### Laughable Laffer Legacy

BACKGROUND:

Back in the 1980's, it was popular with politicians (particularly Republicans) to refer to the Laffer Curve to paint a picture that if taxes where lowered, tax revenues would go up. This curve is represented below. It graphically displays what is intuitively obvious; there is some maximum federal income (revenue) between the two boundary conditions. If the tax rate is zero, revenues are zero. If the tax rate is 100%, nobody will bother working entirely for the government, and revenues are again zero. Where that maximum falls however, is likely well beyond 50% (you can read more about this here http://en.wikipedia.org/wiki/Laffer_curve).

The problem with these discussions were there was never any data presented. People that wanted to lower taxes believed we were on the right side of the peak and argued strongly without ever presenting data. No body else cared. The reality is during WWII, when the top brackets were well over 75%, a few wealthy indivuals may have indeed been on the right side of the peak. This, however, is clearly not the case today where the top bracket is 35%, yet I still hear the Laffer curve as having some applicability to today's tax base.

THE FIGURE:

Let's look at the data. In the curve below, I have plotted the change in the per capita revenues collected from one year to the previous year vs. the change in the effective tax rate from one year to the previous year. Note, the zero-zero point is in the right-center of the figure, not at the lower left-hand side. (Click on the figure to see a larger version.)

THE TAKEAWAY:

The presence of the vast majority data in the upper right and lower left quadrants show that we are clearly on the left half of the peak in the Laffer Curve. In other words, the Laffer Curve does not apply to the modern era!

DISCUSSION:

One can clearly see that every time the effective tax rate was increased, revenues increased (upper right quadrant); just as one would expect if we were on the left half of the peak in the Laffer Curve. Half the time the effective tax rate was lowered, revenues decreased (lower left quadrant); again consistent with being on the left half of the Laffer peak. To be fair, half the time the effective tax rate was lowered, revenues increased (upper left quadrant). However, the few points in the upper left quadrant are due to a significant increase in the economy that overshadowed the loss in revenues from the lower tax rate.

One final note, the three points furthest from the origin in the lower left quadrant are in 2001, 2002, and 2003 where we gave tax breaks to the most wealthy. I discuss the argument that this loss in tax revenues is important to stimulate the economy in my entry on tax rates and revenues: http://datatovirtue.blogspot.com/2006/08/tax-rates-and-revenues.html. Even if we all agree low taxes are a good thing, then the government can't both decrease it's revenues and increase it's spending. That is not a sustainable tactic.

SO WHAT?

Don't let anyone tell you the Laffer Curve, that applied after WWII, is still a justification for lowering tax rates today (i.e., to increase tax revenues); it simply isn't true any more. Urge your representatives to establish a tax rate schedule, leave it alone, and focus on more important issues.

DATA DETAILS:

The effective tax rate was aggregated across all tax brackets. In other words, it is the total revenues collected from income tax divided by the total taxable income reported; an average tax rate across all tax payers. In simpler terms, the figure shows if the taxes collected, per person, in a given year went up or down from the previous year based on whether the effective tax rate went up or down from the previous year.

These data are from http://taxpolicycenter.org/TaxFacts/TFDB/TFTemplate.cfm?Docid=467, starting in 1979.