The Laffer Curve

As the next administration begins to take shape, I am carefully watching the runoff races in Georgia to see who will control the Senate and whether there will be any checks and balances between the White House and the House of Representatives. Naturally, I remain concerned about the second amendment and the reversal of trade policies established in the past four years, but I am particularly concerned about the taxation that will accompany healthcare, environmental policies (AKA the green new deal), and a host of other items on the Democratic Party’s wish list. For that reason, I thought this might be a good time to go back and review the Laffer Curve as a warning that sometimes increased taxation can result in a decrease in federal, state, and local revenues.

The theory is the brainchild of Arthur Laffer, who was active during the Reagan era and is widely credited for that administration’s adoption of supply-side economics. The theory actually dates back to Adam Smith and earlier, but Laffer’s writings brought the doctrine into the 20th century, and he was ultimately awarded the Presidential Medal of Freedom for his works.

Mr. Laffer’s theory is relatively simple. It links the elasticity of tax revenues with the rate of taxation but recognizes a point of diminishing returns. Simple logic dictates that as tax rates increase, then tax revenues should increase as well. The laffer theory demonstrates that increased tax rates can eventually reach a point where they take a toll on both Gross National Product and Gross Domestic Product, ultimately having the effect of reduced government revenues.

Let’s also not forget that diminished private investment and decreased government revenue both have the effect of reducing reinvestment in the economy, which in turn negatively affects employment rates. The old Econ 101 equation is “investment plus labor equals GNP.” If we discourage investment, then employment simply does not follow, and the economy as a whole suffers.

The drawback to the theory is that there is widespread disagreement among economists as to exactly where taxation meets minimum disruption and maximum revenues. Yes, we have historical data to study, and a few conclusions can be drawn from those, but there are a multitude of variables to be tweaked (ie. not only tax rates but brackets, not to mention business, corporate, tariffs, license fees, etc.). The ideal balance is difficult to establish in any given economy and is the subject of perpetual dispute. It’s thorny. It’s messy. It’s enough to make one’s head spin without tossing a pandemic and growing public debt into the mix.

It’s not all a national issue. States and municipalities all like to have shiny new things to enhance the quality of life in their communities, which is appreciated. One of our bigger burdens in Southwest Nebraska is simply the lack of population obligated to support wide expanses of infrastructure. As a general rule, cattle and corn don’t pay sales tax, so the expense falls on property owners. That equation is further exacerbated by an arguably inefficient school district structure. Yes, we appreciate the autonomy of local control, but in a state with 93 counties, we have nearly three times as many school districts. The educational service units attempt to provide some shared services, but the potential for duplication of personnel and resources remains.

Nationally, we need to remember that we not only have a congress and an administration with a hefty wish list, but we also have generations on the way up who didn’t experience the cold war as we older folks did. Bernie Sanders made a substantial showing in the primary as a self-proclaimed Socialist, and an increasing number of younger folks look to European Socialistic models as blueprints for the US economy. Although we tend to veer to the right in this part of the state, I remain concerned about the kids; how they are influenced, and what they are being taught.

We obviously all need to keep an eye on the situation, get out and vote and talk to our elected officials, but we also need to talk to younger folks. If we can articulate the logic of the Laffer Curve, perhaps we can better explain that there is a point of diminishing returns, and if we aren’t careful, we can tax ourselves into another depression.

There’s a great old Margaret Thatcher quote that clarified the issue. The Iron Lady was reported to have once said, “The problem with socialism is that you eventually run out of other people’s money.” That may be an oversimplification, yet it couldn’t be more true

I understand that it’s easy to vote for people who promise free stuff, and I remain hopeful that our political system is strong enough to make necessary corrections before we witness the soup lines of the 1930s. My concern is that we have a substantial number of voters who either have much to gain (via social programs, health care, debt relief, etc.) or don’t understand the dark history of socialistic experimentation throughout the world.