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So what's wrong with the Laffer Curve?

Link: RGE - Deja Vu Voodoo Economics...or Supply Side Voodoo Black Magic....

I was yesterday morning on CNBC debating Arthur Laffer on supply side economics and the Bush tax cuts. Laffer is the father of the "Laffer Curve", the idea that tax cuts will not increase the budget deficit but would rather be self-financing given the strong suplly side response of labor, savings and investment to tax cuts. George Bush father referred to Supply Side Economics as "Voodoo Economics" when he was running for the Republican Presidential nomination against Ronald Reagan in 1980. Twenty five year later, supply side tax cuts are still Vooodo Economics!

So, what's wrong with the Laffer Curve? Won't tax revenues fall to zero if tax rates were either 100% or 0%? If yes, then it must be true that tax revenues must be same for atleast two different tax rates (otherwise how do you connect the dots at the 100% and 0% rates).

Comments

Tim (Random Observations)

I agree, also: I think the basic idea behind the "Laffer Curve" is both sound and obvious. It's called "Voodoo Economics" -- as George HW Bush did so -- for political reasons, not economic ones.

James

The trouble with the Laffer curve is that it's based on the notion that the purpose of taxes is to fund the operations of the government. Opponents of the Laffer curve don't share this premise. They see taxation mostly as a tool to control the distribution of income, or for behavior management. So arguments based on the mathematical model of taxation won't be convincing because they totally miss the critics' concerns.

@mit

The Laffer curve I believe also purports that lowering the Tax rate brings the people on the fence in the net and I think will work better in economies where tax recovery is not that good

Ashish

Steve, I only said that there are atleast two tax rates (except the peak point) for which you will generate the same tax revenue. When I wrote the post I wanted to reply to those who thought Laffer Curve was wrong or is a vodoo economics.

Whether Bush's tax cut indeed increased revenue or not because of Laffer Curve effect is a separate topic of discussion.

Steve
I'm afraid that I don't see your point. Except for the maximal-income point, yes, each revenue point has two rates associated with it. It's fairly obvious that at 0% and 100%, revenue will be approximately 0. Where is the problem?

Unless there is more than one peak to the revenue curve. For example, if there are two peaks, then there could be 2 or 4 tax rates that produce the same tax revenue.

The point is that it is possible to keep your tax revenues constant (or even increase them) by lowering the tax rates as predicted by the Laffer Curve. The article that I quoted from calls this Vodoo economics.

Yes, you are correct if and only if you are to the right of the peak (i.e. if the peak is at tax rate t* and the current tax rate is at t' then there exists at tax rate t" that raises precisely the same revenue as t'). If on the other hand the current tax rate is to the left of the peak, then no, your point does not hold.

Rich

One of the misconceptions of the Laffer Curve is that there is only one tax rate that will raise a certain amount of revenue. But that's not true. As you point out there are two rates. The point is as Laffer will say, do we want to give to the Government the revenue raised at the higher rate (therefore leaving less earnings to the entrepenuer), or do we want to raise the same revenue at a lower rate, allow entrepenues keep more of their earnings and reinvest the capital back into the economy and create greater growth. It's always the latter part of the question that critics of Laffer forget to address.

Ashish Hanwadikar

The point is that it is possible to keep your tax revenues constant (or even increase them) by lowering the tax rates as predicted by the Laffer Curve. The article that I quoted from calls this Vodoo economics.

fred efstone

I'm afraid that I don't see your point. Except for the maximal-income point, yes, each revenue point has two rates associated with it. It's fairly obvious that at 0% and 100%, revenue will be approximately 0. Where is the problem?

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