The Laffer Curve is a hill with icy slopes.
by John Hayward
05/08/2012
There has been an interesting shift in the Left’s relationship with the Laffer Curve, economist Arthur Laffer’s brilliant calculation of the optimum tax level. Liberals spent a long time treating the Laffer Curve as heresy, and pretending it did not exist, despite mountains of hard data to the contrary. Instead, they clung to the absurd “static model” of taxation, which holds that tax rates do not influence the behavior of taxpayers in any meaningful way. Thus, a 5 percent tax hike brings in 5 percent more revenue.
In reality, high taxes depress economic growth, and induce behavior designed to avoid paying the tax. The effects of avoidance grow more pronounced at higher income levels, as wealthy individuals and large corporations have more options for evading taxation. Laffer devised a method for determining the point at which taxes produce the optimum sustained revenue, and since that level is considerably lower than liberal dogma calls for, much controversy ensued.
Lately there has been a move among certain economists on the Left to make their peace with the Laffer Curve, and argue that its peak would support higher tax rates than we are paying now. Chief among these economists are Peter Diamond and Emmanuel Saez, who wrote in the Wall Street Journal a few weeks ago that top marginal rates could be shoved into the 50 to 70 percent range before the ice-covered down slope of Arthur Laffer’s hill was reached.
This effort is accompanied by a growing nostalgia for the 1950s, which liberals used to chide conservatives for idealizing at the cultural level. Now it’s become fashionable for the Left to idealize Fifties economics, which supposedly featured high taxes combined with explosive growth.
It is simply amazing that any educated person could make this argument without mentioning a very significant event that occurred during the Forties. It was in all the papers – a messy little dispute about the borders of Germany, and the unruly behavior of Japanese tourists in Hawaii, which led to the complete devastation of America’s economic competitors. A repeat of those conditions does not appear to be in the cards.
Also, America is currently fighting to avoid tumbling into the abyss of a double-dip recession, or outright depression, not riding upon the crest of an economic boom. Our problem is an excess of government spending and regulation, not an insufficiently large diversion of resources from the productive private sector to our moribund bureaucracy.
The other major factor to consider is the sheer complexity of the modern tax code, which is not easily compared to the tax system of earlier eras. Sensitive to increasing public unhappiness with rules no one understands – not even the IRS! – and only certain people are expected to obey, the Left has begun warming to the concept of tax simplification. They interpret this to mean shutting down tax deductions… or “loopholes,” as liberals prefer to identify deductions they dislike.
This mindset also explains the tendency of statists, notably including President Obama, to refer to deductions as “tax expenditures.” In other words, the government is “spending money” on certain people when it allows them to take tax deductions. This reasoning will absolutely never be applied to the Earned Income Tax Credit, which really is a welfare payment disguised as a “tax break,” frequently granted to people who do not actually pay any taxes.
And, of course, the liberal version of “tax simplification” will never involve assessing the same rate on all taxpayers, or giving up many of the micro-targeted subsidies and penalties used by the government to control economic behavior. In fact, the Left’s thoughts on tax policy move increasingly toward making the tax burden invisible to voters, particularly in the lower and middle income ranges. Instead, taxes will be shifted to evil corporations and the rich people who owe them.
Naturally, those hidden taxes will trickle back down the Laffer Curve and hit the public through elevated prices, but Big Government will leave no fingerprints at the scene of that crime. That’s a major advantage for the Left, which can turn public anger at the oppressive weight of government against what remains of the private sector – a deadly political judo move that will leave a confused populace unable to figure out how things got so bad, and delightfully receptive to appeals from statists who promise they can make life better, if only they are irrevocably granted greater power.
This effort is aided by a greater focus on federal revenue needs, which completely eclipse state and local taxes in the minds of many people. The collapsed housing market, which might not recover for a generation, further obscures local tax burdens from the public mind, since so many of those taxes are assessed against property. Renters pay them, but never see or think about them.
So, what is the ideal tax burden? The Tax Foundation reported last week that “U.S. citizens will pay more than $4 trillion in total federal, state, and local taxes,” which is “$152 billion, or 3.8 percent, more than they will spend on housing, food, and clothing combined.”
Furthermore, a steadily increasing portion of household expenses are now covered by government benefits – which means the government takes piles of cash from the private sector, skims its gigantic overhead off the top, and returns pennies on the dollar in value to our economy. Of course, they’re pennies on someone else’s dollar.
It will take 107 days for the average American to pay off his total tax burden in 2012. That’s obscene. It’s a far greater levy than tyrants of old imposed upon their serfs. The idea that such a burden should be increased upon anyone is absurd, and the amount of our tax burden hidden entirely from our view is an outrage.
The Laffer Curve locates the point of optimum government revenue, but that is not the same thing as the ideal tax burden. Our government has already grown far beyond the point at which an optimum revenue stream can sustain it – hence the titanic national debt, and the complete foolishness of believing trillion-dollar deficits can be closed with tax increases.
It would also be wise to remember how slippery the far side of the Laffer Curve tends to be. When tax rates exceed the point of optimum revenue, politicians have a built-in tendency to demand even higher tax rates to cover those revenue shortfall. The failure of tax increases to produce the anticipated revenue is invariably portrayed as a crime, for which the offending citizens should be punished. This leads to further, increasingly dramatic, failures… which become fuel for ever more strident demands. History does not offer a single example of this death spiral that didn’t end with some degree of violence.
Our national discussion should focus on trimming the government back to performing its essential duties, and then presenting the public with an honest revenue plan to fund those duties. It should be a system that conceals nothing, and deals entirely with financing the government in the simplest and least burdensome manner possible… instead of using the tax code as a tool for “transforming” the public, in accordance with the vision of their betters.
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To read another article by John Hayward, click here.
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