For Richer or Poorer

Our British cousins seem to have hit their head on the Laffer Curve.  Dr. Arthur Laffer, the fellow with the laughable last name, was an economic advisor to President Reagan back in the day.  His name is forever linked to a scale – like Richter’s is to earthquakes – that predicts human behavior when it comes to taxes, even though he learned of that scale from economist John Maynard Keyes, who was by no means a supply side economist.

The Laffer Curve attempts to project the extent to which raising taxes beyond a certain point will actually result in less revenue coming in to the taxing authority.  It seems counter-intuitive that raising taxes would result in less income, but it often happens.  There are two main reasons: 1. If, say, half of what you earn is taken from you, why bother earning more? 2. It’s worth taking devious (but probably legal) steps to avoid paying taxes if the tax rates are too high.

Many people think this theory is hogwash.  I’m not educated enough to know for sure if it is or not, but earlier this year the government of England was surprised to learn that when they raised the tax rate to 50% on the wealthy, they actually brought in considerably less tax revenue than they had the previous year from that group.  Interestingly, tax revenues from the other tax rates – less than 50% by quite a bit, I’m guessing – were actually up.

The results were so startling to them that there is pressure building to rescind that surtax on the wealthy.  Mr. Laffer isn’t surprised, of course.  He’s probably just pointing to the downward slope of his curve right now.

The thing is, it isn’t just wealthy people who want to pay less and keep more.   We all respond to incentives – both good and bad.  Workers will pull rank in order to get hours that pay time-and-a-half.  It’s good to get paid more.  As cigarette taxes have gone up, the black market in cigarettes has flourished.  And, many people earn income in cash or barter that they don’t report.  In fact, some people think that the black market economy is what is keeping the country going, even though it results in billions of dollars of lost tax revenue.

The other implications of the Laffer Curve are that when taxes go down, revenues go up.  During the Bush administration, taxes were put on a gradual reduction plan in 2001, and nothing much happened.  However, in 2003 a significant cut occurred all at once, including a cut in capital gains taxes.  The Congressional Budget Office projected a 35% increase in capital gains revenue from that, but revenue actually went up 50%.

The CBO also projected that the income tax cuts would result in a $75 billion loss in tax revenue, but the actual revenue was up $47 billion from the pre-cut baseline.  The Gross Domestic Product also doubled after 2003, and the jobs picture went from losing about 300,000 in the six quarters before 2003 to gaining 300,000 in the six quarters following the tax cuts.  The next seven quarters saw 5.1 million jobs added.

I’m sure there were other factors involved at that time, as there probably are in England now.  It does seem that letting people keep more of the money they earn works out to be good for those individuals, for the economy, and for the tax coffers.  Many people disagree, but it is certainly an interesting concept to consider.


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