The Laffer Curve
The basic idea behind the relationship between tax rates and tax revenues is that changes in tax rates have two effects on revenues: the arithmetic effect and the economic effect. The arithmetic effect is simply that if tax rates are lowered, tax revenues per dollar of tax base will be lowered by the amount of the decrease in the rate. And, the reverse is true for an increase in tax rates. The economic effect, however, recognizes the positive impact that lower tax rates have on work, output, and employment and thereby the tax base by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities. The arithmetic effect always works in the opposite direction from the economic effect. Therefore, when the economic and the arithmetic effects of tax rate changes are combined, the consequences of the change in tax rates on total tax revenues are no longer quite so obvious.
The diagram at right is a graphic illustration of the concept of the Laffer Curve—not the exact levels of taxation corresponding to specific levels of revenues. At a tax rate of 0%, however, the government would collect no tax revenues, no matter how large the tax base. Likewise, at a tax rate of 100%, the government would also collect no tax revenues because no one would be willing to work for an after-tax wage of zero—there would be no tax base. Between these two extremes there are two tax rates that will collect the same amount of revenue: A high tax rate on a small tax base and a low tax rate on a large tax base.
The Laffer Curve itself doesn’t say whether a tax cut will raise or lower revenues. Revenue responses to a tax rate change will depend upon the tax system in place, the time period being considered, the ease of moving into underground activities, the level of tax rates already in place, the prevalence of legal and accounting-driven tax loopholes, and the proclivities of the productive factors. If the existing tax rate is too high—in the “prohibitive range” shown above—then a tax-rate cut would result in increased tax revenues. The economic effect of the tax cut would outweigh the arithmetic effect of the tax cut.
Moving from total tax revenues to budgets, there is one expenditure effect in addition to the two effects tax-rate changes have on revenues. Because tax cuts create an incentive to increase output, employment and production, tax cuts also help balance the budget by reducing means-tested government expenditures. A faster growing economy means lower unemployment and higher incomes, resulting in reduced unemployment benefits and other social welfare programs.
Over the past 100 years, in the U.S. there have been three major periods of tax-rate cuts: the Harding/Coolidge cuts of the mid-1920s, the Kennedy cuts of the mid-1960s, and the Reagan cuts of the early 1980s. Each of these periods of tax cuts was remarkably successful in terms of virtually any public policy metric.
The Supply-Side Canon
An American Renaissance, by Jack Kemp Democracy Denied, by Phil Kerpen Econoclasts, by Brian Domitrovic
Fueling Freedom: Exposing the Mad War on Energy, by Stephen Moore and Kathleen Hartnett White
How Capitalism Will Save Us, by Steve Forbes and Elizabeth Ames
JFK and the Reagan Revolution, by Lawrence Kudlow and Brian Domitrovic
Knowledge and Power, by George Gilder
Money, by Steve Forbes and Elizabeth Ames
Money, Gold and History, by Lewis E. Lehrman
Nobel Prize Acceptance Speech by Robert Mundell
Popular Economics: What the Rolling Stones, Downton Abbey, and LeBron James Can Teach You about Economics, by John Tamny
Populism and Elitism, by Jeffrey Bell
Prosperity Through Competition, by Ludwig Erhard
Reaganomics: Supply-Side economics in action, by Bruce R. Bartlett
Remarks by President Trump, Presenting the Medal of Freedom to Dr. Arthur B. Laffer
Return to Prosperity, by Stephen Moore
Reviving America, by Steve Forbes and Elizabeth Ames
Seven Fat Years, by Robert Bartley
The Capitalist Manifesto, by Ralph Benko and William Collier, Jr.
The Case for Gold, by Ron Paul and Lewis E. Lehrman
The Economy in Mind, by Warren Brookes
The End of Prosperity, by Arthur B. Laffer, Ph.D, Stephen Moore and Peter Tanous
The End of Work: Why Your Passion Can Become Your Job, by John Tamny
The Freedom Manifesto, by Steve Forbes and Elizabeth Ames
The Mundell-Laffer Hypothesis, by Jude Wanniski
The Reagan Revolution, by Roland Evans and Robert Novak
The Road to Serfdom, by Frederick Hayek The Scandal of Money, by George Gilder The Spirit of Enterprise, by George Gilder
The Supply-Side Solution, by Bruce Bartlett and Timothy Roth
The Ten Commandments of Capitalism, by Ralph Benko (in press)
The True Gold Standard, by Lewis E. Lehrman
The Ultimate Resource 2, by Julian Simon
The Way the World Works, by Jude Wanniski
They’re Both Wrong: A Policy Guide for America’s Frustrated Independent Thinkers, by John Tamny
Trumponomics: Inside the America First Plan to Revive Our Economy, by Arthur B. Laffer and Stephen Moore
Wealth and Poverty, by George Gilder
Wealth of Nations, by Adam Smith
Who Needs the Fed?: What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America’s Central Bank, by John Tamny
Who’s the Fairest of Them All, by Stephen Moore
You’ve Got to Admit It’s Getting Better, by Julian Simon and Stephen Moore
How Money Walks
For many years now the IRS has been tracking the migration of Americans and their income across state and county lines. Every year they produce a detailed report on the tax migration of Americans, showing the amount of people and income that moved.
How Money Walks maps this great migration of American income and raises important questions about American tax policy and how it profoundly affects growth and development in our country:
Why did so much wealth walk? Did people vote with their feet?
Did money walk because the opportunity to keep more personal income talked?
How does taxing personal income affect economic growth?
Which states “won” which states “lost” and why?
These questions are explored in How Money Walks through unimpeachable IRS data mapped by state and metropolitan area. And the answers suggest a simple correlation: the key to accumulating working wealth for any state is a pro-growth tax policy, and that means not taxing personal income.
An Inquiry into the Nature and Causes of the Wealth of States
An Inquiry into the Nature and Causes of the Wealth of States explains why eliminating or lowering tax burdens at the state level leads to economic growth and wealth creation. A passionate argument for tax reform, the book shows that even states with small populations can benefit enormously with the right policies. The authors’ detailed exposition evaluates the impact state and local government policies have on a state’s relative performance and economic growth overall, backed up with economic data and analysis.
Facts don’t lie. But they do point clearly to the failure of so-called progressive tax schemes designed more to curry favor with selected constituencies than to create an economic system that leads to individual wealth as the reward for hard work and entrepreneurial risk taking. An Inquiry into the Nature and Causes of the Wealth of States is a detailed and critical look at income taxation across the nation, and drills down into an analysis of the economic growth or malaise that results from tax policy. Arguing eloquently that a state cannot tax itself into prosperity, just as the impoverished cannot spend themselves into wealth, the authors point out what many inherently know but often fear to say out loud. The book provides detailed quantitative analysis, and discusses the policy variables that can have enormous effects on the financial well-being of states and individual residents, such as:
- Personal and corporate income tax rates
- Total tax burden as a percentage of personal income
- Estate and inheritance taxes
- Right-to-work laws
An Inquiry into the Nature and Causes of the Wealth of States shows everyone how to evaluate state-level fiscal and economic policies to become more competitive.