The Laffer Curve No Laughing Matter

Dr. Arthur Laffer,
Dr. Arthur Laffer, Economist and professor at University of Southern California, with "Laffer Curve" on blackboard, Feb. 23, 1981. (AP Photo) GRAPHIC ILLUSTRATION by DOUG DOBEY

 

by Jack R. Jonhson

One of the fundamental economic principles of the so called Reagan revolution, and now a bedrock of ideological faith among conservative Republicans, was jotted down on the back of a cocktail napkin in 1974. As legend has it, the infamous Laffer Curve was first drawn by economist Arthur Laffer on a cocktail napkin during a small dinner meeting at a Washington Hotel attended by Dick Cheney and Donald Rumsfeld.

Although at first skeptical, Dick Cheney became intrigued when Arthur Laffer explained the gist of the curve, that increases in taxes could conceivably lead to a reduction in overall revenue. If increases in tax could reduce revenue, surely the reverse was also true. Decreasing the tax rate could conceivably increase revenue! With great excitement, the Republican establishment latched onto this idea, arguing counterintuitively that decreases in tax rates would actually increase revenue because so called “wealth producers” would be willing to create “more wealth” through job growth stimulated by tax cuts. In short order, the notorious concept of Supply Side economics was born, with Arther Laffer’s curve serving as its foundational principle.

But many economists have questioned the utility of the Laffer Curve in public discourse. According to Nobel prize laureate James Tobin, “the ‘Laffer Curve’ idea that tax cuts would actually increase revenues turned out to deserve the ridicule with which sober economists had greeted it in 1981.” It would only “increase wealth” to a very limited degree, and based on a fairly precise understanding of what level of taxation would actually deter economic growth, a fairly high rate, as it turned out.

Taken to an extreme, the concept has proven to be highly dysfunctional causing massive deficits when base rates were cut to the bone under George W. Bush’s tenure. Conventional economists acknowledge the basic notion of the Laffer curve, but argue that the peak tax rate could be as high as 65%. Well above Ronald Reagan’s and George W. Bush’s tax cuts—and well above the highest current tax rate of 39.6 % for couples making around half a million dollars a year. As a result of Laffer’s much abused idea, the US economy lost billions of dollars in taxes during the Reagan and George W. Bush era, and stand to lose billions more if Donald Trump and the Republican Congress aggressively cut taxes once again; making Arthur Laffer’s infamous curve… no laughing matter.

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