Laffer Curve Works Again

HUMAN EVENTS ^ | Dec 28, 2005 | Jerry Bowyer

[george76]

Ronald Reagan once said an economist is someone who sees something that works in practice and wonders if it would work in theory.

So why is it that when confronted with a concept that works in both practice and theory, so many people refuse to believe it?

The Laffer Curve, popularized by economist Arthur Laffer, says the government can maximize tax revenue by setting the tax rate at ...

The logic is obvious on the ends of the spectrum: if the tax rate is 0%, the government collects no money.

If it is 100%, people have no reason to earn, and the government still collects no money.

Federal tax receipts for October and November (the first two months of fiscal 2006) were $288 billion. This is up from the first two months of fiscal 2005 ...

Despite cutting tax rates in May 2003, tax receipts for this two-month period have risen for three consecutive years.

We were on the wrong side of the curve (and may still be):

Tax rates were too high.

[neutronsgalore]

"So can I safely assume that you would have responded to the Depression with more fiscal spending?"

Only on infrastructure. Basic infrastructure, defense, regulation of trade with other nations, not much else the govt is really good for. Border security/immigration control I consider part of defense.

[remember]

Your 1980 numbers are off topic.

Are you suggesting that the Laffer curve does not apply to the 1980 numbers?

Lets focus just on the article (at humaneventsonline.com) and decide if Bower's main points are valid:

OK, let's start with the title "Laffer Curve Works Again". The word "again" means that it has worked before. It's likely that he is talking about the Reagan tax cuts. In any case, the following graph shows federal revenues, adjusted for inflation, since 1940:

The actual numbers and sources are at http://home.att.net/~rdavis2/recsrc.html. As you can see, revenues have been generally rising since 1940. They did go down for two years after the 1981 Reagan tax cut, went up sharply after the 1993 tax hike, and went down for two years after the 2001 Bush tax cut. It's interesting how supply-siders seem to have totally forgotten about the 2001 tax cut and focus totally on the 2003 tax cut.

[Mase]

It's interesting how supply-siders seem to have totally forgotten about the 2001 tax cut and focus totally on the 2003 tax cut.

Do you consider the major provisions of the 2001 tax cuts to be supply side (pro-growth) in nature? Did the majority of the 2001 tax cuts reduce tax rates on work, saving, and investment?

It's very easy to forget about Keynesian style tax cuts when they have little or no impact on economic performance.

[Toddsterpatriot]

It's interesting how supply-siders seem to have totally forgotten about the 2001 tax cut and focus totally on the 2003 tax cut.

I really enjoyed the check I received in the mail, but I never considered that a supply side rate cut.

[expat_panama]

The topic is the Laffer curve --the relationship between tax rates and receipts.   Your graph shows receipts and expenditures over the past 60 years.  In order to focus on the topic, we need to consider reciepts and tax rates, as shown in this graph:

You also argue the fact that Reagan's tax cuts preceded a drop in receipts.  I'd argue that they also preceded an increase in revenue.  Same with Clinton's tax hikes preceding a climb in revenue followed by a revenue drop.  

The issue is timing.  The Laffer curve plots revenue and tax rates in two dimensions.   The model does not include time as a third dimension.   Maybe you'd like to refine the model to include three dimensions, call it the "Remember curve", and start a new thread.

[remember]

You also argue the fact that Reagan's tax cuts preceded a drop in receipts. I'd argue that they also preceded an increase in revenue. Same with Clinton's tax hikes preceding a climb in revenue followed by a revenue drop.

The issue is timing. The Laffer curve plots revenue and tax rates in two dimensions. The model does not include time as a third dimension. Maybe you'd like to refine the model to include three dimensions, call it the "Remember curve", and start a new thread.

What in the world are you talking about? The graph in the article on which this thread is based shows federal revenues for the first two months of five consecutive fiscal years. My graph shows the full year revenues for 64 consecutive fiscal years. The only other difference is that I correct my figures for inflation. Neither graph shows the tax rates. Bowyer's graph relies on the knowledge that there was a tax cut in 2003 and my graph relies on the knowledge that there was likewise a tax cut in 2001 and 1981 and a tax hike in 1993.

You, on the other hand, have introduced a mysterious time lag of 2 years for the Reagan tax cut and 7 years for the Clinton tax hike. Perhaps you should call it the "Expat time lag" and start a new thread!

In any case, like Bowyer's graph, your graph does not correct revenues for inflation. Even with the logarithmic scale that you appear to be using, constant real values will appear to be increasing. In fact, revenues tend to grow with GDP which, accept for recessions, tends to grow faster than inflation. The following graph shows individual income tax revenues as a percentage of GDP and the top marginal tax rate:

The actual numbers and sources are at http://home.att.net/~rdavis2/recsrc.html. As can be seen, individual income tax revenues dropped sharply after the 1981 tax cut and then stabilized. Following the 1993 tax hike, they rose sharply until the market crash in 2000. Following the 2001 tax cut, revenues dropped sharply, continuing to drop through 2004. Much of the recent increase in revenues has been due to a partial recovery in corporate tax revenues, the green line in the graph. As seen in the table at the above URL, however, even these revenues are below their 2000 highs.

Anyhow, I hope you had a happy holiday and are all rested up for another year of head-butting!

[expat_panama]

model does not include time as a third dimension...   ...What in the world are you talking about? ...   .. mysterious time lag of 2 years for the Reagan tax cut and 7 years for the Clinton tax hike ...

Maybe you've used economic models such as supply and demand curves, in which case you're having a few laughs.  If so, skip the rest of this paragraph.   If not, here's a Wiki link, and here's one from Investopedia.   The two curves are about the most basic and most useful economic models, and they both ignore time lags to the point that the prof always has to drone on with something like what the Investopedia had in the middle of the page under "Time and Supply".   They have to leave out time because if you included time, then you'd also have to include location, race, age, etc., etc., until you had an entire epic novel, not a graphed formula.   This is why the article that started this thread started by saying:

Ronald Reagan once said an economist is someone who sees something that works in practice and wonders if it would work in theory.

Rather than suggesting the Laffer curve is wrong because it fails to address timing, you might want to attack the curve's relevance and usefulness, and then we could get seriously into all kinds of other factors besides timing --purchasing power, consumer confidence, etc.   Another way of saying it is that the essentials of the Laffer model are impossible to refute because they're so simple.  So, why bother?   I'd have thought you'd be better off saying it's too simple and then offering a refinement.

[SauronOfMordor]

Practically speaking, the tax rate should vary and not be a fixed value,

Practically speaking, FedGov should restrict spending to just those things that the Constitution actually authorizes, and let the taxpayers keep their damn money

I disagree with the underlying concept that taxes should be at a level which maximizes government revenue

[Yardstick]

Yep, I heard that. He sounded like a good guy, smart and confident in what he believed. I thought he handled the caller who disagreed with him really well.

[Paloma_55]

I agree with you on the idea that fed gvt should limit taxes to necessary spending.

[remember]

It's interesting how supply-siders seem to have totally forgotten about the 2001 tax cut and focus totally on the 2003 tax cut.

I really enjoyed the check I received in the mail, but I never considered that a supply side rate cut. [Toddsterpatriot]

Do you consider the major provisions of the 2001 tax cuts to be supply side (pro-growth) in nature? Did the majority of the 2001 tax cuts reduce tax rates on work, saving, and investment?

It's very easy to forget about Keynesian style tax cuts when they have little or no impact on economic performance. [Mase]

According to supply-sider Larry Kudlow, they were supply-side. In his May 29, 2001 National Review article, Kudlow used the word "supply-side" twice and never uttered the word "Keynesian". For example, he stated:

The new take-home rate is therefore nearly 12% better than the old retention rate. This is the new incentive effect. In particular, since top bracket taxpayers have the highest saving rates, Bush’s supply-side tax cut increases the rate of return on capital investment.

Also, an April 27, 2001 Heritage Foundation paper titled "The Economic Impact of President Bush's Tax Relief Plan" concludes:

This dynamic analysis shows that President Bush's tax plan will boost economic activity, create over 1.6 million new jobs, and strengthen the incomes of taxpayers. The plan would reduce excess tax revenue and effectively pay off the publicly held federal debt by FY 2010. Real economic growth, which recently has slowed dramatically, would rise an average of $147 billion per year from FY 2002 to FY 2011. On average, a family of four's after-tax budget would increase by $4,544, which would lead to an increase in consumption and saving. Spending on personal items such as health care and school clothes would increase by an average of $163 billion, and America's anemic savings rate would increase from 1.9 percent to 2.9 percent.

Of course, after federal revenues plunged for several years following the 2001 tax cut, the Heritage Foundation changed their tune, releasing a June 7, 2005 Heritage Foundation paper titled "A "Supply-Side" Success Story". It states:

Tax cuts based on the Keynesian notion of putting money in people’s pockets in the form of rebates and credits do not work—and these are the tax cuts that dominated the tax legislation approved in May 2001. Supply-side tax cuts, by contrast, do improve economic performance because they reduce tax rates on work, saving, and investment. And since lower tax rates on productive behavior dominated the May 2003 legislation, it is hardly surprising that the economy has responded positively

What's hardly surprising is that supply-siders changed their tune about the 2001 tax cut after revenues plunged. Can you provide a link to any well-known supply-siders who declared Bush's 2001 tax cut to be Keynesian at the time it was enacted?

More importantly, did you consider Reagan's 1981 tax cut to be supply-side? As the graphs and tables at http://home.att.net/~rdavis2/recsrc.html show, revenues decreased from 1981 to 1983. They also show revenues rising sharply from 1993 to 2000 following the Clinton tax hike. How do you explain that using supply-side theory?

[Conservative Goddess]

"As Thomas Sowell says, you're in a boat and the guy at the front of the boat shoots a hole in his end -- raising tariffs is like trying to fix the sinking boat by shooting a hole in your end of the boat."

Not to mention the fact that if we raise tariffs, the WTO would probably authorize retaliatory tariffs on our exports. Whereas the fact that we have international obligations has been explained to Willie ad nauseum, he fails to internalize the message and continues to post the same drivel.

[Conservative Goddess]

And we reached a Nash equilibrium....but don't tell Willie...he'll just accuse you of being a free traitor.

[Conservative Goddess]

"The overwhelming majority of trade war threats by other nations are pure bluff. They know we can damage them far more than they can damage us at this point and all it takes is a Presidency and Congress with BALLS to use that leverage."

Nonsense. The WTO wields a mighty big stick...and like it or not, we're members, bound by their decisions. They would authorize retaliatory tariffs on our exports in a New York minute. A year ago we passed a significant tax bill to appease the mighty WTO. Please see: http://www.nmma.org/lib/docs/nmma/gr/policy/Export_Tax_Repeal_Bill.pdf

[Ghost of Philip Marlowe]

Exactly. But you really can't blame the protectionists. They think it is the way to guarantee security of income, of lifestyle. It's like when someone gets nervous before a concert performance. You can tell them that they need to relax, that if they do, they'll perform better and won't feel as nervous. But they still tighten up because it is the survival instinct. Every proof in the world is meaningless at that point. The bottom line is that it is part of the technique of the centrally managed economy, which is socialism, which always fails or at least reduces people to a lowest common denominator.

[Ghost of Philip Marlowe]

Exactly. But you really can't blame the protectionists. They think it is the way to guarantee security of income, of lifestyle. It's like when someone gets nervous before a concert performance. You can tell them that they need to relax, that if they do, they'll perform better and won't feel as nervous. But they still tighten up because it is the survival instinct. Every proof in the world is meaningless at that point. The bottom line is that it is part of the technique of the centrally managed economy, which is socialism, which always fails or at least reduces people to a lowest common denominator.

[Conservative Goddess]

Agreed....and I believe there is a language barrier here of sorts as well.

"Free Trade" or what passes for free trade today is monitored by NGO's like the WTO. Trade Agreements are enforced, interpreted accordingly...and quite often, they are interpreted in a manner that does not favor the US. For those who view "free trade" as trade sanctioned and supervised in this manner...it is easy for me to understand how one would become jaded.

Truly free trade proceeds from the rational self interest of the trading partners...and leaves both partners better off...and it does not require the supervision of an NGO nanny. No one should fear truly free trade, because both sides of the equation will be in a better position after the trade. I think there is a lot of room to discuss our participation in orgs like the WTO....and they are the real danger to our way of life.

[neutronsgalore]

"Nonsense. The WTO wields a mighty big stick...and like it or not, we're members, bound by their decisions."

That's what withdrawal is for, with the tariff legislation set to go in effect the day after the time limit.

"A year ago we passed a significant tax bill to appease the mighty WTO."

Like I said..a complete LACK OF BALLS! There were appeals that could be made that would have locked the whole process up in bureaucracy for 1-3 years, plenty of time for a withdrawal to take place. But the instant the WTO makes a decision the US govt cowers like a beaten dog.

[neutronsgalore]

"The bottom line is that it is part of the technique of the centrally managed economy, which is socialism, which always fails or at least reduces people to a lowest common denominator."

There you go again, ignoring history. By your logic about 170 years of US history is solid socialism, considering it involved solid and irrefutable policies of protectionism. And considering the Buchanan-like protectionist policies espoused by most of the Founding Fathers, this country must've been founded by socialists as well.

[neutronsgalore]

"Truly free trade proceeds from the rational self interest of the trading partners...and leaves both partners better off..."

Except that the "rational self interest" is that of personal financial gain, even at the expendature of national survival in the long term. It's part of the inherent penny-wise pound-foolish element of free trade philosophy that's willing to allow a nation to sell off the national family silver of manufacturing/mining/agriculture for profit.