Tuesday, October 09, 2007

Obligatory Debunking of Supply Side Economics by Liberal Blogger

Jacob mentioned something last week that I had never heard of before: the Laffer Curve. Alas, if only I had been taught economics by Ben Stein, like Ferris Bueller was. The Laffer Curve theorizes that at some rate of taxation, the revenue from taxation will reach a maximum. It is derived from this information:

1. Going up from a tax rate of 0%, the revenue from taxation will increase.
2. Going down from a tax rate of 100%, the revenue from taxation will increase (people will actually have a reason to work and invest).
3. The rest of the function is a continuous, second order equation with one and only one maximum (this is probably not true).

Those emphasizing supply-side trickle-down economics always assume that our nation operates on the high side of the curve. This was the rationale for the series of tax cuts that Ronald Reagan proposed in the early '80's, and you can still hear echos of this sort of thinking from conservative presidential candidates like John McCain and Rudy Giuliani.

Unfortunately, they say it is impossible in real life to empirically determine this magic tax rate, if it even exists (many think it does not). The position of the maximum revenue will be at a different rate depending on the state of the economy and government involved. But assuming the Laffer Curve is an appropriate model, we can see where on the Laffer curve we are by tracking the years where income taxes are cut and seeing if income tax revenue goes up or down as a function of gross domestic product (in order to normalize the data for good and bad economic periods). Or at least, that's what I'm going to try to do right now, with data from my favorite source as of recent, the Congressional Budget Office, and the Tax Foundation.

Methodology: I identified 8 times since 1962 where the tax policy changed from one year to the next. I tried to look at all statuses and all incomes to determine if the intent of the policy was to generally raise taxes or generally lower taxes. I then compared the income tax slash or hike with the change in income tax revenue from the effective policy year to the next.

  • Bush had two tax cut bills, in '01 and '03, effective in '02 and '04. In both '02 and '04, income tax revenue went down, by 1.6% and 0.3% of the GDP, respectively.
  • In '90 and '93, Elder-Bush and Clinton raised taxes. Income tax revenue went up in '94 0.1% of GDP, but went down in '91 by 0.2%.
  • Reagan slashed taxes seemingly every year from '81 to '84, which resulted in a 1.5% decrease in GDP-normalized revenue from '82 to '84.
  • In '78, taxes were raised, and the revenue increased 0.5% the following year.
  • In '69, taxes were lowered, and the revenue decreased 0.3% the following year.
  • In '64, taxes were lowered quite a bit, and revenue decreased 0.5%.
Thus, in every event (except for Elder-Bush's tax hike on the rich in 1990), economic data showed that we were in fact operating on the low side of the Laffer Curve, since tax rate increases always yielded more revenue, and tax rate decreases always yielded less revenue. This even occurred in '64, when those in the top tax bracket were taxed at an astounding 91%. Why is this important? If any presidential candidate tries to insist that they can pay for their tax cuts by the economic gains created for businesses, we should all know now that this is hog-wallop.

- QP

1 comment:

Jacob said...

Do not try to bend point T on the Laffer Curve. That is impossible. Only try to realize the truth- there is no point T.

Actually, the comical Laffer Curve later in the Wikipedia article seems pretty accurate to me. Too many variables to isolate for any real-life use of the Curve to be practical.