Conservatives everywhere condemn the use of tax increases for fear of the Laffer Curve. This is the idea that if taxes are too high, people will lose the incentive to work and therefore revenue will actually decrease. It is most famous for its counter-intuitive argument that a tax cut could increase revenue. Unfortunately there is little or no evidence to support this claim. History clearly shows that cutting taxes does not increase revenue. The Laffer curve is a political idea used to justify tax cuts for the rich. It is not based on sound economics.
Most economists know the Laffer Curve isn’t true. An IGM survey of economists found that not a single one of them agreed that a tax cut will increase revenue. They all agreed that there was little or no supporting evidence. As David Autor said: “Not aware of any evidence in recent history where tax cuts actually raise revenue. Sorry, Laffer.” Or Kenneth Judd: “That did not happen in the past. No reason to think it would happen now.” It is rather politicians who use the Laffer Curve to defend polices they already had. Despite its abandonment by all main economists, it is still clung to by a small group more driven by ideology than evidence.
There is very little evidence behind this theoretical concept. It is a purely hypothetical idea without any backing evidence. Let me repeat that, there is no proof it is real. Its supporters argue that if taxes are 0% revenues will be zero (obviously enough) and if taxes are 100% then revenue will also be 0% (as no one will have an incentive to work). From this a curve resembling the one above is drawn. However there is absolutely no reason why it would be a smooth curve with the peak in the middle. Rather it could rise continuously before dropping off rapidly at the end (see below).
Or it could be a bunch of random squiggles as these “Neo-Laffer Curves” show.
Conservatives argue that if taxes are too high then people will avoid he tax or simply not work. Most advocates abandon any pretence of studying the facts. Instead they claim taxes are too high at any rate. For example Reagan cut taxes from 70% to 50% because he argued taxes were too high and we were the wrong side of the Laffer Curve. Taxes were cut from 50% to 35% for the same reason. Now some people argue that 35% is too high and if we cut some more revenue will still rise. It soon becomes clear that conservatives argue taxes are too high no matter what the tax rate is. Their solution to every problem is to cut taxes. In their world we are permanently on the wrong side of the Laffer Curve.
There are numerous flaws in the argument. For example a 100% tax rate is essentially communism. While it is a terrible economic system it is one where tax revenue is still above 0. Another example is during war-time. Taxes were crushingly high, yet people still worked as hard as ever. After the Second World War America’s highest tax rate was 91% (albeit for a tiny number of extremely wealthy people), yet America still went through a unprecendented economic boom.
Conservatives who subscribe to the Laffer Curve usually are full of praise for the rich. Yet the Laffer Curve describes entrepreneurs as quite lazy. It presumes that some will not bother earning 100 million is they can only keep 50 million of it. Why would the supposedly most imaginative, innovative, hard-working and entrepreneurial people give up so easily? It ignores other motivators such as fame, respect and the thrill of success itself. Most millionaires have more money then they could ever spend, yet they don’t retire. That’s because money for its own worth isn’t important, it is the challenge and thrill of making it that drives them. All humans have a desire for success at everything they do and this is what drives them. If you don’t believe me, note how so many millionaires end up giving away their money. Why would someone work so hard only to give their money away?
If the rich won’t work unless they are incentivised, then what hope do the poor have? If a millionaire lacks incentive, why should anyone work for minimum wage? The truth is that working is an essential part of our culture. It defines who we are. Even if we didn’t need money we would still work. Not working is as socially acceptable as not talking. People will work hard at something they enjoy regardless of the money. For example this blog requires an enormous amount of work for no pay, yet I still devote enormous amounts of my time into it, because it is something I love doing. Even if the money is terrible people will still work.
You could even argue that higher taxes mean people will work harder. For example say your bills are 100 and your income is 100. Then say taxes go up so your income is now 90. You could either cut spending (though this is unlikely as most spending is unavoidable, rent and electricity for example or you may be accustomed to a certain standard of living). So instead you work extra hours to bring your income back to 100. Even Adam Smith argued that there was a backward-bending supply curve (this means that at a certain point a person has enough money and will work less if their wage increases). In this case higher taxes would increase labour supply.
Warren Buffett denies taxes have ever stopped people from making money. “ have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off.” This is because no matter what the tax rate, people will always be richer by working more.
Attempts to measure it are difficult due to its vagueness and the multitude of taxes that affect the economy. Among economists the average laffer curve is estimated to be at 70%. This means that taxes have to be over 70% before cutting them will raise income. Seeing as no country collects 70% of its GDP in taxes, this essentially means the theory is useless. Diamond and Saez estimate you could raise income tax in America to 76% before the Laffer Curve would take effect. Even the Reagan government’s own Treasury Department denied the existence of the Laffer Curve. They estimated that only 10% of the tax cuts would be replaced by increased revenue. That was the best case scenario. The worst case was that the tax cuts would decrease long run economic growth.
The Laffer Curve is not economic theory, but rather wishful thinking on behalf of conservatives who want an excuse to cut taxes for the rich. Cutting taxes leads to less not more revenue. This piece of common sense is acknowledged by economists but still clung to by delusional politicians.