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The (Laugher) Curve & National Review

by Drew J Jones Fri Jan 6th, 2006 at 12:14:05 PM EST

You know, you've really got to wonder sometimes.  National Review's Jerry Bowyer has a column up, claiming another victory for the fabled Laffer Curve.  And, with the combination of NRO's sheer stupidity and nicotine withdrawals (I'm trying to quit smoking), I am, shall we say, made angry more easily than usual.  To his credit, Jerry picks up on an astonishing trend: Tax revenues increase when the economy grows.  Amazing, "innit"?  What Jerry fails to mention, of course, is that revenue fell even after the recession had ended.

Let's discuss the Laffer Curve.


The story goes something like this:

The argument, put forward by scholars as far back as Ibn Khaldun in the 14th Century states that there is a point at which an increase in the tax rate will lead to a fall in government revenues.  (Laffer, in recent years, has attributed the idea to Khaldun and -- irony of ironies, given conservative hatred of him -- John Maynard Keynes.)  Not incredibly difficult to believe.  We can surely imagine a tax level where the government maximizes its revenue.

The name Laffer Curve comes from Jude Wanniski of The Wall Street Journal, who sat in on a 1974 meeting with Laffer and Dick Cheney -- yes, that Dick Cheney -- in which Laffer apparently sketched the curve out on a napkin to illustrate the concept.  The fact that Cheney and Wanniski were so taken with a concept that is, frankly, relatively simple tells you all you need to know about the level of economic intelligence in Washington and in the mainstream media.  Cheney and Wanniski were astounded at the level of "brilliance".

And my friends wonder why I hate listening to idiot reporters and politicians talking about economics.

Which brings us back to Jerry Bowyer and the Laffer Curve's twenty-five-year political legacy.  The theory has been used to justify Supple-Side economic policies under Reagan, Bush I and Bush II, and the results provide little or no support for the view.  In 1981, the year Ronald Reagan entered office, the US national debt stood at roughly $950 billion.  Today, the national debt is almost $8.2 trllion.  $1.5 trllion of it came under the Clinton administration (about the same as under Bush I, though Bush was able to run it in only four years).  In other words, about $5.7 trillion -- about 70% -- of debt has been run up under the last three Republican presidents.

About $4.2 trillion (over half our total debt!) of that came under Reagan and Bush II -- the Supply-Side presidents.  These charts from the CBO show government revenues from 1962 to 2004, and, knowing when Reagan and Bush's tax cuts were implemented, we can see very clearly that tax revenue, in fact, fell dramatically in each president's case.  In Bush's case, revenue has still not recovered to its 2001, pre-tax-cut high, despite an economy that, while very short on job growth, has been growing at reasonably strong rates.  As a percentage of GDP, revenues today are lower than they were in 1962.

Reagan closed some of the gap by consistently raising taxes -- most notably the payroll tax that pays for Social Security and Medicare (but that is also used to cover deficits run on the general budget) -- on working people, thereby shifting the overall tax burden down the pay scale.  How Bush intends to make any progress on the deficit, if he has any such intention, is anybody's guess, but one thing is for sure: Supply-Side economics -- the bastard son of Keynesian fiscal policy -- is, and has always been, bullshit.

It's time for the snake-oil peddlers to go.  And it's time the press stopped giving them air time.

Display:
Great post.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jan 6th, 2006 at 01:04:22 PM EST
In 1981, the year Ronald Reagan entered office, the US national debt stood at roughly $950 billion.  Today, the national debt is almost $8.2 trllion.  $1.5 trllion of it came under the Clinton administration (about the same as under Bush I, though Bush was able to run it in only four years).  In other words, about $5.7 trillion -- about 70% -- of debt has been run up under the last three Republican presidents.

It's a bit even worse if you contrast public debt. (Using data in your link.)

Reagan: +$1.35 billion (first term +$0.6 billion, second -$0.75 billion)
Bush I: +$0.95 billion
Clinton: +$0.4 billion (first term +$0.7 billion, second -$0.3 billion)
Bush II first term: +$0.9 billion

Total: $4.3 billion, 3 Rep Presidents: $3.2 billion/75%

Note: not taking inflation into account, nor 2005.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Fri Jan 6th, 2006 at 01:14:12 PM EST
Typo: Reagan second term was of course +0.75 billion debt.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jan 6th, 2006 at 02:29:21 PM EST
[ Parent ]
The US Budget charts you link to back up your comments on the national debt, and also on Bush II tax cuts, but unless I'm misinterpretting something, they don't back up your comments on the Reagan tax cuts.
These charts from the CBO show government revenues from 1962 to 2004, and, knowing when Reagan and Bush's tax cuts were implemented, we can see very clearly that tax revenue, in fact, fell dramatically in each president's case.
 From 1980 through the end of Bush I, revenues climb every year except 1983 when they fell less than 3%, but climbed 10% in the following year, surpassing 1982 and 1983, and climbed in each of the following years.  Am I misinterpretting something?

PS: I can't vouch for Laffer's theories, but he was one of the funniest profs I have ever had.

by wchurchill on Fri Jan 6th, 2006 at 01:19:25 PM EST
He probably means on a per GDP basis.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jan 6th, 2006 at 01:36:49 PM EST
[ Parent ]
Let me be clear: I'm not bashing Laffer, as a person.  I don't know him.

I was writing from the standpoint of "as a percentage of GDP," as DoDo noted.  Note that revenues did not recover, in percentage terms, until '86-'87 (when Reagan pushed through his payroll tax hike).  Revenues increased and decreased with the economy, in raw dollars.  They always will.  But we have to look at revenues per GDP to see whether the tax cuts "paid for themselves".  They clearly did not.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Fri Jan 6th, 2006 at 01:52:06 PM EST
[ Parent ]
No, I didn't think you were bashing him as a person.  Your comments are never impolite.

You may have to help me with my understanding of the Laffer curve, as it seems to be different than yours--I had him in the early '70's as a prof, which is a few years ago now,,,so long ago that I'm not sure if he even taught that as a concept.

But I thought that the concept was that lowering the tax rate would spur stronger economic growth.  And a lower tax rate times the higher GDP numbers would provide a higher absolute tax revenue--higher than the absolute tax revenue number provided by the higher tax rate times the lower (his theory) GDP numbers.  The concept being, which is of course very open to challenge, that tax cuts spur growth which more than offsets the loss due to the lower rate.  If you cut the tax rate, tax revenue as a % of GDP has to be lower, right?  It's just theoretically the absolute tax revenue could be higher.

by wchurchill on Fri Jan 6th, 2006 at 02:04:56 PM EST
[ Parent ]
The above comment should be qualified--the comments are true up to the peak point on the Laffer curve--ie there is some point at which the tax rate is just too low to cover expenditures, represented by the falling portion (to the right of the midpoint on your graph) of the curve.
by wchurchill on Fri Jan 6th, 2006 at 03:24:00 PM EST
[ Parent ]
I meant to respond to this yesterday, but there was a fire at my neighbor's apartment, and I completely forgot about the discussion.  The landlord gave him an empty fucking fire entinguisher when he moved in last year.

Anyway, you're right.  We're supposed to be talking about raw numbers -- not per GDP.  I'm getting myself a bit mixed up.  Laffer Curve proponents essentially argue that revenues (in raw dollars) will be higher at the lower tax rate, due to stronger GDP growth, than they would've been at the previous, higher rate.

The CBO did a study of a hypothetical 10% tax cut, financed with deficits, with players broken down into three categories -- No Foresight, Lifetime Foresight and Unlimited Foresight.  Bonddad has summarized it, here.

Long story short: We'll see some change in behavior, largely among top earners (as expected), but the change is not large enough to make up for the lost revenue.  The government still ends up losing about 75%, even when the results are very favorable to the Supply-Siders' views.

According to models that account for both supply-side and demand-side effects, those effects might offset somewhat less than 15 percent of the revenue loss over the first five years.

So the CBO model is predicting that the change in behavior will offset a bit less than 15% of the loss.  That's probably a fair estimate, depend, of course, on how high the rates were to begin with.

We can all judge for ourselves whether we believe that is worth the cost, or what tax rates we would all support.  (I think I'm probably a little more in favor of lower taxes than most people on here, since I don't think income tax rates should ever exceed the 40-45% range.)  But I think the data suggests, in all or most cases (the CBO study is, obviously, just one example), that the government would've been better off with the higher rates -- again, depending on how high they were to begin with.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Sat Jan 7th, 2006 at 12:21:11 PM EST
[ Parent ]
Thank you for your well thought out response, and for the link to the CBO article, which I thought was very good.  (BTW, I hope that fire worked out OK--the ole empty fire extinguisher trick again.)  It's too bad that we can't, in economics, hold all other variables constant, and analyze an issue.

While supporting the CBO article, I would make two comments.  First, I believe that the article uses today's tax structure for its analysis, looking at the Federal Income Tax only--which is appropriate BTW.  That means they are starting with a highest marginal tax rate of 35%, where my intuition (no data, just intuition) tells me marginal rates are already pretty low, and I wouldn't expect to get much revenue increase out of it.  I would agree with an earlier comment of yours, which if I'm understanding your meaning, said that it seemed logical that there was a significant revenue benefit from the JFK tax cuts--because the marginal tax rates were so much higher, and the benefits so much greater.

You comment:

(I think I'm probably a little more in favor of lower taxes than most people on here, since I don't think income tax rates should ever exceed the 40-45% range.)
I'm in agreement with your feeling on this point.  And this is just an observation: for those living in California their total marginal tax rate on income is in the middle of your range--35% + 9.3% +1.2% - 3.3% = 42.2% (federal tax + state tax+ medicare tax - benefit of deduction for state tax).  Now of course one does not have to live in CA, NY, or other high state tax states.  But just pointing out that a number of high income tax payers are on a higher marginal tax rate, in reality.

But I'm in agreement with the analysis which I interpret as saying at the lower marginal tax rates of today (2000 and forward), you will not increase tax revenues by lowering marginal tax rates.  Another of Bush's programs that I would disagree with is eliminating the estate tax--raising the ceilings makes some sense, reflecting the impacts of inflation, and maybe then some--but there are really no benefits to elimination.

by wchurchill on Sat Jan 7th, 2006 at 03:05:30 PM EST
[ Parent ]
The fire wasn't too terrible.  My neighbor burned his hand a bit, but no serious damage.  He was more shocked than anything.  The outside walls on the back of the buildings have plastic covering, and those were completely burned away in some parts, but the overall structure seems fine.

I would agree with an earlier comment of yours, which if I'm understanding your meaning, said that it seemed logical that there was a significant revenue benefit from the JFK tax cuts--because the marginal tax rates were so much higher, and the benefits so much greater.

I'm not positive about this, but I believe marginal rates, prior to the JFK cuts, were 90%, which is (in my opinion) just absurd.  It's the case that Republicans always point to, but 39% marginal rates -- I believe 39% was roughly the Clinton-era rate -- are, of course, not comparable to 90% rates.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Sat Jan 7th, 2006 at 04:47:35 PM EST
[ Parent ]
I wonder how te absolute figures would look if they would be inflation-corrected, and if above that they would be 'population increase-corrected'.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jan 6th, 2006 at 02:27:58 PM EST
[ Parent ]
Yeah, so many legitimate ways to twist the numbers...

But correcting for at least inflation is indispensable in this case.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Jan 6th, 2006 at 04:22:22 PM EST
[ Parent ]
I was thinking about the possible supply-sider counter-argument that they want tax income only to maintain the level of government services, i.e. they don't want an increase following GDP growth. But given that the population increases...

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Fri Jan 6th, 2006 at 04:57:32 PM EST
[ Parent ]
Simply point out that his figures are not adjusted for inflation or population growth.  Unfortunately, neither are the CBO figures you cite, which makes the relationship unclear.  

Percent of GDP figures aren't very meaningful because they reflect GDP changes - recessions, booms, as much as tax changes.

by tyronen on Fri Jan 6th, 2006 at 05:18:30 PM EST
One of the problems with the Laffer curve is that no one has been able to draw one using actual data.

You notice that when an example is shown there are never any labels on the axes. Even if it were a real sociological effect, how would you demonstrate it?

At any given period of time there are so many forces at work how can a single action be shown to be the cause of some economic activity.

What we do know is that the change in growth rates and tax rates don't follow any clear cut correlation. We also know that the growth in government expenditures has been covered by borrowing for much of the recent past. Historically this is always a prelude to inflation.

The Laffer curve is just another of a continuing justifications as to why the rich need to keep getting richer.


Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Fri Jan 6th, 2006 at 05:26:16 PM EST
Yes, and the fact that the cons simply assert that the current tax rate (whatever it may by at any given time) is firmly to the right of the peak is an astonishing leap of faith, to say the least.

But of course, faith doesn't require rigor.

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman

by dvx (dvx.clt št gmail dotcom) on Sat Jan 7th, 2006 at 08:36:59 AM EST
[ Parent ]
yes, both rdf's and your opinion are correct IMO.  I have not seen any studies that attempt to use real world data to prove the existence of the curve, or to plot the curve holding other factors concept.  It's just a somewhat intuitively appealling concept, particularly at the extremes--ie 90% marginal tax rates and 10% marginal tax rates.  But intuition just doeszn't cut it in the middle part of the curve, where most of the real world is.
by wchurchill on Sat Jan 7th, 2006 at 10:17:05 AM EST
[ Parent ]
I've certainly never heard of a case where someone was able to derive a Laffer Curve.  Often, the Supply-Siders will point to Jack Kennedy's 1963 tax cuts as evidence of the Laffer Curve's existence.  And it is, I think, a fair example, but it's important to remember that marginal rates were 90% prior to Kennedy's cuts.  That's an incredibly high rate.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Sat Jan 7th, 2006 at 11:08:21 AM EST
[ Parent ]


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