Where Are We on the Laffer Curve?
By David Henderson
A cut in federal income tax rates in the US right now would raise taxable income enough so that the annual total tax revenue would be higher within five years than without the tax cut.
This is one of the questions on the IGM Forum, a forum in which many of the country’s leading economists give their responses and, if they so desire, their reasons.
Not one economist surveyed agrees with this claim. I don’t either. Cutting marginal tax rates will somewhat increase taxable income. But the odds are very high that it wouldn’t increase nearly enough to increase tax revenue. Whereas one can make a case that cutting some marginal tax rates would increase revenue–I have in mind the corporate income tax, for example–it is hard to make a case that cutting marginal tax rates on individuals would increase revenue.
To see why, consider someone paying a marginal tax rate of 25%. If the feds cut the tax rate by 10%–that is, 2.5 percentage points–then his incentive to earn an additional dollar rises from 75 cents on the dollar to 77.5 cents on the dollar. (I’m assuming he’s past the Social Security threshold so that his marginal FICA tax is 0. I’m also assuming he’s in a 0 state income tax state such as Texas. Finally, I’m just ignoring the 1.45% Medicare tax.) For the feds to make the same revenue on him, his income must rise by one ninth, or 11.1%. That seems highly unlikely.
Mark Thoma gives a particularly misleading title to his post highlighting these findings. He calls it “Laughing at the Laffer Curve.” But nothing in the above says that the Laffer Curve is wrong. In fact, the Laffer Curve must be right. At a zero tax rate, the government will collect zero revenue. At a 100% tax rate perfectly enforced, there will be literally zero incentive to make income and so the government will collect zero revenue. At in-between tax rates, the government collects some revenue. QED.
So the question is not whether the Laffer Curve is right. The question is where we are on the Laffer Curve.