The Laffer Curve

In 1974 Arthur Laffer drew what is now called the Laffer Curve on a napkin while in a restaurant with Dick Cheney and Donald Rumsfield. Laffer was demonstrating how lower marginal tax rates could boost tax income for the government. “With lower rates, investors would create taxpaying businesses and hire workers, providing a windfall for Uncle Sam.” This theory has been rejected by economists associated with both Democrats and Republicans. The question is what are the facts?

Over the next couple of weeks US corporations will be providing financial information about quarterly performance. According to the Wall Street Journal American business is doing great. “A third of the way through the second-quarter reporting season, earnings at companies in the Standard and Poor’s 500-stock index are the highest in four years.” These same analysts are reporting that the second half of the reports will be even stronger. Hmm, maybe Laffer curve is right. Great profits resulting in more tax revenue and the hiring of more employees.

Let’s look at the promises that the Laffer Curve makes: Greater tax revenues and more employees hired. In 1981 Reagan tax cuts lower tax revenues by about 30% below where they would have been without the cuts. The Bush tax cuts cost the US government about $1.5 Trillion over a ten year period. However, on top of the tax cuts we have had two wars and a huge recession that has devastated our economy. If I owned a company and the leadership team was losing revenue, and not controlling costs, I would find a new leadership team.

The second promise of the Laffer Curve is that as marginal tax rates go down these same companies will hire more people. The fact is our unemployment rate is stuck on the 9% range. Companies are not hiring. So what does Laffer say about this? Laffer responds to criticism by stating, “The Laffer Curve is really a pedagogic device, it’s not something to be taken too literal.” Too literal? My gosh, we are getting killed out here while our political managers are relying on a theory that is just a pedagogic device created to stimulate discussion in a fairly safe environment, the classroom.

Federal tax revenue is expected to be 14.4% of the gross domestic product in 2011. That is the lowest level in sixty-one years. We have also been on a spending spree that is the highest in decades. It doesn’t take a rocket scientist to determine that our political management system is in trouble. The lack of leadership in this situation is appalling. There was a comment made recently by Timothy Geithner identifying the fact that the whole world is watching us. The time is to stand up and lead, not degenerate into partisanship politics.

And that is my thought for the day!


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