Monday, January 12, 2015

Laffer Curve Turns 40

If you’re going to mark such things, we could look at a date in late December just past and say that was the birth of the Laffer Curve, 40 years ago. The anecdote is that Art Laffer sketched out his idea on a napkin while at dinner with Dick Cheney, Donald Rumsfeld, and Jude Wanniski.

The Laffer Curve
from "The Laffer Curve: Past, Present, and Future," 2004
The Laffer Curve, basically, shows that there are two points at which tax revenue will be absolute zero: at 0% and 100%. At zero, you obviously aren’t taking in any tax revenue. At 100%, no one would be willing to work just to give it all away to the government, so again you’d get no revenue. So, from there you can see that there is a curve where more taxes brings in more revenue up to an optimum point, and then the curve goes the other way, and more taxes brings in less revenue.
It’s a basic economic concept. I wrote about it in 2011, long enough ago that it’s worth reviewing, so I’m about to repeat that post below, which includes links to some videos that are great for grasping the concept. But, if you really want to educate yourself, you might want to add a couple of additional sources. One is a piece by economist Steve Moore, for Heritage, commemorating the 40 years.  The other is an older but larger document, by Art Laffer, “The Laffer Curve: Past, Present, and Future” from 2004, published by Heritage Foundation. The 18-page file is available here.
OK, so below is my post, “Laffer Curve Primer,” first published here November 28, 2011.
In the past week I came across a couple of reminders of the Laffer Curve, grabbing my attention enough to cover it in a post here.

First, I just finished reading Dick Cheney’s autobiography, In My Time. I’m sure I’ll have more to say on that in future posts, but this little anecdote was fun: 

It was in the wake of our loss [Ford’s election bid in 1976] that Don Rumsfeld and I had dinner one night at the Two Continents restaurant in the Hotel Washington with economist Art Laffer, a creative guy who certainly captured my imagination with a curve he drew on the back of my napkin. What it showed was that you can raise taxes only so high before people become disinclined to work. On the other hand, it’s possible to create incentive—and economic growth—with tax cuts. The Laffer Curve subsequently became one of the hallmarks of supply-side economics. I wish I had known how historic my napkin would become so that I could have saved it (p. 78). 

I had a similar response when I first heard of the Laffer Curve. Eye opening. 

Then later in the week I came across an article by Daniel Mitchell spelling out a few of the basics on the Laffer Curve. One of the interesting illustrations shows how much more revenue (about 5 times more) the government took in when Reagan lowered the upper tax rate of 70% down to 28%, comparing 1980 to 1988.  

The article had links to three short videos (about 7 minutes a piece) on the theory and real world evidence for the Laffer Curve, and then the frustration with the way tax bills are measured. They are all informative and clear, but the third one will make you want to do something to change the world. The three together take less time than half a television show without commercials. Definitely worth the time investment. 

The first video gives you the basic theory of the Laffer Curve.

Video II offers real-world examples of the Laffer Curve in action.


The third video covers the frustratingly inaccurate “static scoring” used by the Joint Committee on Taxation, causing bias toward higher taxes. 

If these concepts make sense to you, share them with a friend.

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