Incentives Matter

Courbe de Laffer

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Arthur Laffer writing a piece called Reaganomics: What We Learned in the Wall Street Journal today, plainly explains the Laffer Curve:

The key to Reaganomics was to change people’s behavior with respect to working, investing and producing.

Changing tax rates changed behavior, and changed behavior affected tax revenues. Reagan understood that lowering tax rates led to static revenue losses. But he also understood that lowering tax rates also increased taxable income, whether by increasing output or by causing less use of tax shelters and less tax cheating.

Moreover, Reagan knew from personal experience in making movies that once he was in the highest tax bracket, he’d stop making movies for the rest of the year. In other words, a lower tax rate could increase revenues. And so it was with his tax cuts. The highest 1% of income earners paid more in taxes as a share of GDP in 1988 at lower tax rates than they had in 1980 at higher tax rates.

I always appreciate humility:

To Reagan, what’s been called the “Laffer Curve” (a concept that originated centuries ago and which I had been using without the name in my classes at the University of Chicago) was pure common sense.