04 April 2012

GreyMail: The Laffer Curve

This is what annoys me about the Laffer curve: it's perfectly mathematically and logically sound, but once that's granted, everyone assumes the precise optimum is wherever agrees with their ideology. The extreme value theorem says nothing about WHERE the extreme value occurs. Republicans seem to assume it must occur somewhere around 0.0000001% tax rate (I exaggerate, but only a little). It's just as reasonable (read: not reasonable at all) to conclude, from the fundamental Laffer assumptions, that the nominal rate should be INCREASED, rather than decreased. And I'm pretty sure you know this, so I'm not sure why you wrote what you wrote.

There are probably a few things I should clarify regarding my beliefs in the Laffer curve.  In the first place, it seems obvious that no government will collect any taxes if the rate is 0% or 100%.  The reasons why are obvious, so I won’t elaborate further.

In the second place, the revenue-optimal tax rate (i.e. the tax rate that generates the most money for the government) will be between 0% and 100%.  I don’t think we can ever know what precise rate will generate the absolute largest amount of revenue, but we can be generally sure.

In the third place, I believe that a revenue-optimal tax plan will be simple and feature relatively low rates.  Note that I’m focusing on net revenue (i.e. revenue minus collection costs).  The most efficient tax system will impose minimal costs, and is likely to be either a flat tax or a single-stage consumption tax, with minimal or zero loopholes.  The more complex a tax system, the easier avoidance becomes, and the more costly collection becomes.

As a side note, I would like to point out that there has only ever been one year in which the federal government managed to collect more than 20% of GDP in taxes.  There has never been a single year in which the federal government collected more than 25% of GDP in taxes.  Keep in mind that this 20% wall has existed across extremely high and relatively low tax rates, and across relatively simple and complex tax systems.  For whatever reason, the government is pretty much unable to claim more than 20% of GDP in taxes, which is why I believe that a relatively low tax rate will be the most revenue-optimal.

Finally, note that my optimal tax system would be either a consumption tax set at 20% with no loopholes or a flat tax of 25%.  I would also accept either a slightly progressive income tax (three brackets, 15%, 20%, and 25% tax rates) or a flat income tax of 35% with a few deductions (mostly for oneself, one’s spouse, and one’s children).  I do not think that a revenue-optimal tax rate will be lower than 20%, nor do I think that multiple taxes are revenue-optimal.

In regards to the current system, I do actually agree that taxes should be raised, but only in one particular manner:  I believe that the lower income tax brackets should have their loopholes closed and their effective rates set to at least 15%. This should effectively increase revenue.

I do not see much point in raising income taxes on the wealthy, since they will either leave or find a way to shelter their income.  I don’t see any point in raising corporate taxes, since they are already high, and will carry the risk of offshoring companies and their correlating capital.  In fact, I don’t really see much point in raising any of the taxes that are currently popular with the increase-taxes crowd (taxes on the wealthy, on corporations, on capital gains, etc.) because I don’t think they will increase tax revenue or improve the US’s future economic prospects.  Essentially, raising taxes would be a lose-lose scenario.

In sum, most of the current tax rates would have to be lowered for revenue optimality, and the one tax raise that would increase revenues is sure to be politically unpopular.  The better solution, at this point, is to cut spending by at least 50%, and to reduce tax rates as much as possible without eliminating revenue.


  1. Is there a name for the principle that the probability of a policy ever being implemented is equal to 1 minus the square of its sensibility? That principle applies here.

  2. @Steve N- I call it the Dave Barry Theorem (taken from this article; "The public response has been very positive but the bill has two strikes
    against it: #1 It makes sense. #2 People want it.")