Friday, July 14, 2006

Laffer has the last laugh

The economists I listen to subscribe to the theory that there is a curve called the "Laffer curve." It is bell shaped with the top between 23 and 30 %. If taxes on average center in that range, then you maximize revenue. Our current taxes, on average are to the right of the peak, so by shifting downwards toward that peak, you actually increase revenue by decreasing taxes; however, if you go too far, you do tend to lose revenue. Of course this is an over simplification of a complex dynamic system, but it is a good model to discuss for the purposes of demonstrating the phenomenon.

Tax cuts spur an increase in revenue for the Federal Government. This worked under Kennedy, it worked for Reagan, and it even worked for Clinton (the child tax credit increase, cutting taxes), and of course now it is working under Bush. I'd call that a pretty good trend. And of course the reverse holds true as well, each time the taxes were raised significantly, there was a dent in the economy. I think we are definitely on the Right Hand Side of that LAFFER curve. Shaky ground we are on with most economists, perhaps, with respect to predicting and shaping the economy, but for long term taxation, this is one trend which is continually proven again and again.

The point may be made that when the economy rebounds (either on it's own or when spurred by a tax cut) that inflation may creep, but the Federal Reserve is trying to control that these days. Under Kennedy and the period after that economic recovery, the powers that be did not do a very good job of controlling inflation. Today, they are trying to get a handle on it by increasing interest rates. That does indeed control inflation, because it causes the stock market to stabilize (short term declines), the long term trend is only a slow upward movement, rather than a bubble like we had at other times.

I say, let's just hold taxes steady, because if they let the Bush taxes expire in a few years it will cause a recession, take that to the bank.


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