Wednesday, March 29, 2006

The Laffer Curve

I don't mention the Laffer Curve very much, despite it giving me the inspiration to my own brand of economics (Empty Wallet Economics). Still Bruce Bartlett points out the obvious about the Laffer curve in his latest article, so it's worth while to remind you what it says.

The Laffer Curve suggests that if you completely fail to tax the people, the government will have no money. And if you tax the people at 100% you will similarly have no money (because the economy will collapse). As you approach the 100% tax rate, in theory, people have less and less desire to produce wealth, so the tax revenues will drop. At some points, high on the curve, you would actually make more money by cutting taxes.

Republicans want to cut taxes (and government services) anyway, so they latched onto this as a good justification for what they already wanted to do. And they've kept this thinking right up to the present day.

Well Bruce Bartlett says, accurately, the argument may no longer apply.
However, when President Bush took office, the top rate on dividends was down to 39.6 percent, and the rate on long-term capital gains was just 20 percent -- far below the rates Ronald Reagan inherited. It is very implausible that these rates were in the "prohibitive" range of the Laffer curve, such that a rate reduction would raise revenue.

But even if we grant the theory, how likely is it that the recent rise in revenue owes anything to this effect? Again, not much.

The fact is that it is only in very exceptional circumstances that there would even be the possibility of a tax cut that would so stimulate growth that it would pay for itself. Even the Bush Administration admits this.
There it is. You can't cut taxes (or maintain the Bush Tax Cuts) and assume that you'll be pulling in more money. Where the tax rates are now, I assume it would be quite the opposite.

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