Getting High with the Laffer Curve

Two of my favorite things in life are the Laffer Curve and the Georgia Bulldogs.

So you know I’m going to approve when an economics professor from the University of Georgia writes a column about the power of the Laffer Curve.

And since I’m a libertarian and the specific issue is about curtailing the foolish Drug War, it goes without saying that this is something that belongs on this blog. Especially when we get to celebrate some evidence that statists are acknowledging that tax rates matter!

Here are some excerpts from Jeffrey Dorfman’s column at Real Clear Markets.

Now that the state will let people legally purchase marijuana for recreational use (medicinal use was already legal), the state wants to collect tax revenue from the new industry. What is fascinating about this is that many people who have probably long argued against the concept of the Laffer Curve are suddenly embracing it. …the politicians in Colorado are openly discussing the fact that if they set the tax rate too high on marijuana, people will buy it on the illegal market and avoid the taxes. If the tax rate is set too low, potential tax revenue that is to be designated for school construction would be left on the table. They are searching for just the right tax rate that will bring in the most new tax revenue. In other words, they have accepted the Laffer Curve. The exact same arguments apply to income taxes. If too high a tax rate is levied, people will search for ways around it (loopholes, less work effort, and outright tax fraud). Taxes too low will not produce sufficient tax revenue to fund government. The ideal income tax rate is in the middle somewhere.

I have to interrupt at this point. Professor Dorfman isn’t saying that the goal is to maximize revenue, but I’m worried some people may jump to the wrong conclusion.

The ideal point on the Laffer Curve is very low, sufficient to raise the modest amount of revenue needed to finance the legitimate – and very limited – functions of government.

Let’s continue with another excerpt.

There is an old saying that politics makes strange bedfellows. This is a classic such case. Now that liberals have found a business they like, businesses should be protected from excessive taxes. Suddenly people do respond to taxes by changing their behavior. Finally, we have agreement that incentives matter and taxing something means there will be less of the item that got taxed. Getting liberals to agree with these usually conservative beliefs more broadly is by no means certain. After all, liberals have long held that high cigarette and gas taxes encourage people to change their behavior, convincing people to smoke less and drive more fuel-efficient cars. Yet these same liberals have refused to believe that high income taxes encourage people to earn less (taxable) income. Conservatives, whether in favor of legalizing marijuana or not, should applaud the liberals who now agree with them that tax rates matter to businesses and people and that the Laffer Curve is a reality.

So does this mean that leftists are waking up to reality?

The answer is yes and no. There are some advocates of class warfare who want higher tax rates even if the government doesn’t collect any additional revenue. If you think I’m exaggerating and such people don’t exist, watch this video – especially beginning about the 4:30 mark.

But there are other leftists who are more reasonable, even among those working for traditionally statist international bureaucracies.

• Such as this study from the OECD acknowledging that lower tax rates can lead to more taxable income.
• Or this study by the IMF, which not only acknowledges the Laffer Curve, but even suggests that the turbo-charged version exists.
• Or this European Central Bank study showing substantial Laffer-Curve effects.
• Or the United Nations admitting that the Laffer Curve limits the feasible amount of taxes that can be imposed.

Unfortunately, the ideological left still controls the Joint Committee on Taxation, the congressional bureaucracy that refuses to acknowledge that changes in tax policy can impact economic performance.

Maybe they’ll be less dogmatic if we send them to Colorado for some “field research”?

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Discussing Europe’s Faux Austerity with John Stossel

I want a smaller burden of government spending, so you can only imagine how frustrating it is for me to observe the fight in Europe.

On one side of the debate you have pro-spenders, who call themselves “growth” advocates, but are really just Keynesians. On the other side of the debate, you have pro-taxers, who claim to favor “austerity,” but actually just want big government financed by taxes rather than borrowing.

I had a chance to condemn these statist policy prescriptions in an appearance on the John Stossel show.

Here are 10 takeaways from the discussion, along with links to further information.

1. The main point of the interview was to explain that government spending hasn’t been cut in Europe, with the United Kingdom being a poster child for bad policy (you won’t be surprised that Paul Krugman hasn’t bothered to look at the actual numbers).
2. Austerity in Europe generally is just a code word for higher taxes. Governments only restrain spending as a last resort.
3. Excessive spending is the problem, but many people mistakenly fixate on government borrowing.
4. Keynesian spending doesn’t work, regardless of when it’s been tried.
5. The Baltic nations are a rare good example of how to respond to a crisis (and another example of Krugman misreading the data), though I should have mentioned that Switzerland never got in trouble in the first place because of its admirable fiscal policy.
6. We also discussed some historical examples of good policy, such as fiscal restraint in Canada and New Zealand, as well as a shrinking burden of government spending during the Clinton years.
7. At the end of the interview segment, I say the goal should be to reduce the size of government relative to the productive sector of the economy. I wasn’t narcissistic enough to say “Mitchell’s Golden Rule” on air, but I did say that good fiscal policy occurs when government grows slower than the private sector.
8. In the Q&A section at the end, I talked about the economic impact of different forms of government spending. Politicians and other defenders of statism like to highlight capital spending, which can have positive effects, but they overlook the fact that the vast majority of government outlays are for things that hinder growth.
9. Most important, I made the key point about poor people are much better off in pro-market, small-government jurisdictions such as Singapore and Hong Kong, where at least they have opportunity, rather than France or Italy, where the best they can hope for is permanent dependency.
10. Last but not least, I express some optimism about the possibility of genuine entitlement reform, though I should have acknowledged that nothing good will happen while Obama is in office.

It’s always great to do a show with Stossel since he genuinely care about freedom and wants to explore the details. In previous appearances on his show, I’ve discussed dishonest fiscal policy in Washington, the differences between Texas and California, and the reverse Midas touch of government.

P.S. There is at least one person in Europe who understands the real problem is too much spending.

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