Thursday, September 15, 2011

Abusing the Laffer Curve

If you can get a lot of people to repeat the same specious claim often enough, it effectively becomes “true.” Here’s an example. The Right can’t admit that their tax cuts will bust the budget and still claim to be good fiscal stewards. So, instead, they try to dazzle us with magical thinking: cutting taxes, they say, actually brings more money into the government’s coffers! See, they don’t want to slash and burn popular government programs—their tax cuts will raise more cash to fund ’em!

In 2007, Time magazine’s Justin Fox sampled some Republican opinions on this interesting dynamic and concluded, “If there’s one thing that Republican politicians agree on, it’s that slashing taxes brings the government more money.”

“You cut taxes, and the tax revenues increase,” President Bush said in a speech last year. Keeping taxes low, Vice President Dick Cheney explained in a recent interview, “does produce more revenue for the Federal Government.” Presidential candidate John McCain declared in March that “tax cuts . . . as we all know, increase revenues.” His rival Rudy Giuliani couldn’t agree more. “I know that reducing taxes produces more revenues,” he intones in a new TV ad.

The spin is premised on an egregious distortion of “Laffer’s curve,” the conservative media’s favorite economic theorem. The idea, first scribbled on a cocktail napkin by economist George Laffer (at least, according to lore), is pretty simple. It holds that you can raise income taxes to a degree, but when the top tax rate exceeds a certain point, people will go to such extraordinary lengths to avoid paying the piper that the government will actually end up collecting less revenue.

The thing about Laffer’s curve is that it makes perfect sense in theory, but it completely defies reason in practice, at least in the context of modern America. Most economists agree with Laffer’s argument that there is a point of revenue “maximization,” after which hiking rates will lead to fewer tax dollars coming in. If you were to tax income at a rate of 100 percent, it wouldn’t make much sense for anyone to go to work—at least not on the books.

The hot air hisses out of the balloon when politicians and pundits use the theory to advocate tax cuts in the United States, which is among the more lightly taxed countries in the developed world. The fallacy is simple: top personal and business tax rates have decreased for years, and there’s no evidence whatsoever to suggest that we’re anywhere close to being above Laffer’s curve today. And if you’re below the curve when you cut taxes, you’re not going to generate that surge of new income.

For his Time article, Justin Fox followed up with a survey of what people who understand basic math were saying about this bit of conservative spin:
If there’s one thing that economists agree on, it’s that these claims are false. We’re not talking just ivory-tower lefties. Virtually every economics Ph.D. who has worked in a prominent role in the Bush Administration acknowledges that the tax cuts enacted during the past six years have not paid for themselves—and were never intended to. Harvard professor Greg Mankiw, chairman of Bush’s Council of Economic Advisers from 2003 to 2005, even devotes a section of his best-selling economics textbook to debunking the claim that tax cuts increase revenues.
Andrew Samwick, now at Dartmouth, was the chief economist on Bush’s Council of Economic Advisers during that period. But in 2007, after Bush had claimed yet again that it’s “a fact that our tax cuts have fueled robust economic growth and record revenues,” Samwick responded with a plea to the Bush administration to stop making that claim. In an opinion column in the Wall Street Journal, he wrote, “You are smart people. . . . You know that the tax cuts have not fueled record revenues. You know what it takes to establish causality. You know that the first order effect of cutting taxes is to lower tax revenues."

Yet pointing out that simple truth is anathema in conservative circles. In 2007, Megan McCardle, then an up-and-coming libertarian writer with the Atlantic Monthly, wrote about the editorial higher-ups of an unnamed “conservative publication” spiking a book review she’d written because she hadn’t toed the party line. “Even while otherwise expressing my vast displeasure with the (liberal) economic notions of the book I was reviewing,” she wrote, the editors killed the piece “because I said that the Laffer Curve didn’t apply at American levels of taxation.” She added, “This isn’t me looking for an alternative explanation for the spiking of a bad review: the literary editor accepted it, edited it, and then three hours later told me it couldn’t be published because it violated their editorial line on taxation.”

1 comment:

xanadu said...

One can almost say with any degree of truth, that if the Republicans advocated it it must have problems. Milton Freidman is their god.