Lower Taxes Lead to Greater Revenue

I’ve been leisurely going through Hillsdale College’s free online American Heritage course. The other day I was listening to lecture 4, “The American Founding,” when I made a connection I hadn’t before.

The lecture is a detailed tracing of the movement from being loyal British citizens, asserting their traditional rights, to being independent peoples with natural rights. But there’s a story along the way, about taxes and duties.

For about four decades, the Whigs had been in power in the British Parliament, and they had lived by the philosophy of, “let sleeping dogs lie,” don’t upset what’s basically working. And that meant they had left the colonies mostly to rule themselves. There were governors, but the governors only got paid when the colonial assemblies voted to pay them. And Britain was three months away. So the colonists were pretty used to being left alone. 

But then a new prime minister comes in and starts to be concerned about those colonists getting too independent, and devises ways to crack down on them. I’ll let Dr. Paul Rahe tell this part (starting at 19:00 minutes into the video):

One of the things he does in April 1764, George Grenville, is to supplant the Molasses Act, which was designed to sort of ban molasses from America, with the Sugar Act. And it reduces the duties—the old duties had been set so high that no one could buy anything—so they cut the duties. In cutting the duties they were aiming at a revenue. And so the discontent in America begins with a tax cut, objections to a tax cut.

Well, the original tax was never paid, because it was so high it couldn’t be paid. The cut means that the British are going to seek revenue from the Americans in their own land. And the Americans respond to this with “no taxation without representation,” and they’re not represented in Parliament.

They tighten up the activities of the vice admiralty courts. The Americans were very efficient smugglers. One of the reasons they didn’t object to the Molasses Act is they smuggled molasses in and just skipped past the act. They’re going to tighten the vice admiralty courts so they can hammer these people. Then the Stamp Acts follow in 1965. The colonists are caught flat-footed. For forty-one years they’ve been left to their own devices, and suddenly there’s interference, and suddenly taxes are being imposed upon them, and there have never been taxes on them before

So here is something that governments knew back in the 1700s: higher taxes don’t mean more revenue; you get more revenue when you lower the taxes.

That’s the Laffer Curve, described by economist Art Laffer just forty years ago.

The Laffer Curve
from "The Laffer Curve: Past, Present, and Future," 2004

In short, there’s a point at which you can maximize revenue (if that is your goal—and it is often the goal of governments), and if you raise taxes above that point, the revenue will decrease. Because people avoid paying the tax if it is perceived as confiscatory.

Apparently the early colonists had no qualms about ignoring ridiculously high taxes, or duties (there are differences, but we’ll deal with them as similar enough for our purposes) by smuggling instead of obeying the British-imposed laws. In our day there might be other methods—moving a business out of the country, giving money to children in a trust where it can’t be touched, investing in times and ways that avoid tax, maybe even avoiding earning income over a certain level.

When taxes fall back into the range that people feel is tolerable, they start putting their money to use again, risking the need to pay the tax, because it’s worth paying in order to accomplish various personal goals.

That’s what happened when Reagan lowered to upper tax rate from 70% to 28%, which led us out of the Carter malaise and into a couple of decades of growth.

So, you’d think that if government officials really had the goal of raising revenue, they would find that sweet spot and use it. But they don’t. So they must have some other goal in mind—like appearing to care about the poor by confiscating from the wealthy,so they can get votes to retain their power.

Confiscatory taxes aren't good for a country. (Note: God asks for a flat 10%, given willingly, and maybe some extra offerings for the poor. Does government deserve more than God?) People take it personally when someone forcibly takes the fruits of their labors to use it for some other purpose. As John Locke put it, back in the day, “For what property have I in that which another may by right take when it pleases himself?”

If we want prosperity and growth in the economy, the way to do that is to set people free in the market, to earn what they can, and keep what they earn. You won’t get equal outcomes, but you’ll get better outcomes for everybody who participates.