Back in 2010, I wrote a post entitled “What’s the Ideal Point on the Laffer Curve?”
Except I didn’t answer my own question. I simply pointed out that revenue maximization was not the ideal outcome.
I explained that policy makers instead should seek to maximize prosperity, and that this implied a much lower tax rate.
But what is that tax rate, several people have inquired?
The simple answer is that the tax rate should be set to finance the legitimate functions of government.
But that leads to an obvious follow-up question. What are those legitimate functions?
According to my anarcho-capitalist friends, there’s no need for any public sector. Even national defense and courts can be shifted to the private sector.
In that case, the “right” tax rate obviously is zero.
But what if you’re a squishy, middle-of-the-road moderate like me, and you’re willing to go along with the limited central government envisioned by America’s Founding Fathers?
That system operated very well for about 150 years and the federal government consumed, on average, only about 3 percent of economic output. And even if you include state and local governments, overall government spending was still less than 10 percent of GDP.
Moreover, for much of that time, America prospered with no income tax.
But this doesn’t mean there was no tax burden. There were excise taxes and import taxes, so if the horizontal axis of the Laffer Curve measured “Taxes as a Share of GDP,” then you would be above zero.
Or you could envision a world where those taxes were eliminated and replaced by a flat tax or national sales tax with a very low rate. Perhaps about 5 percent.
So I’m going to pick that number as my answer, even though I know that 5 percent is nothing more than a gut instinct.
For more information about the growth-maximizing size of government, watch this video on the Rahn Curve.
There are two key things to understand about my discussion of the Rahn Curve.
First, I assume in the video that the private sector can’t provide core public goods, so the discussion beginning about 0:33 will irk the anarcho-capitalists. I realize I’m making a blunt assumption, but I try to keep my videos from getting too long and I didn’t want to distract people by getting into issues such as whether things like national defense can be privatized.
Second, you’ll notice around 3:20 of the video that I explain why I think the academic research overstates the growth-maximizing size of government. Practically speaking, this seems irrelevant since the burden of government spending in almost all nations is well above 20 percent-25 percent of GDP.
But I hold out hope that we’ll be able to reform entitlements and take other steps to reduce the size and scope of government. And if that means total government spending drops to 20 percent-25 percent of GDP, I don’t want that to be the stopping point.
At the very least, we should shrink the size of the state back to 10 percent of economic output.
And if we ever get that low, then we can have a fun discussion with the anarcho-capitalists on what else we can privatize.
P.S. If a nation obeys Mitchell’s Golden Rule for a long enough period of time, government spending as a share of GDP asymptotically will approach zero. So perhaps there comes a time where my rule can be relaxed and replaced with something akin to the Swiss debt brake, which allows for the possibility of government growing at the same rate as GDP.
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Responding to the article, it’s always good to have a goal to shoot for, but as Saul Alinsky said in “Rules for Radicals”, “we must work with the world as it is, if we want to change it to the world we would like it to be.”
Without a total implosion of the current system (which is a reasonable possibility) cutting current support levels in any meaningful way will not be feasible. That being the case, we must start where we are and have a plan to transition to a better place over 30+ years, or the time for a generation passing. It will take that long to get back to a society based not on group dependence, but on individuals taking responsibility for themselves and their actions.
Much like the Vermonter when asked directions: “Well stranger, if you want to get there, I wouldn’t start from here.”
Jeremy:
Good point on killing 2 birds. A flat tax by itself is not politically feasible, the top 5% now make 32% of the income but pay 59% of taxes. The 95% would not allow their taxes to drop to 32%.
But how to make the flat tax progressive? A standard deduction would work, but you ruin many of the flat tax benefits. Instead, cash payment would do the trick and for those at the bottom, the cash would become a negative income. The question then becomes how much? Since a negative income tax could replace all means tested programs with their mal-incentives (see the Julia’s Mother graph) the $700M spent on that could be added to the amount saved on deductions, $1 Trillion. While you’re at it you could add another bird, 1/3 of current entitlements, while reducing entitlements by that amount.
The result could be a negative income that brings everyone up to the poverty line as part of the tax code. Julia’s mother would get only half of what she’s currently getting, but the federal government would no longer discriminate between individuals. The states should take over all welfare.
For more see: http://www.youtube.com/watch?v=ESzXZ0LUumY
Mr. Mitchell,
I just want to know, because I am curious, what is your view on the negative income tax, either the model proposed by Friedman or the slightly different formula proposed by Jeff Miron? I believe that would be run as a flat tax, but it would also incorporate a sort of welfare (basic income, more like it) and I think it would kill two birds with one stone. Not sure it could ever be as low as 5% for it to be effective, though.
Just want to know your thoughts on the subject. I haven’t seen it discussed here.
truth be told… our constitution should be the key to the amount of tax revenue the government is allowed to suck out of the economy… if we can scratch and claw our way back to true constructional governance… the laffer curve will become irrelevant to America’s future…
If we had more localism, as in more state independence and less federalism, we would have an additional method to get more empirical data on the most effective levels of taxation, legislation, government share of GDP etc. We would also get more variety and flexibility in choosing the state we would prefer to live, be free, and pursue happiness in. In this respect we are also moving in the wrong direction towards more centralization of planning and power. As it is, the difference in moving across state lines is becoming smaller and smaller, and we will start seeking alternative lands, much further away, once the unfolding US decline brings American prosperity closer to the world average. The reduction of localism and experimentation will of course hasten the overall US decline, just like the unification, harmonization and homogenization of Europe is a step in exactly the wrong direction.
Western civilization citizens are living the end of their privileged status. Oblivious, most will only realize their past good fortune only once it is lost.
Surely, s reasonable answer –that at least initially avoids the debste over the appropriate functions and limits on government — might be to say: “Whatever the individual considers to be the role of government, an estimate should be made as to what that size of government would be. Then, given the projected dollar cost of that size of government, the marginal tax rate to be chosen to generate that amount of tax revenue should be that one to the left of the apex.”
The required amount of government revenue would be forthcoming (if the shape and position of the Laffer Curve has been reasonably estimated), and it would be leaving the largest amount of earned income in the hands of private individuals consistent with that level of taxation. Both to leave as much as possible in the hands of those who have earned that income for their own personal goals, and to minimize the disincentives on work, saving, and investment for future growth in the economy.
Obviously timing is more important than cost at this moment so maybe a couple of referrals as we need this done ASAP so that there is not an order glitch or delay for the launch (meaning we will have to reformat both Kindle CS which takes time).
From: International Liberty Reply-To: International Liberty Date: Sunday, March 31, 2013 3:04 PM To: Robert Demes Subject: [New post] Question of the Week: What¹s the Right Point on the Laffer Curve?
WordPress.com Dan Mitchell posted: “Back in 2010, I wrote a post entitled “What’s the Ideal Point on the Laffer Curve?” Except I didn’t answer my own question. I simply pointed out that revenue maximization was not the ideal outcome. I explained that policy makers instead should seek “