Monday, June 13, 2005

Laffer Proved Right Again

An op-ed in The Wall Street Journal reports on the latest findings from the Congressional Budget Office. Link. (subscription required)
Last week the Congressional Budget Office released its latest report on tax revenue collections. The numbers are an eye-popping vindication of the Laffer Curve and the Bush tax cut's real economic value. Federal tax revenues have surged in the first eight months of this fiscal year by $187 billion. This represents a 15.4% rise in federal tax receipts over 2004. Individual and corporate income tax receipts have exploded like a cap let off a geyser, up 30% in the two years since the tax cut. Once again, tax rate cuts have created a virtuous chain reaction of higher economic growth, more jobs, higher corporate profits, and finally more tax receipts.

This Laffer Curve effect has also created a revenue windfall for states and cities. As the economic expansion has plowed forward, and in some regions of the country accelerated, state tax receipts have climbed 7.5% this year already. Perhaps the most remarkable story from around the nation comes from the perpetually indebted New York City, which suddenly finds itself more than $3 billion IN SURPLUS thanks to an unexpected gush in revenues. Many of President Bush's critics foolishly predicted that states and localities would be victims of the Bush tax cut gamble.

The Laffer Curve is a simple truism. Government revenues will be zero either if the tax rate is set at zero or if it is set at 100%. Despite the strong belief to the contrary by Democrats in Congress, if the tax rate is set at 100%, people will not continue to work as much as they do now and give all of their money to the government. They will stop working and earn zero pre-tax, since they will earn zero after tax no matter what.

Starting from these two extremes, government revenues will increase both with rate increases from zero or with rate reductions from 100%. At some point, the curve will peak at a rate where government revenues will be at their maximum. Any change from there, up or down, will reduce revenues. Rational and intelligent people can disagree as to just where that peak is, but you cannot logically argue that it does not exist.

Where the peak is cannot de deduced by logic. It can only be approximated by experience. When President Reagan cut the top rate from 70% to 28%, government revenues rose rapidly. Unfortunately Congress raised spending even faster. Since the Bush tax cuts, revenues have been rising rapidly, although, again, Congress has been spending more than the additional revenues that are coming in.


  • You're joking right? Clearly at a maximum tax rate of 35% there is almost no way to draw the peak of the Laffer Curve to the left of our effective tax rate. The Laffer Curve applied 30 years ago. It is meaningless today.

    By Blogger SoWhat, at 8:55 PM  

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