Friday, November 19, 2010

Evidence That We're On The Wrong Side Of The Laffer Curve

Ever heard of the Laffer Curve? It's a theory embraced by many on the conservative, anti-tax rightwing to prove that cutting taxes actually could increase overall tax revenues if we are on the "over-taxed" side of the curve. The idea is that the tax revenues generated by the economic growth spurred by tax cuts will both offset and exceed the tax losses incurred by the tax cuts themselves. I admit that there's an intuitive logic to the notion in theory that makes sense at one level. But I'm also realistic enough to know that tax policy, in and of itself, is just one of a whole host of things that affect productivity and economic growth. Things like consumer confidence, unemployment levels, government spending, technology efficiencies, exchange rates, trade policy, monetary policy (i.e. interest rates), sectoral performance, philanthropic giving, natural disasters, wars, terrorist threats, etc., all have an impact on productivity and economic growth. So, I argue that it is nearly impossible to determine what this equilibrium point is on the Laffer curve. Moreover, I would argue that this equilibrium point is a moving target depending on the peculiarities of the moment. A tax cut to a particular rate or level that could be a net revenue generator today (presuming we could even isolate it as such), could actually be a rate or level that would reduce net revenues tomorrow.

But given that we're discussing tax policy today, which is caught up in the debate over whether to extend the Bush era tax cuts, let's take a look at how economic growth fared over the Bush era. What we see is that during the era of the Bush tax cuts, average GDP growth has been at its lowest since 1961. What does this mean? Well, I'd say it doesn't really tell us anything conclusive. But I think it certainly doesn't support the notion that tax cuts produce economic growth and thus increased tax revenues.


eric said...

Of course, overtaxation could very well be what is contributing to stagnant GDP growth. It is worth noting that if you exclude 2001 (when 9/11 happened) and the 2008 financial meltdown, government revenues increased every year during Bush's presidency, in spite of the tax cuts. Now perhaps revenues would have increased more if there had been tax increases (or, given the finicky state of our economy since 9/11, perhaps we would have been in a decade-long recession), but I'd argue the most important lesson you can learn from the Laffer Curve is this: under the right circumstances you can cut taxes in order to raise revenues. And this has been proven time and time again. I know you don't argue against this, but a lot of liberals do, in spite of the evidence.

What I've maintained for a long time is this: If the Laffer Curve is correct, then there is some magic number (pinned to a moving target, for sure) where you get he perfect equilibrium of taxes-to-revenue. We'll never find that number, but what we can be reasonably sure of is that for any amount of government revenue that exists BELOW that number, there is a way to get there on the right side of the Laffer Curve and a way to get there on the left side of the Laffer Curve. Before we EVER try to raise taxes, we should first be as sure as possible that lowering them would not produce positive results. The government has an ethical responsibility to always look for solutions on the left side of the curve first... i.e., until it results in decreasing revenues, tax cuts should always be tried before tax increases.

Huck said...

But, again, Eric, I don't see how anyone can attribute increases or decreases in revenues exclusively to changes in tax rates. For example, with regard to the Bush era, where you claim that revenues have increased every year except for 2001 and 2008 (do you have a link that can point me to the evidence that proves this?), even if this were true, one might argue that the impacts of government spending and a consistently declining interest rate, as opposed to tax policy, could be the reason for such revenue increases. Likewise, I could make the argument that it was tax policy that depressed average GDP growth rates over the Bush years, and how could you contest that point? My point is that the Laffer curve is nice theory, but that it is a theory that is impossible to test with any measure of conclusivity.

eric said...

From :

Year Total Revenue ($bln)
2000 4181.16
2001 4229.34
2002 3615.73
2003 4000.08
2004 4063.30
2005 4306.69
2006 4612.90
2007 4931.02
2008 4394.34

eric said...

"one might argue that the impacts of government spending and a consistently declining interest rate, as opposed to tax policy, could be the reason for such revenue increases."

And those things undoubtedly DID contribute to revenue increases (though I'd note the Discount Rate did not consistently decline during that period, in fact it steadily increased from 2003 to 2007

I'm just saying that there is excellent historical evidence that tax cuts can help boost revenues. The Laffer Curve tells us that logically there will be a point where this fails to work, but so revenue increases have always followed significant tax cuts.

Anonymous said...


These videos from Dan Mitchell are a quick introduction to the Laffer Curve, I thought they may be a good contribution to the discussion:

Part 1 -
Part 2 -
Part 3 -