The Laffer Curve took The Right by storm in the mid-1970s. Stemming from a meeting between Dick Cheney, Donald Rumsfeld with economists Jude Wanniski and Arthur Laffer, the Laffer Curve became the cause celebre of the New Right in the United States and elsewhere by the 1980s.
The Curve postulates that above a certain level, the higher the nominal income tax rate, the lower will be government revenue. So, within a progressive income tax regime, a 90% top income tax bracket will actually pull in less revenue than having a 40% top income tax bracket. The reason is pretty simple. If a working person is in the highest income tax bracket, and they know that for every extra dollar they earn the Government will take 90 cents, they will not work that extra hour, at a new cost to both the economy and the government. Above a certain level, the higher the rate the lower the revenue from that highest bracket.
The Laffer Curve became the primary philosophical driver behind what has been two generations of tax cuts throughout the Western world....even tax cuts unrelated to tax brackets. For example, in the mid-1970's, the maximum tax bracket in the United States was about 70%. By the end of the 1980's this had been reduced to about 28%. It was thought that dramatically reducing the maximum tax bracket would not only increase government revenues, but also stimulate economic growth and even allow governments to run a surplus and reduce debt. The Laffer Tax Cut Experience was to be a Win-Win-Win...growing economy, growing government revenue, and balanced budgets with debt reduction all at the same time.
There seems no question that cutting maximum tax rates did stimulate economic growth. People who had hitherto avoided work to avoid paying the majority of that income to government did in fact work resulting in economic growth, and new revenues to government. That part of the theory did what it was supposed to do.
But once politicians got the tax-cut bug, they went too far. The Laffer Curve not only postulates that above a certain rate of taxation government revenues will drop, but at the other end of the curve it also shows that below a certain tax rate, the same thing happens...governments lose revenue. Moving from a 70% maximum tax bracket to a 28% maximum bracket was too much of a drop. By the mid-1980s the United States Government was running what was then a massive deficit of some $220 Billion a year. The maximum rate was raised to 40% by 1993, and by the end of the decade the US Government ran what was the first of four consecutive surpluses.
Regardless of this experience, which suggests that governments maximize revenues when tax brackets are high enough to generate revenue but not so high as to discourage people from working, the "cult of the tax cut" continued well into the 1990s, and continues even today. It is fair to say that the Laffer's original rationale has long since been exhausted, and we are now in an age where tax cuts are recommended for reasons entirely divorced fro Laffer; primarily the need to "grow the economy" by returning cash to tax payers. The cult still maintains that all taxes should be reduced regardless of the deficit and debt situation that a government faces, as any economic growth will more than off-set loses to government revenue from the tax cuts. This made sense when maximum tax rates were, say 70%. It makes no sense after 40 years of tax cuts, when maximum rates are everywhere below 50%.
One great example of this cult in action was in Ontario in the mid-1990s. At the time, the Harris government oversaw a $20 Billion cut in taxes over four years. The Government of Ontario ran a budget deficit throughout this time, with a total of $22 Billion added to the debt during those four years before the Ontario Government started a string of surpluses. The surpluses were so small that this debt has never been paid.
The interest that Ontario residents have paid for this $20 Billion tax cut has now just about exceeded...you guessed it....$20 Billion! Paying billions in interest occasioned by the need to borrow billions so that a government can to give tax cuts that will eventually be worth less than the total amount of interest paid on that same debt is simply stupid. Put another way, cutting taxes while running a deficit and never running a surplus to pay off that new debt is a recipe for even more taxes in the long run. It may be time to consign Laffer to the dust heap.
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