Fun With the Laffer Curve

The New York Sun produces an editorial featuring a bullet-point list of things that define being a Republican. Number one on the list:

Reductions in top marginal tax rates provide incentives for growth and lead to greater government revenues in the long run. That is not always the case. There is a point on the Laffer Curve at which tax cuts on the top margin stop generating increased income, but we are nowhere near that point now.

Ramesh Ponnuru unleashes what I hope is a dry wit and pretends to be puzzled by this:

Presumably what they mean is that the top income tax rate is higher than the revenue-maximizing rate, but I'm not sure why they think that it is. Bush's tax cuts appear to have caused revenue to be lower than it would otherwise have been, which suggests that we're already below the revenue-maximizing tax rate.

Meanwhile, McArdle has a book review spiked from a conservative publication for failure to conform to supply-side dogma.

Comments

I like how the Sun specifically doesn't say that tax cuts generally promote growth and an increase in revenues -- no -- it's cuts in *top marginal tax rates*. Which is to say, tax rates for rich people and only rich people. Aren't they supposed to at least pretend to support middle class people too?

Posted by Alex F | October 17, 2007 12:47 AM

Did they tell her why they killed the review? Her post doesn't say that, I don't think.

Posted by anmik | October 17, 2007 12:55 AM

Dear Republican Party,

Your faith in supply-side economics maintains that cutting taxes for the rich spurs economic growth and actually increases tax revenues. Given that George W. Bush has aggressively cut taxes for the wealthy more than any other President in history, why aren't we currently experiencing the largest budget surplus in American history?

Oh, it's not that simple? Surprising...I thought supply-side was exactly that simple. And, as H. L. Mencken said, every complex problem has a solution that is simple, easy to understand, and wrong.

Thanks,
Lev

Posted by Lev | October 17, 2007 12:59 AM

anmik,
I thought her post made it very clear that the sole reason her piece - which was apparently invited and initially accepted - got bounced was her heresy on the laffer curve.

I hope she at least demands to be paid for the review.

Frankly, I'm a bit upset: either this is accepted practice at political mags (which would be news to me, and disappointing) or these people are thugs. In the latter case, ideally McMegan would feel free to name and shame. I know she probably can't afford to offend the publishers and their friends - she makes her living and advances her career off of getting things into their magazines, but this really isn't acceptable.

If a parallel episode were reported as happening at a progressive mag - and for all I know they do happen there too - critics on the right would denounce the return of Stalinist enforcement of the party line. For once, they'd be right. I think we should do the same here.

Posted by Warren Terra | October 17, 2007 1:10 AM

She said conservative "publication", not "magazine", which makes me wonder if it was the WSJ -- which has a history of doing precisely this. (In fact, they did it to her own bete noire Paul Krugman about a decade ago; see his book "The Accidental Theorist".)

Posted by Bruce Moomaw | October 17, 2007 1:17 AM

Warren, it's a fair point that naming names could cause her problems down the road. But my point was that having an editor spell out that s/he killed a review for purely ideological reasons would be surprising. Unprecedented? Probably not. But still surprising. And that's not what Megan says on her blog. In the meantime, if she's worried about her career, why post about it at all.

Posted by anmik | October 17, 2007 1:25 AM

"There is a point on the Laffer Curve at which tax cuts on the top margin stop generating increased income, but we are nowhere near that point now."

-I assume they mean "stop generating increased government revenue"--obviously, the income of citizenry is likely to keep increasing as taxes are cut, right?

Posted by Jeff | October 17, 2007 1:30 AM

I like how the Sun specifically doesn't say that tax cuts generally promote growth and an increase in revenues -- no -- it's cuts in *top marginal tax rates*. Which is to say, tax rates for rich people and only rich people. Aren't they supposed to at least pretend to support middle class people too?

Presumably top marginal rates are the most likely to be to the right of the "Laffer peak," as they are the highest rates.

Posted by Glaivester | October 17, 2007 3:36 AM

The Laffer curve is an over simplification; A lot depends on the time frame you look at. Lowering the top rate doesn't just immediately reduce tax avoidance, it causes behavioral changes to increase growth rates, and THAT part of the change compounds over time.

IOW, (This is the theory, I'm aware there are real world complexities.) the lower you drop the rate, the higher the subsequent growth rate, and for any tax rate above zero, enhanced growth will eventually yield higher revenues.

Of course, there is such a thing as discounting future revenues, because you don't get to spend them now. But, the revenue maximizing rate is a function of the rate at which you discount future revenue, and the weaker your time preference, the lower that rate goes.

In short, we may be at a tax rate where cutting taxes lowers revenue today, but we are not at a tax rate where cutting taxes lowers revenue in the long run. We could probably lower tax rates today, and be better off for it in ten years.

Politicians, of course, have a relatively short time horizon, the next election, so they're strongly motivated to keep that rate too high for the long term good of the country.

Posted by Brett Bellmore | October 17, 2007 7:10 AM

Presumably we never actually reach the point on the Laffer curve at which we no longer benefit by cutting top tax rates. We keep approaching it, but it ever recedes to infinity.

And of course, this is really just a dodge -- people advocating for the "Laffer curve" as a serious determinant of policy do not care about the revenue side -- the entire point is to cut taxes on the rich.

The "increases revenue" part of the argument is just a distraction to put a pretend moral justification on a policy to cut taxes on the rich. That's it. There's no complicated argument. That's all it is.

Posted by El Cid | October 17, 2007 7:36 AM

Brett,

The 2005 CBO study found that at the end of ten years, the stimulus effect of a 10% cut in taxes would in their best case offset only about 32% of the lost revenue (and it could be much lower). A 2006 Treasury study concluded that making the Bush tax cuts permanent would at most increase output in the long run by a cumulative total of 0.7 percent, which would not be nearly enough to offset the lost revenue (for example, if that 0.7 percent had been realized as quickly as 10 years, the revenue offset would only have been about 10%).

And my understanding is that the long term effects on economic growth depend largely on how you imagine the tax cut being funded. In particular, if you hypothesize that the tax cut is funded not by spending cuts but rather by deficits, then even if the tax cuts have a short term stimulus effect, they are actually likely to create long term drag. So in the long term deficit-funded tax cuts actually offset less and less revenue, and will eventually start going the other direction.

All that said, I always think there is a good point being lost in all the bad points involving the stimulus effect of tax cuts. The good point is that if you can cut spending by a certain amount, thanks to the stimulus effect you could actually cut taxes a bit more than you would otherwise have thought. But of course that doesn't fit the free lunch narrative, so it tends not to get much play.

Posted by DTM | October 17, 2007 7:52 AM

Brett, "Lowering the top rate ... causes behavioral changes to increase growth rates...

How do you know that? All I know is that at least my behavior changes it in such a way that increases my slacking off on the job. That is not something that might help increase growth rates, is it?

Posted by abb1 | October 17, 2007 8:13 AM

But my point was that having an editor spell out that s/he killed a review for purely ideological reasons would be surprising. Unprecedented? Probably not. But still surprising. And that's not what Megan says on her blog

What a troll you are, Anmik! Of course, that's exactly what she says, in so many words:

the literary editor accepted it, edited it, and then three hours later told me it couldn't be published because it violated their editorial line on taxation.

Posted by rea | October 17, 2007 8:34 AM

The Laffer Curve is not about being right, it's about being different.

It's a marketing tool. It is the Unique Selling Proposition of the GOP. "New and Improved" does not have to be true, it just has to be in large letters on the box.

Posted by Davis X. Machina | October 17, 2007 8:40 AM

Economists are always doing things like assuming 10 year horizons and such. As if the welter of events doesn't swallow up the effects of our pokes and prods. A 10 year horizon for a tax stimulus? They live in such an ethereal realm that they're absolutely insane.

Posted by Jeffrey Davis | October 17, 2007 9:01 AM

Brett at least has the theory right, if not the empirical evidence.

It seems to me that it's entirely fair for Ponnuru to judge the success of the Bush tax cuts now, as opposed to waiting 10 years, given that the strategy of the tax-cut ideologues seems to be (1) cut taxes; (2) wait for the first quarter of impressive revenues; and (3) scream about how this proves the tax cuts are working. You certainly don't see them patiently waiting for the long run.

In Bruce Bartlett's recent op-ed on the intellectual emptiness of today's supply-side movement, he mentioned that when he helped write the Kemp-Roth tax cut in the 80's, he relied on studies which showed that the 1964 tax cut recouped about one-third of the lost revenue in the long run. Surely the passage of more than 15 years was long enough for them to make that judgment. (And since the 1964 tax cut lowered the top rate from an alarming 91 percent, you'd certainly expect it to have more of an economy-stimulating effect than the rather sober reductions of today.)

Of course, back in 1981, Bartlett thought recouping one-third of the lost revenue was a pretty good thing and a good reason to advocate for tax cuts. That's not good enough for today's supply-siders, though. They must maintain, in the face of all available evidence, that tax cuts actually increase revenues. Crazy.

Posted by Steve | October 17, 2007 10:54 AM

Look, I'm just describing the theory, which isn't insane, I suppose I should have been clearer about the fact that I don't have any confidence about where we currently stand on the Laffer curve, which is an empirical matter.

My personal view is that I don't WANT the government to maximize sustainable revenues, because it shouldn't be spending every last cent that it's possible to extract from the economy without killing the golden goose. I think we should be a heck of a long way from that revenue maximizing point, and on the lower side of the curve.

I might feel differently if the government were doing only things it should be doing, and was still starved for revenue. Back in the real world, much of the federal budget is devoted to things which the government shouldn't be doing if money grew on trees. Heck, a good deal of the budget is devoted to activities, such as the war on drugs, where we'd be better off if the money were just being buried in a landfill. Much of the ballance is spend on things which, while they might be nice, are hardly even worth the money spent on them, let alone valuable enough to justify funding them by something as coercive as taxation.

In short, while I view the Laffer curve as interesting theory, I don't think it should be driving tax policy. The amount of money we really need to spend should drive that policy.

Posted by Brett Bellmore | October 17, 2007 11:08 AM

AND, the amount of money we really need to spend is a heck of a lot less than we presently are spending... Stop worrying about how to maximize revenues, and start carving away at the spending on things that the government shouldn't be doing.

Posted by Brett Bellmore | October 17, 2007 11:17 AM

Brett,

Just to be clear, I was mostly responding to this part of your prior post:

"In short, we may be at a tax rate where cutting taxes lowers revenue today, but we are not at a tax rate where cutting taxes lowers revenue in the long run. We could probably lower tax rates today, and be better off for it in ten years."

I am now unclear on whether you were endorsing those claims or merely relating them, but in any event I thought it was worth briefly responding.

As a final note, you also wrote: "Politicians, of course, have a relatively short time horizon, the next election, so they're strongly motivated to keep that rate too high for the long term good of the country."

Again, I am now unclear if you were actually speaking for yourself, but I do hope that many politicians reject the long term claims that you were relating not just because they are short-term thinkers, but also because those long term claims are very likely wrong.

Posted by DTM | October 17, 2007 11:21 AM

Since Laffer Curve nonsense is practically his raison d'etre, I think National Review should challenge Larry Kudlow to argue this point with Ramesh, or else never post on The Corner again.

I won't hold my breath.

Posted by AKL | October 17, 2007 12:47 PM

What I find interesting is that Douglas Holtz-Eakin former CBO Director and author of this study which strikes a mighty blow against the Laffer curve theory is the policy director for John McCain's campaign.

Is McCain echoing this wrong side of the laffer curve nonsense too?

Posted by djslippyb | October 17, 2007 2:53 PM

Jonathan Chait is really blowing apart the GOP. His book is great for separating the liars from the useful idiots.

(I guess Megan and Ramesh now know where they stand.)

Posted by bob | October 17, 2007 3:04 PM