The Laffer curve makes a simple point about tax rates, tax revenues, and economic behavior:
A tax rate of zero will earn no revenue. But a marginal rate of 100 percent will earn, if not quite zero, close enough to make any such revenue negligible. If every additional dollar is completely confiscated, people will flee into alternatives: stop working, shelter their income, engage in fraud, revert to barter - anything but work to pay the 100 percent rate.
Somewhere between these extremes, therefore, must be a point at which further rate increases paradoxically begin to yield lower government revenue. Laffer referred to this as the "Prohibitive Range." Since the curve contains no other numbers apart from zero and 100, the determination of where this range lay was a matter of educated speculation.
A sound theory. No one has ever suggested - to my knowledge - that the behavioral changes the lower rates would encourage would in every case completely offset the revenue losses that static analysis attributes to a reduction in tax rates. What Laffer economists do claim is that just as high marginal rates affect behavior, so too do low marginal tax rates. As a result, the increased economic output that would result from rate cuts would offset some of the revenue loss associated with the lower rates.
Sounds good, but the analysis contains an implicit assumption which is problematic - at least if it is used in the political realm to justify lower (or higher) marginal tax rates. The curve seems to implicitly assume that revenue maximization is a desirable outcome and that tax rates ought to be set with this goal in mind. For my part, I wonder whether increasing the power and, hence, control of the managerial state through revenue maximization is really a triumph for a free citizenry. See the article here, by David Henderson.
A tax rate of zero will earn no revenue. But a marginal rate of 100 percent will earn, if not quite zero, close enough to make any such revenue negligible. If every additional dollar is completely confiscated, people will flee into alternatives: stop working, shelter their income, engage in fraud, revert to barter - anything but work to pay the 100 percent rate.Somewhere between these extremes, therefore, must be a point at which further rate increases paradoxically begin to yield lower government revenue. Laffer referred to this as the "Prohibitive Range." Since the curve contains no other numbers apart from zero and 100, the determination of where this range lay was a matter of educated speculation.
A sound theory. No one has ever suggested - to my knowledge - that the behavioral changes the lower rates would encourage would in every case completely offset the revenue losses that static analysis attributes to a reduction in tax rates. What Laffer economists do claim is that just as high marginal rates affect behavior, so too do low marginal tax rates. As a result, the increased economic output that would result from rate cuts would offset some of the revenue loss associated with the lower rates.
Sounds good, but the analysis contains an implicit assumption which is problematic - at least if it is used in the political realm to justify lower (or higher) marginal tax rates. The curve seems to implicitly assume that revenue maximization is a desirable outcome and that tax rates ought to be set with this goal in mind. For my part, I wonder whether increasing the power and, hence, control of the managerial state through revenue maximization is really a triumph for a free citizenry. See the article here, by David Henderson.
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The curve seems to implicitly assume that revenue maximization is a desirable outcome and that tax rates ought to be set with this goal in mind.
Well, no, actually, it does not assume any such thing. Perhaps your graph reading skills are rusty?
The graph simply describes a relationship between two quantitatively-expressed concepts.
Now, if a line representing some sort of existing state of revenues were added, and another suggesting a higher, preferred one, that might be interpreted as normative.
But, as Laffer's diagram stands, I don't think it is.
-CN
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