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No Laffing Matter

In his excellent Principles of Economics, Greg Mankiw commits a surprising blunder. Here it is:

Subsequent history failed to confirm [economist Arthur] Laffer’s conjecture that lower tax rates would raise tax revenue. When Reagan cut taxes after he was elected, the result was less tax revenue, not more. Revenue from personal income taxes (per person, adjusted for inflation) fell by 9 percent from 1980 to 1984, even though average income (per person, adjusted for inflation) grew by 4 percent over this period. [3rd edition, pages 170-171]

First, and least importantly, it’s not clear why the relevant comparison is 1980 and 1984. The first full year in which the first Reagan tax cut took effect was 1982.

Second, and much more significantly, “Laffer’s conjecture” (as Mankiw calls it) — or, more generally, supply-side economics — is not confined to tax-revenue effects per person. I assume that by “per person” Mankiw means the tax revenue contributed on average by each taxpayer (that is, total tax revenue from personal income taxes divided by the number of taxpayers). If my assumption about Mankiw’s meaning is correct, then Mankiw overlooks whatever effect a lowering of tax rates might have on bringing more people into the legal – that is, tax-paying – workforce. Total tax revenues might well increase even though tax-revenue contributed per taxpayer falls. Laffer’s conjecture is about total tax revenues, not about tax-revenue contributed per taxpayer.