Tuesday, October 27, 2015

Lower Taxes = Higher Revenue (No, really!): The Laffer Curve

Fact: People change their behavior based on actions.
So, what really happens when taxes are lowered? Based on the propaganda from the "Left" and "Progressives", you would think that raising taxes significantly would generate more revenue and that would be the logical step in a stagnant economy and a large deficit.  In fact, the exact opposite is true.  The Laffer Curve is a simple economic model with proven positive historical economic results. 

1) The basic premise is: Less (Average) Taxes = More Output  > More Output = More Revenue
According to the Laffer Curve, there is a "sweet spot" to maximize revenue (see graph).  Raising taxes too much penalizes participation in taxed activities (working, starting a business, investing, spending, etc.) and increases the need for expenditures (unemployment, medicare, social services, etc.)
2) A high tax rate on a small tax base, the top 10% percentile, (and what progressive democratic "socialists" label the evil 1%) generates LESS revenue.
A lower tax rate on a large tax base generates MORE revenue.

"Supply-side economics was never just about slashing tax rates. As Laffer told me in a recent interview: “We also emphasized sound money, free trade and deregulation. It was a package of reforms to clear away the obstacles to increased economic output.” [2]

Lets give a few examples.
A) The Harding-Coolidge tax cuts in 1920. This cut the tax rate on the highest-income bracket through to the lowest-income bracket. This increased the GDP, unemployment decreased thus putting more workers in the tax-base, and improved everyone's general quality of life significantly.

B) Kennedy tax cuts in 1964. In the 4 years following JFK's tax cuts, the top tax bracket went from 94% > 70%, as well as lowering taxes for all other brackets as well.  The government revenue increased 9% annually and at a faster rate. 


C) Regan tax cuts.  During the 1980's the country was suffering from Stagflation, which is high inflation, high interest rates, and high unemployment.  Reducing income taxes and capital gains taxes in 1981 helped launch what we now appreciate as one of the greatest and longest periods of wealth creation in world history.

"Prior to the tax cut, the economy was choking on high inflation, high Interest rates, and high unemployment. All three of these economic bellwethers dropped sharply after the tax cuts. The unemployment rate, which peaked at 9.7 percent in 1982, began a steady decline, reaching 7.0 percent by 1986 and 5.3 percent when Reagan left office in January 1989.

Inflation-adjusted revenue growth dramatically improved. Over the four years prior to 1983, federal income tax revenue declined at an average rate of 2.8 percent per year, and total government income tax revenue declined at an annual rate of 2.6 percent. Between 1983 and 1986, federal income tax revenue increased by 2.7 percent annually, and total government income tax revenue increased by 3.5 percent annually.
The most controversial portion of Reagan's tax revolution was reducing the highest marginal income tax rate from 70 percent (when he took office in 1981) to 28 percent in 1988. However, Internal Revenue Service data reveal that tax collections from the wealthy, as measured by personal income taxes paid by top percentile earners, increased between 1980 and 1988--despite significantly lower tax rates."

Reducing capital gains taxes in 1997 further increased asset values, productivity, and private sector capital investments than in the previous decade starting in 1987.
During periods of tax increases, budget offices consistently over-estimate revenues because they fail to consider economic feedback effects incorporated in the Laffer Curve. 

"Seldom in economics does real life conform so conveniently to theory as this capital gains example does to the Laffer Curve. Lower tax rates change people's economic behavior and stimulate economic growth, which can create more--not less--tax revenues."
1. http://www.heritage.org/research/reports/2004/06/the-laffer-curve-past-present-and-future
2. https://www.washingtonpost.com/opinions/the-laffer-curve-at-40-still-looks-good/2014/12/26/4cded164-853d-11e4-a702-fa31ff4ae98e_story.html
3.  Supply-Side Economics: https://en.wikipedia.org/wiki/Supply-side_economics

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