The Laffer Curve
Dylan Matthews asked a number of economists what tax rate maximizes government revenue. Greg Mankiw gave the best answer: In the long-run the rate that maximizes revenue is the rate that maximizes economic growth. Gerry Scully estimated that rate for the NCPA at 23%.
Full article on the Laffer Curve here.
I assume we are talking about all government — federal, state and local. If 23% is the ideal, then we are probably sacrificing a lot of growth, since in normal times I believe government is about 33% of national income.
I remember the Scully study when it first came out. Great study. Great economist. Too bad he is no longer with us.
I find it almost unbelievable that many (otherwise intelligent) economists argue in favor of tax and spend economic policies. I believe it to be self-evident that high taxes are a burden an economy. For instance, private businesses try to improve their productivity to ensure profits year after year. Employees like to work for successful firms (like Microsoft) that are expanding and increasing job prospects. Worker use their pay to purchase goods and services that are utility increasing.
Balance the aforementioned goals against a tax, which is a politicians’ way of deciding that private funds should be spent on non-productive activities that neither workers nor employers would fund on their own. The more we tax and spend, the bigger the non-productive segment of the economy becomes. Of course, there are some productive uses for tax dollars – road building and enforcing property rights both come to mind. The bureaucracies in Washington may be growth industries but the average consumer doesn’t want more paper pushers; rather consumers want tangible goods like houses, cars, vacations, etc. Why is it not self-evident that government extracting capital and using it to create bureaucracies that provide service the average consumer does not want slows economic growth by diverting capital away from its most productive use?
It seems to me the rate would vary with type of tax. A given tax rate against gross sales extracts more dollars than the identical tax rate applied to net income. And some kinds of taxes have a bigger impact on economic activity than others.
Another point, which I think some of the economists made, is that by the time you’re close to maximizing revenue, you’re already suppressing economic activity for no good reason. In other words, tax increases near the revenue maximizing tax rate are much more effective at suppressing growth than at raising revenue. So rates should be kept well below this level.
Before Kennedy cut taxes, the top rate was 90%. Before Reagan, 70%. Before Bush, less than 40%. To me the case for the Bush cuts was less compelling than the previous two. I was also disappointed that they didn’t do a better job of balancing cuts with reforms– a wasted opportunity. It was almost as though they were trying to repeat a formula– Cargo Cult Reaganomics, as it were.
At this point I’d rather see the Bush cuts expire in their entirety, rather than merely soaking investors along with the rich. If Congress wants to do something worthwhile, it should retroactively plug the suicide exemption before people start checking out in droves.
We desperately need a study to determine the tax rate that will minimize government revenue.
Also, I just noticed that Scully’s 23% figure wasn’t the level intended to maximize government revenue, it was the level which maximizes economic growth.
This seems to assume that the 23% of GDP collected in taxes is spent only on those government activities that contribute to growth, such as infrastructure (see Scully’s first paragraph, and his first bullet point).
I can only assume from this that the level of taxation which maximizes government revenue is considerably higher than 23% of GDP. Since many popular government programs don’t contribute to growth, any reasonable level of taxation would have to be somewhere between the growth-maximizing and the revenue-maximizing figures.
Where in the Declaration of Independence did Thomas Jefferson talk about maximizing government revenue? Maybe in the Constitution?
This rhetoric totally misses the point. Maximizing freedom is the point.