A Well-Deserved Honor

Steven Hayward posted an article at Power Line Blog today about a Presidential Medal of Freedom that President Trump will be awarding to Arthur Laffer, the father of the Laffer Curve.

So what is the Laffer Curve. The International Finance website defines it as follows:

The term “ Laffer Curve” was coined by Jude Wanniski (former associate editor of the The Wall Street Journal) in 1978 when Wanniski penned an article named “Taxes, Revenues and the Laffer Curve”. In December 1974, Wanniski who was the associate editor of The Wall Street Journal along with Arthur Laffer, Professor at the Chicago University, Donald Rumsfeld ( Chief of Staff of to President Gerald Ford) and Dickey Cheney (Rumsfeld’s deputy) were discussing President Ford’s WIN (Whip Inflation Now)  proposal for tax increases at a restaurant in Washington, Laffer grabbed a napkin and a pen and sketched  a curve on the napkin illustrating the tradeoff between tax rates and tax revenues, Wanniski later named it as the “Laffer Curve”.  A humble and honest academician who served Former U.S. President Ronald Reagan’s Economic Advisory Board, Arthur credited the theory to 14th century Muslim scholar Ibn Khaldun and eminent Economist John Maynard Keynes.

This is what the Laffer Curve looks like:

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The “Laffer Curve” is a theoretical curve showing the relationship between applied income tax rate and the resulting government revenue. The theory propagates the following points:

    • A tax rate of zero would result in zero government revenue
    • A tax rate of 100% will also result in zero government revenue
    • As the tax rate increases to above zero, there is an increase in the revenues of the government
    • As the tax rate continues to increase, the resultant increase in government revenue begins to slow
    • At a particular point the curve peaks and turns back towards the horizontal axis

The Laffer Curve is the reason that the federal government will collect more tax revenue this year despite the fact that President Trump lowered taxes. When taxes are raised, those with the money to hire good tax accountants find a way to avoid paying high taxes and tax revenues go down. Those of us without good tax accountants (usually the middle class) are stuck paying the increased taxes. The spending power of the middle class decreases, and the economy slows down. When the middle class has more money to spend, the economy does well.

Congratulations, Arthur Lapper. The recognition is well deserved.

Proof The Laffer Curve Works

On Wednesday, CBN News reported that France was ending its super tax on millionaires.

The article reports:

Socialist President Francois Hollande proposed a tax of up to 75 percent on people earning above 1 million euros a year, equal to about $1.2 million a year in the United States

One critic of the super-tax said it makes France “Cuba without the sun.”

Many wealthy French citizens fled the country to avoid paying the super tax, including actor Gerard Depardieu, who became a Russian citizen. 

Because millionaires left the country or found tax shelters, the excessive tax did not generate nearly the amount of money that politicians predicted it would.

What is at play here is the Laffer Curve.

On April 15, 2012, Forbes Magazine posted a graph of the Laffer Curve:

Contrary to what you may have heard, people are not stupid. If it becomes obvious that the harder they work the more will be taken from them, they will not work as hard. There is a point where excessive taxation does not reap positive rewards. Congress  needs to remember this. It didn’t work in France, and it won’t work in America.

A Chart That Tells It All

The chart below was posted in the Wall Street Journal yesterday:

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The chart is based on numbers from the International Monetary Fund. The chart is contained in an article by Arthur Laffer about the impact of government stimulus spending.

In the article Mr. Laffer points out:

The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth. The United States was no different, with greater spending (up 7.3%) followed by far lower growth rates (down 8.4%).

These numbers are particularly relevant as countries around the world are debating whether or not another round of stimulus spending is the answer to the current recession.

Mr. Laffer states:

Still, the debate rages between those who espouse stimulus spending as a remedy for our weak economy and those who argue it is the cause of our current malaise. The numbers at stake aren’t small. Federal government spending as a share of GDP rose to a high of 27.3% in 2009 from 21.4% in late 2007. This increase is virtually all stimulus spending, including add-ons to the agricultural and housing bills in 2007, the $600 per capita tax rebate in 2008, the TARP and Fannie Mae and Freddie Mac bailouts, “cash for clunkers,” additional mortgage relief subsidies and, of course, President Obama’s $860 billion stimulus plan that promised to deliver unemployment rates below 6% by now. Stimulus spending over the past five years totaled more than $4 trillion.

If you believe, as I do, that the macro economy is the sum total of all of its micro parts, then stimulus spending really doesn’t make much sense. In essence, it’s when government takes additional resources beyond what it would otherwise take from one group of people (usually the people who produced the resources) and then gives those resources to another group of people (often to non-workers and non-producers).

If the government wants the producers in our society to continue producing, it needs to understand how human nature and incentives work. If I can make more money by not working than I can for working, it doesn’t take a rocket scientist to figure out that I am less likely to work.

I think Mr. Laffer is on to something. Please read the entire article at the Wall Street Journal for more information on the impact of government stimulus programs.

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