Wednesday, February 20, 2002

Laffer lives

If you want to raise more govt revenue, sometimes you have to lower tax rates. Yes, it's true - the Laffer curve tells me so.

Now stick with me for a second. The Laffer curve is a plot of tax rates on the horizontal axis vs. tax revenues on the vertical axis. Here is an example.

You might have expected such a plot to show that increasing tax rates increase tax revenues at all times. But in fact there is some magic tax rate at which the revenue is at a maximum. It isn't easy to find that value, but knowing that it exists is good, because it shows that under the right conditions lowering tax rates can increase tax revenue. And that's an idea that many people find counterintuitive.

It's not just theoretical, especially with respect to capital gains taxes:
Actual experience also indicates that lower capital gains taxes have a positive impact on federal revenues. The most impressive evidence involves the period from 1978 to 1985. During those years the top marginal federal tax rate on capital gains was cut almost in half-from 35 percent to 20 percent—but total individual capital gains tax receipts nearly tripled, from $9.1 billion to $26.5 billion annually.

What a deal! - liberals can have more tax receipts while the rest of us can increase our wealth and improve the economy. Yet the Laffer curve is anathema to many politicians. Why?

Because it might lead to lowering tax rates. And lower tax rates mean that govt favors are worth less. And if govt favors are worth less, people will spend less trying to influence the govt.

Hmm - could it be that the best way to achieve campaign finance reform is to lower tax rates?

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