The Laffer Curve

Yes, there’s more to tax revenue than rates. I think that from an economic growth (and revenue) standpoint, a reduction in regulations would be more effective. I don’t think that most people understand the regulatory cost to the economy. It’s probably trillions.

[Update a while later]

This, on the continuing and growing ignorance of the media, seems related:

The article explained that unlike Egypt or Pakistan, America doesn’t really have a powerful deep state, and to claim that it does “presents apolitical civil servants as partisan agents.”

Give me a break. “Apolitical civil servants”?

A deep state absolutely exists. Some call it “administrative state” or “regulatory state.” These are the people who crush innovation and freedom by issuing hundreds of new rules. Regulators, if they don’t pass new rules, think they’re not doing their jobs.

Even “anti-regulator” President George W. Bush hired 90,000 new regulators. Calling them “nonpartisan” doesn’t make them harmless—it just means we put up with them through multiple administrations.

Even if you exclude the military and post office, more than 20 million Americans work for the government. Because of civil service rules, it’s almost impossible to fire them.

The Times calls these 20 million people “apolitical”. Please. Most are just as partisan as you or I. Maybe more so, as leaks and signs of bureaucratic resistance to presidential edicts demonstrate.

The notion that George W. Bush was an anti-regulator is ludicrous.

19 thoughts on “The Laffer Curve”

  1. I’m not sure ignorance (although technically correct) is the right word more like willful blindness. The truth is obvious, they just refuse to see it (along with projecting their evil on others.)

    Another point about the Laffer curve is changing rates often can be as bad as regulation. People need time to adjust to changes. Laffer is about getting the right tax rate, not the lowest. The confusion comes from govt. thinking any problem can be solved with more taxes which tends to move toward too high.

    1. Beware of taking the mathematics of the Laffer curve for the morality of the Laffer curve. The discussion tends to get people to think that finding the peak of the curve is the goal. No, that’s just the point that maximizes government revenue. Our goal isn’t maximizing government revenue (how much blood can you squeeze out of the turnip), or goal is the minimum government that can accomplish the goals laid out in the Declaration of Independence.

      Don’t think like the parasite, think like the host.

      1. Good point George. That’s why we need friends to help with our perspective. We are so deluged with the media barrage it’s hard to keep everything straight. I even fell for the “Trump cuts Meals on wheels” misleading narrative until I read National Review.

  2. Regarding the Kansas disaster, it was blindness to some simple math. People respond to the overall tax rate (fed, state, local). Suppose that is 45% of 100X, resulting in 45X of total government revenue, of which the state’s take is 2%, or 2X. If the state cuts its tax rate in half then the overall tax rate drops to 44%, producing a very slight increase in economic activity, say up 3% to 103X. Overall revenue goes up to 44% of 103, to 45.3X , but the state’s share drops from 2% to 1%, dropping state revenues from 2X to 1.03X. Then you have a bunch of state legislators sitting around wondering WTF happened because their own revenue collapsed.

    Well, math happened. The revenue gains went to the largest revenue collector, the federal government, while the state just took a much smaller slice of an only slightly larger pie.

    I should point out that the reverse logic is also true for state or local government. Increasing their tax rates can give them a much bigger slice of a slightly small pie. Although hyenas fighting over a rotting carcass might be a better analogy.

    1. Yes, tragedy of the commons is easy to stumble into when you have federal, state, and local governments all taxing the same pie. Another reason the federal government should not be taxing citizens directly.

  3. I always thought the main argument for lowering taxes was to allow people to spend more money, save more money, and invest more money. And to allow business owners to invest more money in their businesses. The argument is that allowing people and businesses to spend more of their money how they want to will help the economy. That people choosing how to spend their own money is more effective in the long run than the government spending their money.

    Let’s say someone is working 40 hours a week and they are offered a new job that will bump them into a higher tax bracket. But this job also is 40 hours a week, so even though they lose more money to the government they also gain for the same hours of work. Lowering taxes isn’t going to make this person want to work 70 hours, it just allows them to do more with the money they are already earning.

    There are only so many hours in a day. The tax rate doesn’t change that.

    McArdle is saying that because people can only work so many hours, it doesn’t matter that much if they get to keep less of their money. She should be looking at it as maximizing the return for the limited hours available to work and how that allows them to save more for retirement or college, start a business, pay for their own health care, and in general, realize their own ambitions.

    The sweet spot isn’t just how it affects government but how it enables the populace.

    What is likely to stop people from working more hours is losing welfare benefits because they would need a really big jump in pay to make up for the loss.

    1. “McArdle is saying that because people can only work so many hours, it doesn’t matter that much if they get to keep less of their money.” Well, it seemed to me that she was making a simple point. Not a argument for higher taxes. Simply, that if you lower taxes assuming that your tax revenues will rise to make up for it, you may well be fooling yourself. Make your budget based on the money you actually have.

      1. With Reagan and Bush, the budget increased and tax revenues increased*. That spending exceeded the increased revenue doesn’t mean that tax rate decreases didn’t work. She then blames workers despite them sending more money to Uncle Sam.

        Her unstated assumption is that tax revenues would have increased without any cuts to tax rates and the increase would have been bigger than the increase with tax rate cuts. But how can she know?

        It is easy enough to show she is wrong in part because tax revenues were already declining before Bush passed his tax plan. And how could she claim that the Reagan years would have had larger tax revenues? It is an exercise in predicting an alternate reality.

        She is partially right to say that labor is inelastic but she wasn’t clear that this is because there are a limited number of hours to work. Because labor hours are inelastic, it means that letting people keep more of their own money functions like creating more of the bottleneck resource, time.

        What is the Laffer Curve for people and businesses using their own money? I’d wager the amount of money that a person or business needs to acquire before not using it or experiencing diminishing returns, is very high.

        Make your budget based on the money you actually have.

        This is true and even if that was the point of her article, she got to the answer by being wrong about her evidence.

        * Reagan had a year where revenues dipped but then kept climbing. Bush had two years where revenues dropped but then climbed. And during this time there was the dot.com bubble burst and 9/11.

        1. After Reagan’s tax cuts .. the revenues rose because of the 11 tax increases.

          “revenues as a percentage of gross domestic product (GDP), which is the best way to compare across years, dropped from 19.1 percent in 1981 to a low of 16.9 percent in 1984, before rebounding slightly to 17.8 percent in 1989. One reason the deficit soared during Reagan’s term is because spending went up as a share of the economy and revenues went down.

          But we can get even more specific about the impact of the 1981 cut in rates. A Treasury Department study on the impact of tax bills since 1940, first released in 2006 and later updated, found that the 1981 tax cut reduced revenues by $208 billion in its first four years. (These figures are rendered in constant 2012 dollars.) The tax reform act of 1986, which was designed to be revenue neutral, reduced revenues by less than $1 billion four years after enactment.

          But Reagan’s tax increases in 1982, 1983, 1984 and 1987 boosted revenue by $137 billion. Overall, that’s a revenue loss from Reagan’s various tax bills, but it also shows that Moore is crediting to Reagan’s tax cuts revenues generated by Reagan’s tax increases.

          Moore, in an interview, acknowledged that “certainly there were tax increases” but he insisted that the cut in tax rates generated “huge revenue gains.” He said that the “tax increases were small, compared to the tax cut, which was huge.” In particular, he said that the wealthy started paying more in taxes, and he said the booming economy resulted in increased tax revenues.

          That’s actually not readily apparent from the data. Certainly, the share of taxes paid by the top 1 percent went from 17.9 percent in 1981 to 25.2 percent in 1989, for an increase of 37 percent, according to IRS data. But the income share of the top 1 percent increased even more dramatically, from 8.3 percent to 14.2 percent—a gain of 71 percent. So a lot of the increase in taxes came from a more dramatic increase in wealth.”

          https://www.washingtonpost.com/news/fact-checker/wp/2015/04/10/rand-pauls-claim-that-reagans-tax-cuts-produced-more-revenue-and-tens-of-millions-of-jobs/

          1. revenues as a percentage of gross domestic product

            So GDP went up? Seems like a policy failure then.

            Tax rates go down, this reduces the need to have so many exemptions, so tax policy can be simplified. Revenues go up. GDP goes up, skewing the ratio to GDP and Revenue.

            It is still hard to argue that revenues would have been higher without the policies that lead to the GDP growth.

            Is it such a bad thing to have a smaller share of a larger pie even if the piece of pie is larger than the one you had before?

    2. I say crap.

      Back in the UK, I calculated at one point that, if my employer paid me an extra pound, the government would get about 65% of it in tax if I spent it on something were I’d have to pay sales tax, or about 85% if I spent it on gas.

      Needless to say, once I worked that out, I had very little motivation to work any harder than I did. Why stress myself out when most of that extra money would go to the government?

      It’s not just the number of hours, it’s the productivity in those hours. If people don’t see themselves as better off for working harder, they won’t.

      1. She’s not saying that high marginal rates don’t discourage work, she’s just saying that you can’t cut a random rate by a random amount and necessarily expect an increase in revenue.

        1. Except that revenue did increase. She is implying, without be very clear about it, that revenue would have been even higher without any tax rate cuts. She also conflates revenue increases with deficits, which can still happen with increases in revenue.

  4. Using the terms “civil servants” and “apolitical” is an effort to create a priest class that is unquestionable, unaccountable, and all powerful. The only reason why some people want this is because they know that government workers, or at least their unions, largely support Democrat politicians.

    It is just like you aren’t allowed to question the motives, funding, and organizational structure of Democrat “protesters”. They are always portrayed as being the representatives of the populace whose demands must be met.

    Also, same situation with AGW alarmists.

    It’s all a little too convenient if you ask me.

  5. “I don’t think that most people understand the regulatory cost to the economy. It’s probably trillions.” It would be nice to be able to quantify the answer to this. One simple test would be change the number of employees for a given regulation. A lot of regulations click on at 50 employees. Make it 60. See if a lot of businesses move from 49 to 59 employees.
    Too much of what we believe about politics is religious. Let’s test it.

    1. Testing it is the whole idea of having states. Texas seems to be winning. California is losing. Even though CA beats TX in better weather and geography.

      1. Too many variables: Texas differs from California in many ways. That’s what makes economics hard.
        How about a real live experiment: Make my _federal_ regulatory change in half the states, chosen randomly.

    2. Just talk to a doctor/dentist and see how many people they have dedicated to regulations and dealing with insurance companies. You could also analyze the start up costs for a business in jumping hurdles, like what is the regulatory cost to opening a childcare facility or a restaraunt?

      There is a lot of quantitative analysis that can be done right now.

  6. If our bureaucrats are truly non-political as a class, then no one could object if they were forbidden membership in any political party, from making campaign contributions, or from voting in federal elections as a condition of their employment.

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