If it were not for it’s rhetorical value to befuddle the unknowing, the Laffer Curve would be little more than a laughable academic exercise. No Republican has ever structured the marginal tax rate to reflect comprehensive analysis using the curve, and the current deficit and growing debt reflect this reality. They, in fact, simply talk around the reality that they use it to validate their belief in the myth of supply side theory, also known as “trickle-down” economics, and overlook the fact that the curve’s purpose is to determine the highest tax rate to optimize revenue.
There is nothing about the Laffer Curve that is invalid, albeit one study found serious flaws in the methodology. It is, by any account, a valid measure of optimizing revenue, even among those critics of its use who are falsely ridiculed for their criticism. Any criticism that can be validly made of the curve is rooted either in the methodology of the study, or the rhetorical argument that obscures its real world application.
A favorite target of the rhetorical attacks against critics of the curve, due likely to his credibility as an authority, Paul Krugman’s position is often mischaracterized by those with no credibility, as well as those whose credibility lies in their association with such institutions as the Cato Institute, whose fellows, like Daniel J. Mitchell, first denied global warming then propounded on the business opportunity it would provide. Krugman’s real views are however not at all as depicted. He in fact acknowledges the validity of the measure, albeit he falls in with the mainstream thought that is skeptical that cuts in tax rates increase revenue, and the optimum top marginal tax rate falls in the range of 65 to 70 percent.
When not mischaracterizing its critics, proponents of lower taxes present half-truths involving microeconomic scenarios on everything from taxes on tobacco to luxury taxes on yachts in Italy, and other single purpose taxes to validate application of the curve to macroeconomic principle. What Mitchell does not reveal in each of these examples is that he is both a proponent of a flat tax, which could be subject to his line of argument, and that the complexity of applying the curve to macroeconomics wherein the tax structure is progressive invalidates his position.
Take in example one study that assumes a flat tax and finds that the revenue-maximizing tax rate is between 32.67% and 35.21%. In that the Laffer Curve presumes that revenue declines due to the contraction of economic activity if taxes are too high or too low, this figure provides an interesting insight to how investment in job creation can be foregone in lieu of capital investment to take advantage of the capital gains tax rate.
Now, imagine the effect of such a tax on persons earning a poverty level income—or even a median income of around $51,000. Then add in a 6.4 to 11.8 percent state taxes on income. Would their own argument not apply that so burdensome a tax rate would encourage emigration to states with lower taxes? Were the line of argument valid, would people earning up to a median income not leave states, like New Jersey, New York and a half dozen other states? If so, who would do the laundry, flip the burgers, wait tables, and clean the rooms at the hotels and motels?
The idea is absurd. There would of course not likely be adequate employment elsewhere. It is however not too far a stretch of the imagination that widespread civil unrest and a rise in the crime rate would seriously offset any gain, as noted in another argument (PDF) by a proponent of lower taxes.
The arguments fail to take into account factors that similarly affect the affluent. Would they move to Saudi Arabia or the United Arab Emirates, where they would pay no taxes? If so, why have they not done so already. Could it be that they would also be subject to Sharia Law, and need to hire a security force adequate to protect them that would still leave them vulnerable to a mortar attack?
Getting more realistic, the wealthy would also have to divest themselves of income earning assets in the United States to avoid taxation. The reality that they would need to divest themselves of some of their most stable, highest earning investments, and the fact that no one has even proposed a top marginal tax rate in excess of 65 to 70 percent should make the patent absurdity of arguing that tax rates should be half that level obvious.
When put to a serious test, such as an analysis by the Congressional Budget Office (CBO), no advantage was found to lowering taxes over the near or short term. In fact the study showed modest productivity “increases of 0.5 percent to 0.8 percent over the first five years on average, and from a decrease of 0.1 percent to an increase of 1.1 percent over the second five years. The budgetary impact of the economic changes was estimated to offset between 1 percent and 22 percent of the revenue loss from the tax cut over the first five years and add as much as 5 percent to that loss or offset as much as 32 percent of it over the second five years.”
While not an across-the-board tax cut, Congressional Republicans nonetheless went ahead with the Tax Increase Prevention and Reconciliation Act of 2005, which further reduced taxes for upper income earners, and increased taxes for most middle income earners. The offsets of the tax increases did however cause a $50 billion shortfall in revenue, thus adding further to the national debt.
The Republicans in fact have a long history of disregarding application of the Laffer Curve. Since their ill advised gamble on budget projections by the CBO in 2001, the premises upon which the projected budget deficit changed within four months with the 911 attack on the US, and again just over a year later when the US went to war in Iraq again. No adjustment was made thereafter to offset the cost of the war, and other legislation that increased spending. Now—despite CBO projections of nearly a trillion dollars savings by allowing the tax breaks for upper income earners to expire—congressional Republicans remain in total opposition to extending cuts to low and middle income earners in order to protect the cuts to the wealthy.
Certainly, the advocates of lower taxes must have some motive in mind other than the fiscal strength of the United States and economic prosperity that improves the lives of all Americans. The answer is the “starve the beast” strategy described by Paul Krugman:
The conservative answer, which evolved in the late 1970s, would be dubbed “starving the beast” during the Reagan years. The idea — propounded by many members of the conservative intelligentsia, from Alan Greenspan to Irving Kristol — was basically that sympathetic politicians should engage in a game of bait-and-switch. Rather than proposing unpopular spending cuts, Republicans would push through popular tax cuts, with the deliberate intention of worsening the government’s fiscal position. Spending cuts could then be sold as a necessity rather than a choice, the only way to eliminate an unsustainable budget deficit.
The austerity thus imposed on government—and by extension on the general public—reveals them to be as misinformed, if at all honest, as they are misanthropic. If the preceding does not clearly reveal that no part of their agenda is supportable through reasoned application of economic principle, just common sense should. Their total disregard for application of the very measure they purport to validate their tax cuts resulted in the largest deficit in the nation’s history. Moreover, their imposition of austerity is the entire impetus toward the “fiscal cliff” they use as a boogey man to frighten the public into embracing their agenda.
No, the Laffer Curve is not a laughing matter. It is a serious measure that should inform any who know its purpose and understand its application that the Republicans have misrepresented it to the public. Were they sincerely interested in the general economic health of the nation—and wanted to avoid the fiscal cliff—they would make every effort to raise taxes within the parameters of the curve that would end the borrow and spend pattern they have followed over the past decade.