Let's discuss an important concept from economics, the Laffer Curve.
This concept is named after the man who developed it, Arthur Laffer, a major American economist
who has taught at the University of Chicago, University of Southern California, and elsewhere.
The Laffer Curve illustrates the two most important things we need to know about taxes:
how much money the government can raise from taxes and at what level of taxation the government
might start getting less, not more, revenue.
The Laffer Curve is illustrated here by a two-dimensional graph. The horizontal line
is the tax rate that the government chooses, and the vertical line is the revenue that
the government receives from that tax rate.
First, because zero times any number is zero, if the tax rate is zero, the government receives
zero revenue. Accordingly, zero-zero is our first point on the curve.
Now suppose the government chooses a very small tax rate, say 1 percent. The government
will then begin to receive some revenue from citizens. This means that another point on
the curve must be something like this.
Now suppose the government charges a 2 percent tax rate, then, everyone would agree,that it will receive even more revenue
-- which means that another point on the curve must be something like this.
And if the government keeps raising the rate, then revenue will continue to go up.
at least when we're in the low-tax-rate part of the graph.
This means that if we fill in the curve, it has an upward slope -- at least when
we're in the low-tax-rate-part of the graph.
Now suppose the government charges a 100% tax rate. If this happens, then no one would work.
Why would anyone work when the government is going to take all the money that they make?
And if no one works, then the national income will be zero. This means that government revenue
will be 100% of zero, or zero. This means that another point on the curve must
be here.
Now let's complete the curve. And when we do, we see that the curve must have a hump.
That is, it could look like this, or this, or this. But it has to have a hump -- because
This is simply because the revenue line has to go up in the low tax rate part of the graph
and has to start going down to reach the point we drew at the 100 percent tax rate.
But if the curve slopes downward it implies something remarkable -- something that few
of those who push for higher and higher taxes want to admit. It means that when tax rates
are high, if you make them higher, you'll actually bring in less revenue to the government.
This has in fact occurred in practice. For instance, during the Great Depression, when
Congress passed the Hawley-Smoot tariff bill, although the bill raised taxes on imported
goods, the revenue that came from those taxes actually decreased. A more recent example
occurred in the early 1980s. After President Reagan and Congress drastically reduced the
tax rates on the rich, the tax revenue that came from the rich actually increased.
All economists -- even the most leftwing ones -- agree that the true Laffer Curve, the one
that reflects real life, has a hump, and that therefore the curve has a downward sloping
part, meaning at some point tax revenues start going down when you increase rates.
So where, then, do economists disagree? They disagree about exactly where the hump occurs.
When I took my first economics class, in 1984 at Stanford University, the textbook said
that the hump occurs somewhere around the 70% tax rate. But apparently I was taught something wrong!
New evidence from an unexpected source suggests that the hump occurs at a much lower
tax rate, something around 33 percent.
That source is a study by Christina Romer and her husband David Romer. Both are economics
professors at University of California Berkeley. Christina Romer was the chairman of President
Barack Obama's Council of Economic advisors. In other words, the study was written by one
of the most influential liberal economists in the United States. And it was published
in the American Economic Review, the most widely respected economics journal in the
world.
This study examined how national income responds to tax rates. But as far as what concerns
us here, the key point is that, if you do the math, the results imply that the hump on the Laffer Curve
occurs where the tax rate is around 33 percent -- much lower than economists previously thought.
Let's now put these findings into political terms. They suggest, that no matter what your politics,
you should not want tax rates to be above 33 percent. Obviously, conservatives and many moderates think
rates should be lower than that. But even if you are an extreme leftwinger and your only
goal is to make government as big as possible -- you should still oppose a tax rate higher than 33 percent
The reason is that, as the Romer & Romer study suggests,
when tax rates go higher than that, the government actually gets less money.
Everyone of every political persuasion should pay attention to the Romer and Romer Study and its important implications.
They suggest that if we decrease tax rates, government revenues might actually rise.
I'm Tim Groseclose, professor of political science and economics at UCLA for Prager University.