Laffer Curve
From RationalWiki
The Laffer Curve is the holy symbol of the faith of supply side economics, also known as "trickle down" or "voodoo" economics. It was popularised by Arthur Laffer, a supply side economist who was a member of Ronald Reagan's Economic Policy Advisory Board between 1981 and 1989. The diagrams, famously sketched on a restaurant napkin, purport to show that under certain specific circumstances, a major cut in marginal income tax rates, along with careful spending discipline for the ensuing short term, will, in the long term, actually increase government tax revenue.
The term voodoo economics was used by George H. W. Bush, during the Republican Primary campaign in 1980. He was referring to Ronald Reagan's promotion of supply side economics.
It was thought that at that time in US history, the tax rates and current budget fell within the window of what Laffer predicted. When Reagan attained the Presidency, he did indeed pursue an aggressive program of tax reduction -- however, the required corresponding budget discipline was ignored as he went on a military borrowing and spending spree. Apologists for Reagan (and supply side economics in general), of course, blame the Democratic-led Congress for the spending.
The Laffer Curve is often used as a blanket ideological justification to reduce income taxes, especially the higher marginal rates paid by high-income individuals, regardless of where current tax rates might lie on it.
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[edit] Lulz
"Today we have a similar debate over this. Anyone know what this is? Class? Anyone? Anyone? Anyone seen this before? The Laffer Curve. Anyone know what this says? It says that at this point on the revenue curve, you will get exactly the same amount of revenue as at this point. This is very controversial. Does anyone know what Vice President Bush called this in 1980? Anyone? Something-d-o-o economics. VOO-doo economics." - Ben Stein
[edit] Argument
The argument for lower taxes goes something like this:
- If the income tax rate were 0 percent, the government gets zero revenue because it isn't collecting any money.
- If the income tax rate were 100 percent, nobody has an incentive to work because nobody gets to actually keep any money they earn. So nobody works. When nobody works, nobody has income to tax. Therefore, the government gets zero revenue in this instance also.
- Given 1 and 2, the government revenue is maximized at some tax rate between 0 and 100 percent. The Laffer Curve is a plot of government revenue as a function of tax rate. It is zero at 0% and 100% tax rates, and it looks something like a parabola. Where the maximum occurs is a wild-ass guess.
- Given 3, taxes should be slashed.
[edit] Why the argument is a fantasy
Sadly, economics is usually harder than drawing a hand-wavy curve between two points.
- Obviously the government can't have a 100% tax rate. But the argument above implies that if the tax rate was anywhere close to 100 percent, people would stop working. However, even if the tax rate was very high (say, 95%), people would still work. After all, keeping 5 percent of your wages is better than earning nothing at all. The highest income tax bracket rate in the United States was close to 90% around World War II, and everyone seemed to work just fine then.
- Point 4 above does not necessarily follow from point 3. Assuming the Laffer Curve's assumptions are correct, cutting taxes would only increase government revenue if the current tax rate is greater than the "optimal" tax rate. If the current tax rate is on the wrong (left) side of the maximum in the Laffer Curve, cutting taxes decreases government income.
- To justify cutting taxes, the Laffer Curve's proponents have to 1.) demonstrate that the shape of the Laffer Curve is correct; 2.) Define the "ideal" tax rate that maximizes revenue; and 3.) Show that the current tax rate is on the wrong side of the "ideal" tax rate. You can't just shout "Laffer Curve!", lower taxes, and expect everything to be great.
The current highest tax bracket rate in the U.S. is about 38%. A worker earning about $20,000 a year pays a 15% income tax plus almost 15% in "payroll" taxes towards the Social Security and Medicare/Medicaid programs, or about 25% less than the tax rate paid by someone earning a hundred times as much.
