Friday, January 13, 2012

Why the Laffer Curve is Wrong

The Laffer Curve, supposedly invented by the conservative economist Arthur Laffer during lunch with Ronald Reagan and sketched on a napkin, is one of the key arguments used by conservatives to justify low tax rates for the rich.  The graph on which the curve appears has tax rates on the up-and-down y-axis and government revenues on the left-to-right x-axis.  The object of the exercise is to figure out what tax rate will maximize government tax revenues.

The argument is that at zero tax rate the government will collect nothing no matter how much money the taxpayers earn because the rate is zero..  At 100% tax rate the government will again collect nothing because no one will bother to work.  The government will take all their money so there is no point in working.  No one works, no one has any money, so the government revenue is again zero.

According to Laffer, somewhere in between is a tax rate that maximizes government revenue.  Among those who accept the premise, the debate is whether the rate should be low (advocated by conservatives) or high (advocated by everyone else).  Conservatives think anything above 35% will discourage capitalists from working to make more money.  Everyone else thinks the figure is around 65%

But even a moment's thought tell us that the two premises behind the Laffer Curve are both false.  First is the idea that capitalists are lazy.  According to conservatives, if a capitalist has to make three million to keep two she will be too discouraged to continue to make more money and will go fishing.  Capitalists are just too lazy to take the trouble of making money if they have to give up more than a third.   (Actually that's a hypothetical male capitalist.  Anybody knows that a woman with two million dollars will go not fishing but shopping, which is  itself a good thing for the economy.)

We can get some idea of how high the highest tax rate can go before people will give up working from the old Beatle's song, 'Taxman'.  Click on the link on the next line.
Let me tell you how it will be
There's one for you, nineteen for me
'Cause I'm the taxman, yeah, I'm the taxman

Should five per cent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah I'm the taxman

If you drive a car, I'll tax the street
If you try to sit, I'll tax your seat
If you get too cold I'll tax the heat
If you take a walk, I'll tax your feet

'Cause I'm the taxman, yeah I'm the taxman

Don't ask me what I want it for (Aahh Mr. Wilson)
If you don't want to pay some more (Aahh Mr. Heath)
'Cause I'm the taxman, yeah, I'm the taxman

Now my advice for those who die
Declare the pennies on your eyes
'Cause I'm the taxman, yeah, I'm the taxman

And you're working for no one but me

For those still wet behind the ears, Mr. Wilson and Mr. Heath were the heads of the Labour and Tory parties when the song was released on their 1966 album, 'Revolver'.  The relevance is that even though they were paying a tax rate of 95%, the Beatles continued to write, perform, and publish songs.  So far from stifling their willingness to work, they went on to write, perform, and publish, 'Rubber Soul', 'Sergeant Pepper', 'Magical Mystery Tour',  and 'the white album', some of their best music ever.    We are not talking about mere work here, but work informed by a splendid creativity.

Had they paid no taxes and earned twenty times as much as the 5% that made them absurdly rich, they might well have had too much money to bother to write, perform, and publish at all.  George Harrison would have retired to a huge estate in India with his own private ashram and harem of groupies.  John Lennon would have bought a castle in Scotland and the title that went with it and then gone on to terrorize the House of Lords.  Paul McCartney would have married for love someone who married for money and been fleeced by her attorneys.  Ringo Starr would have gotten confused about how many zeroes were involved and have bought a pub in Liverpool for 182 million quid.

Joking aside, too much money might have made them lazy and uncreative, as the children of self-made women so often are.  Being clipped of most of their money every year most likely kept  them from retiring in their twenties as they might otherwise have done.  

In fact high earners are usually hard-working unto driven and unpleasant.  High taxes will rarely keep them from working.

The unspoken assumption behind the Laffer Curve is that people work for money and only for money.  In fact only people whose jobs are boring drudgery to them work only for money.

Nuns and priests pay an almost 100% tax on what their work might otherwise produce.  They live in cloisters or rectories often in spartan conditions and work long and hard at teaching, nursing, ministry, or as missionaries because they are dedicated to their work and to the service of the Church, not for the money.  They take vows of poverty.   They worship G-d, not Mammon.

Soldiers live in barracks and in wartime in foxholes, eat in messes, are on call 24 hours a day, and perform not only hard work but often heroically struggle to the death.  There is no overtime for being under fire all night.  Selflessly risking her life gets a soldier not a fat bonus but a shiny medal to show her mom.  Soldiers serve for honor, duty, and love of country and of their comrades, not money.

Similarly, it is a rare poet who is in it for the money.  Yet most of what we treasure of our heritage from past ages is poetry.  

So the first premise of the Laffer Curve is mistaken.  Even at a 100% tax rate, dedicated people will work long and hard.  Whether the tax gatherer is the Church or the Marine Corps or the Muse, people work long and hard for no material reward.

The second premise is related.  It is that how hard and well people work in ordinary occupations like small business owners, professionals, highly skilled workers, and so on, is proportionate to the incomes they earn from their labor.

Among ordinary occupations it is everyone's experience that one works harder and longer at work one enjoys doing.  People are excellent and devoted at work they love.  And that is what the economic and tax systems are for - to get people to produce the most and best goods and services they can.  And the social system, according to Aristotle, is about enabling people to use their talents to the full.  People who enjoy their work are only secondarily motivated by money.

So the correlation between tax rate and the amount of work done, i.e. the taxable production of each person, does not correspond in any important way with the tax rate.

So the Laffer Curve, which is merely an extrapolation from its endpoints of 0% and 100%, is wrong at both of them, and wrong at every point in between.

Alexander the Great, when shown the legendary Gordian Knot which could not be untied, drew his sword and chopped it in half.  "Thus do I untie all Gordian Knots", he said.  Thus do I untie all Laffer Curves, and, like the Marine Corps, piss on their corpses.



  1. Wow, that was really great Jack! Or I think it probably is, I don't have the energy to read it.

  2. Well you should. There is some great stuff in this post - rock 'n' roll, reminiscence, reflections on economics, thoughts on politics and human nature, witty canards about people those under 50 have scarcely heard of, partisan obloquy, classical learning and quotes, Cartesian geometry, support for the troops and the clergy, logical deduction, political incorrectness, topicality. It's got everything. What's not to like?

  3. Anonymous5:26 PM

    You're a pompous blowhard. Maybe you should ask Rita when she will get bored and leave.

  4. I am sure Anonymous is just being malicious, but she may be nearer to right than she realizes.

  5. Mohammed Jihad12:57 PM

    Hi Jack!