Learn the Laffer Curve

Excellent! How do I access parts II and III? Thanks

Keynes, von Mises and others described the "Laffer curve" long before Laffer.

http://en.wikipedia.org/wiki/Laffer_curve

High marginal income tax rates were never supposed to collect revenue. They were supposed to encourage tax deductible investments. The top marginal rate of 70% in the seventies was considerably lower than the top marginal rate in the fifties, which was over 90%, yet the fifties were a period of robust growth. "Tax loopholes" were the whole point.

As Roberts notes in a recent blog post here, the Laffer curve effect on Federal revenue in the Bush administration is extremely dubious. Even in the Reagan administration, the effect is debatable, because revenue initially fell and then rose only as GDP rose. This effect could occur on either side of the peak.

Something else followed the Reagan cuts, a plummeting savings rate, ultimately culminating in the negative savings rate we have now, and Reagan also raised taxes substantially, specifically the payroll tax.

But suppose the Laffer curve theorists are right, and we got more Federal revenue by cutting marginal income tax rates, because people realized more taxable income than they would have otherwise. Am I supposed to celebrate this effect? More Federal revenue and less savings or private investment? That's a good thing?

I think not. We may raise marginal income tax rates again precisely in order to cut Federal revenue. In fact, we may encourage this effect by creating an unlimited entitlement to shelter any amount of income in a tax deferred investment account, as radical leftists like Sam Nunn and Pete Domenici advocated in the eighties. We want wealthy people investing directly rather than channeling income to the Congress for more central "investment". That's the whole point of a progressive consumption tax. The point is not to raise revenue. The point is not to raise revenue.

Very well done. That's what Dr. Laffer has maintained from the beginning. People misconstrue the effect and then laugh at it.

He says Keynes like "Kanes." I always said "Keens." Which is it?

Posted by: Will | Feb 2, 2008 5:27:12 PM

Laffer vs the Supply Siders

Someone claimed that Laffer wrote in a 2000 WSJ article that the Reagan tax cuts increased revenue, and now he says he never said that. If true, then would shatter Laffer's credibility.

Yeah I'd gut Social Security, Medicare and Welfare direct payments first. That's $1.5 trillion right there!

Even if Congress couldn't stop you, you wouldn't survive your first term, unless you have alternatives in mind. Marginal income taxes don't fund Social Security and Medicare, not yet anyway. They probably will soon. That's the "trust fund" that Reagan dramatically expanded when cutting marginal income tax rates and that Bush tried to repeal as the bill comes due due.

How much could we raise the payroll tax without cutting revenue? A hell of a lot. When you tax the first dollars of income, you can tax practically to the point of starvation, because people won't starve themselves to avoid your taxes. They might start shooting back, but they won't starve themselves.

A state can tax 100% of income if it feeds taxpayers with tax revenue. [There really is no "income" in this scenario, but that's another story.] It can happen on a small scale. Slavery existed. It's not a myth. Slavery on a massive scale is simply inefficient, in the economic sense of "efficiency". Mass enslavement to a hierarchical authority, as in state socialism, doesn't effectively convey the value of resources. Prices signal little information about the balance of supply and common demand.

When a state feeds people generally, "good nutrition" becomes equivalent to "weapons of mass destruction". It's out there if the statesmen say it is. More likely, you send out your troops to collect grain for export, so you and your cronies can drive Mercedes, and you simply decree that everyone is well fed. Anyone saying otherwise is invisible.

But a marginal consumption tax (which Adam Smith advocated as a "tax on luxury") can approach 100% without starving people. Rates approaching 100% increase individual investment, if the tax doesn't apply to investment. Yes, these rates lower Federal revenue, but that's the whole point. We don't want central authorities reinvesting the income. That's what a wealthy capitalist is supposed to do. It's his job.

When we decide that a few lords of capital have a divine right to build themselves castles, and drive Mercedes, we must expect them to do that. History is overwhelmingly clear on this score.

Castles and Mercedes aren't the only shape this problem takes. A small class of corporatist lords can entitle themselves to years of consuming anything without producing anything themselves. They can grant themselves bank accounts full of cash and purchase entitlement to future tax revenue and other rents. They don't even need the bank accounts full of cash, but they can create these accounts if they want, if the accounts make the entitlements seem more divine.

It happens all the time. I hope it hasn't reached a catastrophic point. We'll know in a few more years. The leading edge of the baby boom hits the customary retirement age around 2010. We don't know yet how much this generation has forbidden us to produce except for their idle consumption, but we'll soon find out. The problem is a lot larger than Social Security. Anyone imagining that Social Security is the only block in this pyramid simply worships a state without this program. We did have states before Social Security. We even had states before income taxes.

Great video. Thanks for posting!

Martin Gardner was much cleverer than Laffer.

Martin Brock:

You are a bit too obsessed with the rich's playthings. They are not the problem in the economy. Unskilled workers are. You still can't say how do we deal with that. Taxing the rich on the investment or consumption side won't solve that problem, except for salving the hurt feelings of the lower middle class. You seem to worry more about feelings then hard economic facts.

Martin,

"Something else followed the Reagan cuts, a plummeting savings rate, ultimately culminating in the negative savings rate we have now, and Reagan also raised taxes substantially, specifically the payroll tax."

It would make more sense to attribute the plummeting savings rate to the increased payroll tax. How would letting people keep more of their money cause them to save less? And why would we not assume that people would choose to decrease their savings first when a substantial percentage of their earnings is "reallocated for other uses" by the people who control the state?

Hypothesis. People tend to spend on the following in order;

1. Necessities
2. Minor luxuries
3. Savings
4. Major luxuries

A increase to the progressive income tax will cut into the spending on major luxuries by the wealthy, which will in turn cut into the earnings of those who provide major luxuries, which will reduce their savings. The increase will also cut directly into the savings of those who have not yet begun to spend on major luxuries.

An increase in a payroll tax will hit primarily at those who have not begun to spend on major luxuries and will therefore decrease their savings and minor luxuries.

Therefore, the primary result of any tax is a greater dependancy on the state to return the savings it has "reallocated".

P.S. Yes, I know I should throw in the phrase marginal propensity at serveral points – but this is a blog comment and I'm trying to keep it short.

It would make more sense to attribute the plummeting savings rate to the increased payroll tax.

It was a factor presumably, but the savings rate is an average. If the rate drops, then lower savings by lower income people is not offset by higher savings by higher income people, and we still have the higher Federal revenue, the higher Federal spending as a percent of GDP, the higher deficits and the rest.

How would letting people keep more of their money cause them to save less?

Investment is something people may do with money. The issue is what people do with the money they keep.

And why would we not assume that people would choose to decrease their savings first when a substantial percentage of their earnings is "reallocated for other uses" by the people who control the state?

A progressive consumption tax removes the income of the wealthy from the hands of central authorities. That's the whole point. I'll keep repeating the point until it sinks in. The point is not to raise Federal revenue. The point is not to raise Federal revenue. Raising taxes on the wealthy lowers Federal revenue? I think that's great. I wouldn't have it any other way.

Your argument incredibly assumes a zero sum game.

Martin,

I wasn't referring to your proposal at all, but only to the effects of taxation as it is. The key point in the hypothesis is that people spend on minor luxuries before they save, and that reallocations by the state therefore come out of savings. A subpoint applicable to your proposal is that spending on major luxuries by those who can afford it only occurs after the desired amount of savings (and investment) has already occurred.

Martin,

Re; "Define "desired amount of savings (and investment)".

Security and/or profit. People don't invest or save for the pure joy of it. They do it either to set aside for future security, or because they recognize an opportunity for profit. The marginal propensity to save/invest declines as the desired level of security rises and as the quality of investment opportunities declines.

I should toss in here that I think that investment is overrated. For investment to be useful, there has to be something useful to invest in. The railroad boom, the auto boom, the information technology boom, etc., and in the interim periods, not so much – with investors dropping wealth into cash, bonds, and real estate just to protect it.

I would also add that I believe the next boom will be in luxuries. Not anything new, just bigger, better, faster versions of what already exists. So while I do see value in an unlimited tax free account – and do see how it could incentivize many people to same more than they do, I see no reason to disincentivize luxury spending, as the increase in luxury spending is what the investors will be investing in.

Randy:

Re; "Define "desired amount of savings (and investment)".

Security and/or profit. People don't invest or save for the pure joy of it. They do it either to set aside for future security, or because they recognize an opportunity for profit.

I have no problem with these motivations to invest, but Bill Gates didn't accumulate a hundred billion dollars worth of assets to secure his daily bread.

The marginal propensity to save/invest declines as the desired level of security rises and as the quality of investment opportunities declines.

The marginal propensity to save/invest does not decline as the level of security rises, not for everyone anyway. Wealth is an end in itself. It's victory in a game of king of the hill. If people didn't pursue ends for this reason, we'd have no Olympic athletes. We can expect people to pursue profits under a progressive consumption tax, and we have historical precedents.

"Quality of investment opportunity" is a relative, subjective judgment. New investment opportunities always exist. We don't want to throw money at novel investment indiscriminately, but no one proposes this policy.

A private castle is not an intrinsically more rational expenditure than a museum that never profits. The castle never profits either. If the museum never profits, investors more likely reorganize the resources, but a castle is never expected to profit.

I should toss in here that I think that investment is overrated. For investment to be useful, there has to be something useful to invest in. The railroad boom, the auto boom, the information technology boom, etc., and in the interim periods, not so much – with investors dropping wealth into cash, bonds, and real estate just to protect it.

Genuine investment is a gamble on the productive or more productive organization of resources. There is always something potentially useful to invest in. There are no interim periods in which these opportunities are absent.

I would also add that I believe the next boom will be in luxuries. Not anything new, just bigger, better, faster versions of what already exists.

Of course, we'll produce better, faster versions of what already exists. Bigger? I don't want a bigger computer. I want a smaller one. My current mp3 player is much smaller than my first. The printer/scanner/copier in my home office is far smaller than anything my father had downtown, and he never had color.

So while I do see value in an unlimited tax free account – and do see how it could incentivize many people to same more than they do, I see no reason to disincentivize luxury spending, as the increase in luxury spending is what the investors will be investing in.

Here again, you simply ignore your own distinction between "minor" and "major" luxuries. A progressive consumption tax doesn't forbid luxuries at all. It channels investment toward a greater variety of more common luxuries, like the automobiles, radios, televisions, record players and rock and roll we produced in the fifties when marginal income tax rates exceeded 90%, while real median income actually rose.

Historical precedent does not support your alarming assertions. Castle builders don't starve when we stop building castles. They find other work. All the Federal employees who would lose their jobs under a progressive consumption tax would also find other work.

You realize that with all your "progressive" income/consumption taxes that if you piss off the rich folks, they'll take their liquidity elsewhere, like Malaysia. Because they can.

That you don't like the word "progressive" doesn't concern me. I'm happy to call the reform something else.

People may sell income earning assets in the U.S. and buy assets elsewhere. That's fine with me. I don't care. Someone else will buy the assets here. We had income tax rates exceeding 90% in the fifties, with exemptions for investment, and everything didn't go to hell in a hand basket. Your alarmist theories in favor of some state you prefer does not contradict empirical experience.

It's the duty of any nation to not piss off the investor class, because we depend on them for our livelihood.

Far from pissing them off, I propose to cut the taxes of the investor class practically to nothing.

Now the only other solution is to do like Lenin did and kill them all, but where does that leave us except living in a Communist hell-hole.

This false choice is simple nonsense. I'm not so simple. Try it on someone else.

If the 90% income tax rates worked so well, why were they ended?

Ask John Fitzgerald Kennedy and his allies in the Congress. Maybe they thought the investment exemptions too limited, though they could have loosened these restrictions. Maybe they wanted more entitlement to marginal consumption. Maybe they wanted more Federal revenue. Whatever their reasons, they made the decision.

I'll emphasize again that I favor high marginal tax rates only in the context of an unlimited entitlement to avoid the tax through investment. I advocate a progressive consumption tax, not a progressive income tax. The point is to channel investment toward expanding and improving the variety of goods and services commonly available, not to raise Federal revenue. Lower Federal revenue is the goal.

I suspect that the political class disagrees with you.

When I say "the point", I mean "my point", not the "the point of the political class". That goes without saying.

I for one think that higher federal revenue is precisely the goal.

Kennedy might have sold it this way. I haven't seen the Congressional record. He probably sold it differently to different people. That's politics. I don't labor long to wonder what he got out of it himself.

The available evidence certainly gives me no reason to trust their professions of altruism, and your insistence on granting them a role is my primary point of contention with your ideas.

I don't grant anyone's role, but I propose to halve Congressional revenue in favor of less central investment. Congressmen and other statesmen write the law governing property. Politicians play this role. You propose nothing else. You just say "political class" derisively when you oppose a reform some reason and say something else when you favor a reform. This rhetoric is persuasive, not to me anyway.

I don't have a "plan", Martin. My method is to get the believers to understand what kind of people they are placing their faith in.

Of course, you have a plan. Private property, markets and the rest of the rule of law is a plan. It's not "central planning" in the narrow sense of these words, but it certainly is a plan. You don't want everyone free to do anything.

Yes, I use the term "political class" with as much "derision" as I can muster. As far as I'm concerned, they are the type who would rob people in dark alleys if they hadn't stumbled upon a more effective method.

Without a state, you have nothing to rob, because nothing is property. Natural territoriality is not property. Property is forcible propriety, and it is always bounded.

What works for me is irrelevant. "Stealing" violates propriety by definition, and lawmakers define "propriety". We needn't like it, and we can try to change it, for what it's worth. What I won't do, or can't do, is accept it without complaint.

Martinduck,

Furthermore, robbers certainly predated the "state". As a matter of fact robbers and how to deal with them were one of the many reasons for inventing the "state".

I supoose that you're one to believe that the state is the entity that grants rights to us, don't you?

Legal rights are the will of armed men, and pretending that they aren't is the worst possible pretense. If you want to discuss other "rights", you need to define them first.

vidyohs:

You forget that property is not just land, or maybe you'd like to tailor your statement here:

I hardly forget it. I say it over and over again. For example, I say that Treasury notes are "private property" as well as entitlement to tax revenue, because that's the law as a matter of fact. This statement is no defense of Treasury notes. It's just a fact.

Humans certainly possessed property long before such a thing as a "state" came into being.

You may call something preceding the rule of law "property" if you choose. John Locke did, but his "property" is as meaningless as yours in modernity. It was already meaningless when he described it. I don't live on a Lockean frontier, and in my neck of the words, when people use the word "property", particularly the uniformed people wearing guns, they mean legal entitlement, and that's all they mean.

The FRNs I get when I cash a client's check is my "property".

Exactly. Assuming you obtained the check lawfully.

The car I drive is my "property".

Assuming you have the title.

The spear that Og carried 30,000 BC was Og's property.

No. It was his possession. It might have been Gor's possession a day earlier, and he might well have killed Gor to obtain it.

The shell necklace Og made for his sweetie Oog was Oog's property.

No. That was her possession too. Since Og made it, it's more like Lockean property, but it still isn't "property" in any modern sense.

They even possessed land before states came along, and they held the land until someone with more force came along and took it from them.

Exactly. They possessed it when they could hold it by their own force. This state is natural territoriality, not property. Read Locke. Even he wouldn't call this possession "property". Lockean property doesn't exist among hunter/gatherers. It appears only with agriculture, when one man farms a parcel of land himself. When you show me any reputable authority calling Og's territory "property", you'll have a leg to stand on.

The fact that it was taken from them did not negate the fact that they possessed it for X amount of time, which may have been centuries.

People didn't live for centuries 30,000 years ago, and they certainly had no titles to property, because they had no written language. They didn't even have Lockean property.

http://en.wikipedia.org/wiki/History_of_writing#Proto-writing

Property rights are establised by the possession by individuals that can retain it against all challengers (physical or legal) using whatever means, even including the force of a state.

No. That's territory and possession. It's not at all what we call "property" today. It's not even what Locke called property in the 17th century. Where do you find anyone at any time using the word "property" this way? "Conservatives" don't use the word this way. "Liberals" don't use the word this way. "Libertarians" don't use the word this way. Anthropologists don't use the word this way. Do words simply mean whatever you say they mean?

Martinduck,

Yep the old mulberry bush crap again. Because you can have the time to construct voluminous rebuttals to anything and everything means that you mistake the act of overwhelming as superior knowledge. Tain't so, it is just another trip around the bush.

You're so hung up on the state that you refuse to see anything but your own erroneous twiddle.

Og has it, he keeps it, he uses it, and no one else has access to it, but it isn't property?

Yeah right. Use whatever name you want it makes no difference, the thing was Og's, and that makes it property.

Property is a thing, an object. Possession is an act. Got it?

Contrary to your assertion that no one uses the word property to describe possessions today is blatantly wrong, it is used quite commonly in every taxing office in the land, and so those who pay taxes on property also use it. Which pretty much includes everyone, doesn't it martinduck?

Look back over your shoulder, martinduck. I won't be there to chase you around on what has obviously become another one of your chase me people, chase me.