Laughing at Laffer
I recenty ran across, for the umpteenth time, a comment thread where some left-leaning person was saying, "Conservatives actually believe you can INCREASE government revenues by LOWERING taxes."
Now, if there is some conservative who thinks you can always raise revenues by lowering taxes, they are obviously nuts. (If the tax is at, say, 1%, you cannot get more revenue by lowering it to 0%.) But if some liberal thinks you can never increase revenues by lowering taxes, they are every bit as nuts. Essentially, the latter position involves the belief that price has no effect on demand. An nice example of a case where raising a tax caused revenues to plunge is the Smoot-Hawley Tariff.
Now, whether Arthur Laffer was right that, in 1980, taxes were high enough that lowering them would increase revenues is an empirical question. But the notion of the Laffer Curve, meaning that there is some level at which a decrease in taxes will raise revenues, is a simple matter of economic logic.
Now, if there is some conservative who thinks you can always raise revenues by lowering taxes, they are obviously nuts. (If the tax is at, say, 1%, you cannot get more revenue by lowering it to 0%.) But if some liberal thinks you can never increase revenues by lowering taxes, they are every bit as nuts. Essentially, the latter position involves the belief that price has no effect on demand. An nice example of a case where raising a tax caused revenues to plunge is the Smoot-Hawley Tariff.
Now, whether Arthur Laffer was right that, in 1980, taxes were high enough that lowering them would increase revenues is an empirical question. But the notion of the Laffer Curve, meaning that there is some level at which a decrease in taxes will raise revenues, is a simple matter of economic logic.
Another common misperception is that Laffer thinks the "optimal" tax rate is that which maximizes revenues. He never said that in the time I worked for him, and I went over his papers from previous decades quite extensively, and he never said that as far as I could see. He never even led the reader to believe that's what he (Laffer) thought.
ReplyDeleteOn the contrary, he quite consistently said that people who use static analyses (i.e. ignoring effects in the tax base) will always overestimate the gains from a tax rate increase, and will overestimate the losses from a tax rate reduction. In some cases--like you say Gene--the overestimates can be so bad that they get the overall direction wrong. (I.e. thinking revenues will go up, when in fact they go down, or vice versa.)
What's interesting is that federal tax revenues unambigously rose during the Reagan Administration. So when people now claim that "the Laffer Curve has been debunked," they mean that they do regressions blah blah blah and can explain the huge increase in tax revenues by other factors.
That may be fine; I haven't vetted those econometric studies. But a lot of people think that the federal deficit exploded in the 1980s because the government was starved of revenue, when no, the opposite happened.