The Laffer Curve, ETI – And Libya

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By George Noga
More Liberty, Less Government

Previous articles presented the Rahn Curve and Hauser’s Law along with data and logic to prove that increasing income tax rates not only is ineffectual but counterproductive. Nevertheless, there is more, much more, data that further solidifies this axiom. To wit: in this article I present the Laffer Curve and the the Elasticity of Taxable Income or ETI.

We begin with the Laffer Curve (shown below) which has existed for eons, although it was named after a recent acolyte, economist Arthur Laffer.

Understanding the Laffer Curve

Both ends of the Laffer Curve are easy to grasp. At a zero tax rate the government obviously will not collect any taxes; likewise, at a 100% rate the same result ensues as there is no incentive for anyone to work legally except for survival. At low rates people are incentivized to earn money with the tax rate not much of a deterrent; nor is there much incentive to reduce taxes. As tax rates increase, the incentives change – the more rates increase, the more dramatically incentives shift.

At higher and higher rates people are less inclined to earn money at the margin and more inclined to take countermeasures. Eventually a point is reached when a marginal increase in tax rates produces less aggregate tax revenue than at the lower rate that existed prior to the increase. This point is the apex of the Laffer Curve and is depicted on the graph at between 35% and 40%. Economists debate the precise point at which tax revenues begin to decline, but there is no serious disagreement about the overall shape of the curve. High marginal tax rates are not only unproductive but counterproductive.

The Elasticity of Taxable Income or “ETI”

Another way to examine this same phenomenon is the ETI which correlates income tax rates with tax revenue on a micro level – much as the Laffer Curve accomplishes on a macro level. Moreover, ETI has the advantage of being more easily measured and quantified. There are numerous published academic studies of ETI based on examining tax returns both before and after a tax increase. Let’s look at the results uncovered by the good professors at MIT, Michigan and Nebraska.

An ETI of 1.0 means that none of the possible revenue from a tax increase is actually collected. An ETI greater than 1.0 means less revenue is collected after the increase. For the top 2% of Americans (AGI > $500,000), the ETI is 1.2; this means the new higher rate collects less, much less, tax than the old rate. For capital gains and dividends the ETI is 0.9, meaning very little new tax is collected. Clearly, people are not sheep docily waiting to be shorn.

Putting it all Together: Rahn, Hauser, Laffer, ETI and (Noga?)

It is time to connect all the dots. Standing alone, the Rahn Curve, Hauser’s Law, the Laffer Curve or ETI are sufficient to prove the point that higher tax rates reduce tax collections and are a disaster for the economy. There is yet another concept I plan to present in the future; it correlates the percentage of the working population employed by the government with GDP and GDP growth. Insofar as I know, this metric is new ground; perhaps one day it will become known as the Noga Curve. When one objectively considers all these aforementioned metrics together, he/she would have to live under a rock not to grasp the point.

“Higher taxes don’t work for the same reason socialism fails; it is fundamentally against immutable human nature and people respond to incentives and to disincentives.”

Despite this utterly overwhelming evidence, many political leaders argue for higher tax rates. The only rational explanations are: (1) they want to bring down the rich even at the price of destroying everyone; (2) they are kool-aide-drinking, dyed-in-the wool socialists; or (3) they are economically illiterate – or a combination thereof. In any event, they are troglodytes.

Higher taxes do not work for the same reason socialism doesn’t work, i.e. it is fundamentally against human nature and people respond to incentives and to disincentives. Laws may change but human nature is immutable. Please remember all this the next time you hear someone say that higher taxes are necessary to reduce the deficit.

What Should US Policy Be Toward Libya?

During the past week I have received calls and emails asking about the MLLG take on Libya; I even was asked a few times on the golf course. My take was uttered on July 4, 1821 by President John Quincy Adams; it is quoted in part below:

“Whenever the standard of freedom and independence has been or shall be unfurled, there will be (America’s) heart, her benedictions and her prayers. But she goes not abroad in search of monsters to destroy. She is the well-wisher to the freedom and independence of all, but she is the champion and vindicator only of her own.”

US intervention in Libya is bad policy. There is a legitimate role for supranational organizations in preventing massacres and genocides. I would have supported US participation in a supranational effort to stop the slaughter in Rwanda; Bosnia was a close call but arguably supportable because of the genocide. Libya is a civil war and does not come close to rising to the standard where US intervention, even as part of an international force, is acceptable.

Libya is not distinguishable from other civil wars, insurrections and slaughters extant such as Yemen, Syria, Myanmar, Zimbabwe and Ivory Coast to name only a few. Why do we intervene in Libya but not these others? Moreover, the Libyan rebels who we are supporting may be even worse than Qaddafi. US intervention in Libya is wrongheaded, illogical and a mistake. John Quincy Adams got it right 190 years ago; we ignore his admonition at our peril.

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