In economics, the Laffer curve is a representation of the relationship between rates of taxation and the resulting levels of government revenue. The Laffer curve claims to illustrate the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation. It postulates that no tax revenue will be raised at the extreme tax rates of 0% and 100% and that there must be at least one rate which maximizes government taxation revenue. The Laffer curve is typically represented as a graph which starts at 0% tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate. The shape of the curve is uncertain and disputed.
One implication of the Laffer curve is that increasing tax rates beyond a certain point will be counter-productive for raising further tax revenue. A hypothetical Laffer curve for any given economy can only be estimated and such estimates are controversial. The New Palgrave Dictionary of Economics reports that estimates of revenue-maximizing tax rates have varied widely, with a mid-range of around 70%. Generally, economists have found little support for the claim that tax cuts increase tax revenues or that most taxes are on the wrong side of the Laffer curve.
Although economist Arthur Laffer does not claim to have invented the Laffer curve concept, it was popularized in the United States with policymakers following an afternoon meeting with Ford Administration officials Dick Cheney and Donald Rumsfeld in 1974 in which he reportedly sketched the curve on a napkin to illustrate his argument. The term “Laffer curve” was coined by Jude Wanniski, who was also present at the meeting. The basic concept was not new; Laffer himself notes antecedents in the writings of the 14th-century social philosopher Ibn Khaldun.
In 1980, Mickey Kantor and I joined forces to defeat an initiative constitutional amendment in California that would have radically cut income tax rates. The proposal was written and advanced by Howard Jarvis,
In 1978, Howard Jarvis hired me to direct the campaign for Proposition 13, the famous property tax limitation initiative which, unfortunately, ultimately gave the country Ronald Reagan. I supported the idea of removing real estate taxes from funding local school districts, as the result had been that schools in poor neighborhoods were chronically underfunded.
After our stunning upset victory, Howard and I discussed his future tax cutting proposals, He had originally planned on eliminating the sales tax, an idea I fully supported. However he eventually caved to corporate and Republican backers who convinced him to attack the income tax.
At the time, Mickey Kantor was one of the most prominent Democratic organizers and fund raisers in California. He would later become US Trade Representative and then Secretary of Commerce under Bill Clinton. Our collaboration built the largest political coalition in the history of California politics, and scored an upset victory against Jarvis, Ronald Reagan, and the Republican establishment in California.
Jarvis’ entire premise was that limiting income taxes would result in higher tax revenues, and that supply-side economics would drive an enhanced economy.
Among the many people I debated during the campaign was Howard Jarvis himself, who touted the Laffer Curve as proof that cutting taxes would increase revenues to the state.
The Laffer Curve, however suggests that the highest tax revenues would be achieved by imposing a 50% tax on all income. As most taxpayers in California were paying substantially lower tax rates than 50%, the Laffer argument collapsed.
It was, however, taken up by David Stockman in Reagan’s first year in office and used to push the biggest corporate tax giveaway in history.
The Laffer Curve was the first nail in the coffin of the American Middle Class.
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