There’s been a buzz in blogland lately about the Laffer Curve. For those of you who don’t know, the Laffer Curve is napkin sketch made by economist Arthur Laffer that illustrates that there is a diminishing return to government revenue after raising tax rates beyond a certain optimal rate. The idea being that as the government share of productivity rises beyond that level, people do less and work harder to find loopholes.
For example, if I were to choose between working an extra job at night and spending time at home, how much I take home from that extra job matters. If the government taxes my income on that extra job so that I take only 25% – 50% of what I make, I’ll be more likely to skip the extra job.
Laffer himself points out the concept was not original and has been around since at least the 14th century.
Recently, Washington Post columnist Ezra Klein asked a group of economists where the Laffer Curve bends, which sparked quite a discussion the blogosphere.
First, the discussion pleasantly surprised me. It seems like just a short while ago, the left didn’t want to admit the Laffer Curve existed. In fact, I had discussions where I was treated as a moron for believing in such nonsense. So, it was pleasantly surprising to see some on left (like Brad DeLong in Ezra Klein’s column) admit the Laffer Curve existed. I also saw evidence of this admission in Paul Krugman and in the comments of blogs such as Megan McArdle’s at The Atlantic.
Second, it struck me at how few gave the right answer: it doesn’t matter. The closest to that answer was Martin Feldstein, economist from Harvard:
“Why look for the rate that maximizes revenue? As the tax rate rises, the “deadweight loss” (real loss to the economy rises) so as the rate gets close to maximizing revenue the loss to the economy exceeds the gain in revenue.
Maximizing government revenue should not be the goal. The goal should be to minimize government spending to fund the activities that government is actually empowered to carry out and then try to raise those funds in the least harmful way possible.
This gives rise two to sticking points: 1) What is the government empowered to do? 2) What the least harmful way of raising the funds to carry out these activities? While there will be large disagreement on these two sticking points, I’d rather discuss these.
Though, baby steps. The fact that people who seemed before to brush of the reality of the Laffer Curve now accept it is a big baby step.