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.