I’ve written dozens of columns about the Laffer Curve and its implications.
My favorite may be the one that pointed out why it generally is misguided to raise tax rates even if the government would collect more revenue (i.e., don’t give politicians $1 if it means reducing the private economy by $5).
And I’m always reminding people that the goal is to maximize growth rather than revenue.
I’ve even written about how the Laffer Curve relates to issues as diverse as sex and ISIS.
But I haven’t paid much attention to the history of the issue. Now, thanks to some great research from Nima Sanandaji, we can investigate that topic.
…the Laffer Curve has been used by supporters of low taxes around the world to reinforce their ideas. …it has helped
to inspire a downward shift in taxation. Ronald Reagan’s administration introduced massive changes, which dropped the marginal tax rate to 28 percent. …even the proponents of high tax policy are aware of Laffer’s warnings: there is a limit to how high taxes can be raised.
All that’s true.
Reagan’s lower tax rates did produce a windfall of tax revenue from the rich.
And even folks on the left admit that the revenue-maximizing tax rate is below 100 percent, so they acknowledge the Laffer Curve is real.
But what many people don’t know is that the concept of the Laffer Curve existed long before Art drew his famous curve on a napkin.
Nima points to the example of Ibn Khaldun.
…Laffer’s theory was far from new. …Laffer has himself explained that he didn’t invent the curve, but took it from Ibn Khaldun, a 14th-century Muslim, North African philosopher. …Born in 14th-century Tunisia, Khaldun was a prominent scholar and one of the founders of economics and social sciences. Khaldun believed that a just government should only, in accordance with Islamic law, impose low taxes. …However, rulers tend to increase the tax to benefit themselves. High taxes hurt commerce and trade. When tax rates are raised to pay for a bloated government, it will finally cause the tax base to shrink so much that the government cannot meet its obligations. …at this point the state would often implode under its own weight, leading to a period of chaos and the rise of a new state.
Here’s Khaldun’s most famous statement on tax rates and tax revenue.
By the way, there were plenty of people between Khaldun and Laffer who understood why punitive tax rates are foolish, including Alexander Hamilton and John Maynard Keynes(!).
P.S. Perhaps because they’re exposed to the real-world impact, America’s CPAs also understand the Laffer Curve is very real.
P.P.S. Nima has just written a fascinating new book, The Birthplace of Capitalism – The Middle East, which can be ordered here.
It would be interesting to growth and revenue for each governmental entity in light of different tax authorities taxing at different rates. For example, if the Federal government taxes at 30%, the State government at 10% and the local government at 15%, what is the effect when each entity raises or lowers its tax rate(s)? Most local governments get most of their revenue from property taxes, state governments from a mix, and the Feds from personal income, business income and tariffs.
Third paragraph.. Do you really mean that the goal is to maximize growth rather than revenues?? With growth revenues will always rise..
On Sat, Jun 2, 2018 at 11:01 AM, International Liberty wrote:
> Dan Mitchell posted: “I’ve written dozens of columns about the Laffer > Curve and its implications. My favorite may be the one that pointed out why > it generally is misguided to raise tax rates even if the government would > collect more revenue (i.e., don’t give politicians $1 ” >
Jeff:
The Laffer curve says nothing about time, but most of the adjustments to the tax base occur over time. For example, the tax rate could be raised to 100% in t2, and because they couldn’t close fast enough you might have more revenue than t1, but by t4 you would have no revenue, since all would have closed. The base would have evaporated.
Leftists need to move the peak of their Laffer curve more to the… …left…of the diagram.
More importantly they need to understand that long term prosperity depends on the peak of the Rahn Curve not the Laffer Curve, and that the peak of the former comes much earlier than the peak of the latter. This is because exponentially compounding growth dwarfs all other components of prosperity in the mid to long term.
PS. I hope the spirit of Khaldun is still around and that he can see Singapore and France.
Jeff, nedlandp,
The Laffer Curve contains no time element. In fact, there are different Laffer curves for different time horizons. The Laffer Curve for tomorrow is pretty much like the left dreams: Almost a straight line. If the government raises taxes to one hundred percent over the weekend, very few people will resign on Monday. However, by the end of the year many will have resigned. By the end of a generation most people will not even bother going to school.
In the end, at the longest time horizons the Laffer Curve converges to the Rahn Curve (you can call this Zorba’s theorem). This is because in the long term growth becomes the main determinant of prosperity (and thus tax revenue) which dwarfs all other revenue factors. Fast growing low tax Singapore is close to collecting more tax revenue per capita than slow growth high tax France. And the difference will keep growing — exponentially.
Ibn Khaldun’s family lived in Seville (Spain) until year 1248 when they emigrated to Tunisia
Zorba,
You didn’t ask me, but I agree with you in principle that the Laffer and Rahn curves converge because in the long run growth drives all. But it’s more of a philosophical point. There are so many moving parts in the real-world economy that it’s hard to isolate the impact of just the tax rate. But the image of the curves does a nice job of communicating the two concepts.