Tax cuts good for the economy? Don’t make me Laffer!

This post is going to be slightly technical, but if you possibly can, please plough through to the end. If you’re reading this blog because you want to know the truth about what the Coalition government and its supporters say about the economy, I think you’ll find it worthwhile. Honest!

If you pay attention to the economic debates and reports that feature fairly frequently in the media, you’ve probably heard of a concept called ‘The Laffer Curve‘ – and if you haven’t yet, you soon will. For supporters of tax-cuts for the wealthy, the Laffer Curve is very useful – their ‘go-to’ argument as a support for the idea that cutting taxes for the rich is actually good for all of us.

The Laffer Curve is a term coined to express an idea by the right-wing US economist Arthur Laffer, who was a member of Ronald Reagan’s ‘Economic Policy Advisory Board’ in the 1980s – and a colleague of the odious Milton Friedman, whose ideas are the foundation of neoliberalism, at the University of Chicago. Its basic assumption is that government will raise zero tax revenue if the tax rate is zero (obviously) and – crucially – that the government will also raise zero revenue if the tax rate it 100%. It goes on to make the leap that these two zero points must mean that tax revenue vs the tax rate must be a curve. That is, that as the tax rate rises, revenue will rise – but that suddenly a tipping point will be reached where increasing the tax rate will reduce tax revenue, as high earners either decide not to work any more, or else find ways to avoid paying tax. In other words, that somewhere in the range of possible tax rates between 0% and 100%, there is a magical, optimum rate that will bring in the maximum amount of tax revenue – tax less than this and revenue will fall, and tax more than this, and revenue will also fall.

If, like me, you don’t believe that the rich need to be coddled with low tax rates, the problem posed by the LC concept is that right-wingers will use it to blind you with pseudo-science. Graphs and formulae can be trotted out that no one but a mathematician or trained economist has a hope of following, and you can be written off as a poor unfortunate who’s too dim to be able to grasp the complex truths bandied about by your ‘betters’.

So, since good information is always the best antidote to bad information, I’m going to try to give you a user-friendly overview of the concept – and the reasons why it’s simply so much fog: aimed to obscure the truth and not to illuminate it.

The graph below shows a hypothetical Laffer Curve:


If this graph represents reality, then what you can see is tax revenues rising as the tax rate rises – until suddenly, the crucial point is reached and increasing tax rates reduces the tax-take. So much for the concept. Proponents use it to support arguments for lower personal and corporate taxes, often going so far as to treat it as fact instead of hypothesis (it doesn’t merit the scientific definition of a theory).

The only small problem with this concept is that it’s a load of dogmatic rubbish. Here’s why:

1.  It has no basis in fact

The Laffer Curve is not based on experience or experiment. There’s no realistic way to test whether the idea works in practice (which is why it’s a hypothesis and not a theory). Proponents of the idea will therefore look at the tax and revenue situations of various countries and try to fit the data into the graph.

On 13/7/2007, the Wall Street Journal published a claim that Kevin Hasset had discovered the Laffer Curve in the data drawn from a range of developed economies. Here’s the graph they published:


As you can see, the revenue curve drops away dramatically at a tax rate of about 27%. The graph used to support an article making the usual plea for more tax cuts. However, in their over-greediness, they shot themselves in the foot rather laughably – or should that be Laffably? – in a couple of very clear ways.

First, they drew the falling-off of tax revenues in such a way that zero tax-revenue would be reached at a tax-rate of about 33%, Since many countries – including several on the graph! – have rates higher than 33% and don’t have zero tax-revenue, the very graph supposed to support the article actually proves it to be merely so much hogwash.

Secondly, they drew the curve to pass through the most ‘outlying’ country – Norway – completely ignoring the main mass of countries on the graph. Very bad statistical practice, and demonstrating nothing other than their eagerness to fit the data to their hypothesis, rather than the other way round. If the same graph was supposed to represent how Norway prospered and abounded in enterprise in spite of high tax rates, the same people would tell you that you have to ignore Norway because it’s too far outside the main data.

The points on the graph that represent each country’s tax rates and revenue simply don’t fit the curve they wanted to draw – so they drew it anyway. If you were going to plot a line to accurately represent the data, it would look rather different – something like this:


The very data the WSJ claimed to support the Laffer Curve concept actually demonstrates – at least as far as the extent of the tax rates shown on the graph – that tax revenues increase linearly as tax rates increase. The very opposite of what the tax-cutters would have us believe.

Let’s look at some UK-specific data that demonstrates the same in another way. First, here’s a graph I first used in my article “THE LIE OF ‘UNAFFORDABILITY’: THE FOUNDATIONS OF THE WELFARE STATE AND THE REAL ‘STRUCTURAL’ PROBLEMS“:


This graph shows how the effective tax rate (as declared by companies, so these figures are likely to be significantly higher than what they really paid, but we’ll go with them for now) paid by FTSE companies went down over the period 2000-2008. Now, if the Laffer-Curve apologists are correct, this lowering of taxes should be reflected in an increase in tax revenues.

Well, very fortunately, I was able to find the following graph, which covers exactly the same period:


This graph shows the breakdown of the UK’s GDP during the period when the corporation tax rates were falling as demonstrated in the graph before it. The key lines to pay attention to are the red line, which represents the percentage of GDP made up of corporate profits, and the darkest blue line, which represents the state’s tax revenues, also as a percentage of GDP. Very clearly, during this 9-year period, corporate profits went up but tax revenues went down.

So, we have two graphs showing the same thing in different ways. As tax rates go up, tax revenues also rise – and if tax rates are lowered, tax revenues fall. Very logical, very simple, very intuitive – and completely borne out by real data. No complex theories to make black appear white, up appear down and right appear wrong.

So the right-wing threat, that raising tax-rates will stifle enterprise, drive away businesses and result in lower tax-takes for the government, is shown to be, well, not to put too fine a point on it: a steaming pile of manure.

2.  Even if the LC idea is correct, it doesn’t say what they claim it says

Here’s another thing you’ll never hear the tax-cut advocates tell you. Even if the Laffer idea is correct, it’s actually arguing for a tax increase.

Yes, you read that correctly. If Laffer was right, then the solution to our budget deficit is still to put taxes up. Because it’s such a vaporous idea, there’s a lot of argument among its proponents about where the tipping point would be – at what tax rate revenue would start to fall – but, according to The New Palgrave Dictionary of Economics, the consensus is around the 70% rate.

You see, LC-advocates will talk about the curve and always, always use it to argue for a cut in tax. But that’s completely dishonest. Let’s take a look again at the first graph – our idealised, hypothetical Laffer Curve:


Now, even according to Laffer supporters, the peak of the curve should be at 70%, considerably to the right of what’s shown here, where it’s at 50%, but let’s work with it for now. At any tax rate up to the 50% mark, tax revenues increase. Given that our corporate tax rate is in the mid-20s at the moment, and will be coming down in each of the next 2 tax years, the right-wing, spending-cut Laffer’s idea says: ‘PUT TAXES UP’. If Laffer is correct, corporation taxes should be at least double what they are now, and the 50% top rate of tax is about right. Given that the real peak is at 70%, then there’s plenty of room for an increase in both private and corporate taxes without any harm to the Treasury’s income. Here’s what a Laffer curve with its peak at 70% might look like:

The French President François Hollande, who swept to power on a promise to raise the top tax rate for the wealthy to a whopping 75%, appears not to have been far off!

And if – as the data indicate – Laffer is wrong, then there’s even more room, because tax revenues will increase proportionally to the tax rate. We can increase taxes and eradicate the deficit far more effectively than we can do so by cutting public spending, which only reduces demand and depresses the economy.

Of course, the people who expound Laffer and all the related tax-cutting, trickle-down ideas most definitely do not want you to do these sums or come to these conclusions. But, as so often with neoliberals, the Tory leadership, and the people we see on the media supporting their ideas and actions, are using such things not to illuminate the truth but to hide it, so they can get away with some self-enriching measure while claiming it’s all for the good of all of us. That ‘we’re all in it together’.

If you’ve made it this far, well done and thank you! Hopefully, it’s been worth your while and with this post I’ve provided you with some kind of fog-lamp to cut through to the reality behind the rhetoric and ‘theory’ – or a useful bullshit-meter that smells past the cloud of ‘perfume’ to the crap beneath. I certainly hope so.

Of course, there are all kinds of other, similar veils that our current ‘leaders’ will try to pull over the truth to obscure it, too. God willing, I’ll continue to shed a little light on those as I see or hear them. But a proper look at the Laffer-Curve idea exposes the underlying principle: these days, if a Tory’s lips are moving, he’s probably lying.

Whatever you hear them saying, don’t assume there’s any real truth in it – or if he’s including any kind of truth, it’s there purely to strengthen the deception. So spread the word, so that others do the same.

7 responses to “Tax cuts good for the economy? Don’t make me Laffer!

  1. If the premise of the curve is that there will reach a point where someone will consider the post-tax return from his/her endeavors not worth it, and will thus either seek to avoid the tax or simply not put in the endeavors, then it rather seems to me like you’re looking at the wrong tax. Those are decisions we make more often as individuals than companies make as institutions.

    I’ve never hear laffer fans talk of corporation tax being at the wrong point of the curve. It’s always about personal tax. Further, I’ve never heard those people saying the pinch point is 70%.. even Richard Murphy (not a fan) has said he thinks 50% is a reasonable estimate (and, of course, all we can do is estimate).

    So, the marginal personal tax rate in the UK for a higher rate taxpayer (not a top rate payer) is about 49% when one (as one should) takes all NIC’s into account. I think the ‘science’ of the laffer curve has limited use.. and, agree, it can be used to push the agenda of whoever is pushing. Putting it to the side, however, I can quite understand the psychological impact of someone knowing that more than half of the product of his/her earnings are taken by tax. An awful lot of people in the UK are pretty close to that position.

    • In looking at corporate tax, I was just following the lead set by the WSJ – the first multi-country graph is theirs, and is supposed to support the Laffer curve. I think the same applies to corporations and people, though – especially as the Tories like to say high corporate taxes are an ‘enemy of enterprise’ just as much as high personal taxes.

      As for personal taxation, I think the tipping point will come at a much higher rate than 50%. In the 70s, there was a top rate of – what, 95%? Didn’t stop a lot of people getting rich.

      And if it stops an individual wanting to work to get even richer, so what? One aspect of economics I’m sure we both agree with is that of supply & demand. If one person decides he’s rich enough and can’t be bothered to work more to be even richer because, say, 70% is getting taken from him, what will happen? Some other person will create a company or do the work to exploit the opportunity instead of the first guy, and we’ll have fewer super-rich people but a better spread of wealth. Good result, in my book.

  2. Thanks for the post. Most interesting.

    I must agree with your first respondent that Laffer is generally cited in reference to personal tax rather than corporation tax. Most larger companies pay what they think they can get away with – the rest is transferred to a more “tax friendly” regime like Dublin. That said, those arch Tories U2 worked out a better deal by declaring their profits in the Netherlands, but you see the point.

    Big business pays what it wants. Not fair perhaps, but fact. The world’s socialists can stop this tomorrow by storming and closing down Jersey, Monaco, the BVI, Switzerland, Lichtenstein, Caymen Islands, Belize, Bermuda….. well, you get the point.

    Speaking personally, at 40% (more with NI) I am at the very limit of what I’m prepared to pay. When many goods carry high VAT and other duties (e.g. petrol), it leaves many, including me, thinking they’re just working for the government.

    Socialists decry this attitude as being selfish, but we’re not all as dumb as they appear to think, and can see that the money is often wasted horribly and doesn’t ever get to the handicapped and those unable to help themselves. Then there is the whole agenda of state-dependency that the left wishes to impose. In the UK, we have ludicrous universal benefits which are the manifestation of this stupidity (winter fuel allowance for rich pensioners, family allowance for doctors etc.) and woe betide the politician who tries to take them away or target them on the needy.

    You’ll probably ridicule it SKW, but the Adam Smith Institute publishes the tax freedom date each year, and each year it’s moving further and further into the year. I know you’ll probably think it should be 30th December, but please accept that some of us take a different view!

    Back to the personal tax: events recently have shown that even “right on” folk like Jimmy Carr secretly resent paying half their earnings to the state, so I cannot see where the idea that 70% is the optimum level comes from. You’re citing a consensus from an economics dictionary on this as fact. Where’s the evidence? (Actually, France has kindly offered to conduct a live experiment which is awfully good of them).

    I’m not sure your regression line through some data points shed any more light than does the initial curve which is also wrong as you point out.

    The only argument with the Laffer curve is the shape. At each end, there’s zero revenue. I think a poll of the man in the street would reveal that most would consider losing half their income in direct tax (and obviously more again indirectly) to be a huge tipping point. Amongst entrepreneurs, who have a different mindset from socialists (obviously!) I suspect the tipping point comes much sooner, but this is of course just my conjecture.

    The evidence from the States was that cutting high taxes increased tax revenue. That happened, so why you suggest there’s no evidence is puzzling. It also happened that 95% tax actually managed to spawn the only vaguely right-wing pop song ever – Tax Man by the Beatles.

    One of the most obscene wastes of energy in this country is the tax avoidance industry. What could those very clever people achieve if they devoted their efforts to productive industry rather than keeping the flabby government tax departments on the run?

    • I can just about agree with your final point – but I’d say we should achieve that by making the way profits are calculated very simple, and then taxing it effectively, with no deviation allowed from a simple application of the decided percentage.

      I’ll come back on the other parts tomorrow as I’m off to bed shortly and in the middle of reading something just now. But Krugman’s article I referenced does give figures and reasons why the tax-cut->increased revenue argument is fallacious, and specifically about the Reagan era. The article he links to on the more general situation gives even more info. So it should be pretty clear why Reagan’s ‘achievement’ of bringing in more revenue by cutting taxes ain’t so.

      Sleep well and ‘see’ you tomorrow!

  3. Pingback: The curious Tory maths inability: police, NHS, economy and more | skwalker1964·

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