Posted by: Dale Franks on Thursday, September 13, 2007
Jon's Post below mentions the Laffer Curve, and states we're on the left side of the curve. One commenter takes strong exception to this, stating bluntly, "We’re indisputably operating on the RIGHT side of the Laffer Curve. Not on the left."
Oh, really. Well, let's take a look at that, shall we?
First, for review, let's look at the Laffer Curve itself.
The simple explanation of the Laffer Curve is that there are two tax rates that will yield the same tax revenues. In this case, the tax rate at point A is significantly lower than that at point B, yet they both yield the same rate.
If the tax rate is 0%, you get no tax revenue, because there are no taxes. If the tax rate is 100%, you still get no revenues, because no one will work if everything they make is taken away from them. So, as you raise tax rates from 0%, tax revenues will start to rise, but, once tax rates get too high, i.e., at the right side of the equilibrium point, tax revenues start to fall, because tax rates become a disincentive to produce.
The trouble is that Art Laffer defined the equilibrium point as the rate at which the population consents to be taxed. So, the equilibrium point is quite fluid. If a war occurs like WWII, that rate might be quite high indeed. In peacetime, that rate might be quite low. It may shift about some due to public concerns about the budget deficit or the national debt. Since that point varies with public opinion, it is never really possible to say at what tax rate the equilibrium point is.
Additionally, some people consent to be taxed at different rates than other people, depending on how they view taxation in general, or how much income they have, or any of a number of other reasons. So, in reality, there's no real equilibrium point, rather, there's an equilibrium range.
So, while the Laffer Curve is useful conceptually, it can't really be taken too literally.
With the above in mind, then, it might be possible to gauge where it was in the past, which we shall discuss in due course, but it's pretty difficult to say what it is at any particular point in time.
So, are we on the left or right side of the Laffer Curve?
Let's look at some numbers.
I think pretty much everyone will agree that in 1980, we were on the right side of the curve, with a top statutory rate of 70%.
When we look at IRS collections for the years 1982-1988 (Excel spreadsheet), i.e., the eight years following the initial Reagan tax cut legislation in 1981, we see that personal income tax revenues for 1982 were $352,608,936. By 1989, that had risen to $515,731,504, an increase of 46%.
Now, that seems impressive, until you look at tax revenues that followed the Clinton tax increases of 1993—which were made retroactive for that year, to much wailing and gnashing of supply-sider teeth. In 1993's tax year, revenues for personal income tax were $585,774,159, and in 2000, they were $1,137,077,702. That is an increase of 94%.
Since the above figures use current dollars, the numbers are actually a bit less impressive. Still using constant dollars, we come up with a Reagan increase of 28.4% in Federal revenues, and a Clinton increase of 36%.
Ah, and since 2000, revenues have increased to $1,236,259,371 in the 2006 tax year, an increase of 9% in current dollars, and in constant dollars, an increase of practically nothing.
So, please explain, if we are on the right side of the Laffer Curve, how tax revenues increased after the 1993 tax increases, and why tax revenue increases have been so anemic since 2000.
Hint: tax rates had very little to do with it...but that's another post. In any event, what the Laffer tells is is that major tax policy changes can have quite an impact. Fudging around a few percent at the top rates, when that rate is already historically low, simply doesn't have an outsized effect.
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