--Summary of Receipts, Outlays, and Surpluses or Deficits. Not only is there information going back to 1789, but the White House projects their numbers through the year 2017.
Let's look at George W Bush's presidency first. Revenue went down from 2000-2003. From 2003-2007, revenue went up each year, from 1,782,314 in '03 to 2,567,985 in '07 (in millions of dollars).
Now let's go back twenty years and examine the Reagan presidency. Revenue went up every year with one exception from 1980-1988. Revenue continued to go up every year through the Bush 41 and Clinton administrations.
If we go back another twenty years to the beginning of the Kennedy administration, we will see revenue went up every year from 1960 until the third year of the Nixon presidency.
The Washington Times has this to offer about the Bush tax cuts:
So when TheVanBurenBoyz, for example, wonder why I believe our current tax rate is to the right of the maximum revenue generating tax rate, this is why. The numbers aren't perfect, but if the tax cuts were so bad for the economy, why has revenue gone up almost every year they were implemented? And even if "taxes are near historical lows," this does not mean they can't go down even lower and continue to produce more revenue.
As for the issue of economic growth, I need to give this more thought. It seems intuitive to me that the economy will grow more efficiently with the private sector leading the way (while the government rests on the sidelines, having a lesser role). However, intuition alone does not provide a convincing argument.
I am really ignorant about this subject, but thinking about it abstractly; saying that just because revenues increased during a given tax cut, to me, doesn't necessarily mean that it was created by those cuts. There are many other factors to consider, e.g. overall growth and tax participant growth?
Do these seem like possible factors to anyone else?
Est quo non quia quia eaque ut et rerum. Officia atque molestiae maxime quaerat. Itaque vel ea culpa. Qui expedita rerum aut facilis. Laboriosam corporis quod deleniti a non.
In temporibus impedit quidem. Quia totam ipsa eos explicabo quod at. Sunt debitis ea explicabo qui quae est.
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