Politics of Laffer Curve don't match economics
Allow me to bore you half to death with a few words about some fairly dry economics, but arm you with an understanding of a very important and timely issue: the relationship between taxes, jobs and government revenue. In the end, it will be worth it, I promise.
Different camps often tout either reducing taxes or stimulus spending as ways to strengthen the job market, and both ideas actually work in the short run, although both have an effect on tax revenue the government brings in to pay for roads and schools, and both affect the deficit and debt. This, of course, is where political division lies, and there are smart people on both sides making good arguments.
But some of the rhetoric falls short of reality, and that's where I'd like to shine a little light.
First, we need to understand inflation's effect on some of the numbers given. For instance, when you hear things like, "the largest tax cut in history" or "the largest tax increase in history," that may be true in terms of the number of dollars, but after adjusting for inflation it's usually just puffery. You know how your grandparents are always saying they could buy a loaf of bread for 3 cents and now it's $3? Same thing with statements like that. A dollar today certainly does not equal a dollar from 80 years ago by any measure.
Second, the effect of tax rates on things like employment and government revenue gets skewed in today's rhetoric. We hear phrases like "job killer" to describe any form of tax increase. We are told whenever you lower the tax rate, more money flows into the government because a rising tide lifts all boats. Some even call it by name: supply-side economics or more specifically, the Laffer curve.
The Laffer Curve is basically a economics supply/demand curve, with tax rate along one axis, and government revenue along the other, and it works like this: along parts of the curve, if you lower the rate, you'll actually bring in more revenue. This also correlates to jobs in this way: if you lower the tax rate, it provides an incentive for more people to work. So the curve is also demonstrates a relationship between the supply of labor (jobs) and tax rates. Imagine it this way: if the income tax rate was 80 percent, and you were offered a job for $100,000 a year, but had to pay $20,000 per year in day care, there's no incentive to work, because you'd pay $80,000 to the government and $20,000 to day care, so you'd make no money. You'd rather stay at home. Now let's say the government lowers the tax rate to 50 percent. You'd now put $30,000 in your pocket, so it's probably worth packing a lunch and hitting the assembly line.
People in the public eye today who reference the Laffer Curve probably have a better grasp on how to throw a Bert Blyleven curve ball than they understand how the Laffer Curve actually works. That's because it's a curve, and that's key. A change in tax rate doesn't have a 1:1 change on tax revenue or employment.
Let's go back to the tax rate's effect on government revenue. Let's say the tax rate is 99 percent. Almost no one would work, and despite the high percentage, with no one working, very little money would flow into the government as tax collections. So you lower the rate to 90 percent. A lot more people would go to work, and instead of collecting 99 percent of almost no national income, the government would collect 90 percent of a much larger pie, and the overall take in tax revenue would go up. Lower it to 80 percent and many more would go to work, but it be enough new workers to offset the loss of that 10 percent of revenue? It depends where on the curve you are, but probably. But as you can see, at some point cutting the rate would mean less tax revenue. Think about the rate at 5 percent. Would there really be people unwilling to work if they kept 95 percent of their gross salary? Would they really rather make nothing and hold out for a 4 percent rate? Or let's take the Laffer Curve to its logical end: if the tax rate is zero, what would government revenue be? The answer, of course, is zero. And it would mean we stop paying soldiers, stop sending Social Security checks and default on our debt.
As promised, it's some dry reading. But it's imperative to understand that the Laffer Curve actually, um, curves. And every tax rate reduction doesn't result in an explosion of employment and government revenue. If the top tax rate was 90 percent as it was in the 1940s, 1950s and 1960s, the effect of a rate cut would be huge. But the top tax rate today is 35 percent -- about a two-thirds less than where it was, and a cut would be unlikely to produce enough revenue to make up for cut in rate.
I'm not making any political arguments today. I'm making an economic one. Curves don't lie.
The Pioneer Journal editorial represents the voice of the newspaper's editorial board. Today's editorial was written by Steve Schulz, editor and publisher.