by Mitch Kokai
Senior Political Analyst, John Locke Foundation
In his latest editorial commentary, Thomas Donlan of Barron’s offers an interesting assessment of the Laffer Curve — the famous 40-year-old diagram showing that cutting tax rates can lead to higher tax revenues under certain conditions.
All other things being equal, the Reagan tax cuts either did or did not restore prosperity, as partisans also say of the Bush I tax increase, the Clinton tax increase, the Bush II tax cut, and all the gyrations of fiscal policy that have marked the Obama administration.
All other things, of course, are never equal, and the U.S. economy is too complex for computational economics to make them so, even in a model, much less in a political experiment. We don’t know the location of the extreme, revenue-maximizing point of the Laffer Curve for any one tax, much less for all of them in combination. We also don’t know if we want to be there; perhaps we prefer more growth and less revenue, or vice versa. We don’t even know how to get wherever it is we think we want to go; the tax laws are so convoluted that the only certain governing principle is the law of unintended consequences.
That’s a helpful approach to take whenever a pundit or prognosticator claims to have detailed knowledge about how a particular tax change will affect revenue. It reminds me of the following passage from a column posted last year at CarolinaJournal.com.
[T]he curve basically says that government will collect no revenue at tax rates of either zero percent or 100 percent. There is no tax to collect with a rate of zero percent, and no one will choose to work if she cannot keep even a fraction of a penny from her labor at a tax rate of 100 percent.
Offer no more specifics than this, and the idea is sound. A critic would have a hard time disputing that logic.
Here’s the problem: That basic concept offers little practical guidance for policymakers considering the best tax rates to meet particular goals.
Don’t get me wrong. The Laffer Curve provides a useful tool for debunking the notion that doubling a tax rate will necessarily double tax revenue. It also illustrates the important fact that cutting an overly high tax rate can, under the right conditions, increase the amount of tax revenue flowing into a government’s treasury.
But applying the Laffer Curve to specific cases is difficult at best. Too many people on the political right argue reflexively that cutting tax rates will increase revenues, citing the Laffer Curve as their evidence.
If you cut the top marginal income tax rate from 99 percent to 95 percent, will tax revenue go up? What about cutting the top rate from 95 to 70 percent? It’s likely that the answer is yes in both cases of extraordinarily high tax rates. But what about a cut from 50 percent to 40 percent? From 40 percent to 30 percent?
Researchers have filled many jargon-filled pages with calculations designed to label a “sweet spot” on the Laffer Curve, the point beyond which tax revenues are likely to fall rather than rise. Their goal is to use the curve to justify cuts from overly inflated tax rates.
But you don’t have to be a liberal with an inherent distaste for tax cuts to see that historical data offer only a limited guide about “ideal” tax rates. The overall health of an economy, the impact of other government policies, national and worldwide political events, and other factors all play a role in determining the amount of government revenue. The economy is not a vacuum-sealed controlled experiment. It never will be.