The Laffer Curve is one of those things that certain types love to insist doesn’t actually happen. Yet also one of those things which is simply a basic truth about our world. There are tax rates high enough to lower the amount of revenue collected. This means that, if the rate is currently above that, then revenue can be increased by lowering rates. The corollary is also that there are rates too low to be revenue maximising.
It doesn’t then go on to prove what Art Laffer himself has been saying for some decades now, that lower tax rates always pay for themselves. It does say just what it does say, that there’s a – or even several – peaks in revenue collection as a tax rate goes from 0% to 100%.
The difficulty in calculating exactly what that rate is comes from two different levels of complexity. The first is that it is different for every tax within a certain societal structure. Famously, the European Union showed that 0.01% for a financial transactions tax was above the Laffer Curve peak – it lost revenue, not gained it. The rise in VAT rates from 7 and 8 % to 15 and 20% shows that the peak for a VAT is, well, it’s not 7 or 8% at least.
The second level of complexity comes when we start to talk about income taxation for there are two effects. At some point people look at their post-tax pay and declare “Sod it, I’m off fishing.” This is the substitution effect. People will also, sometimes, look at their post-tax income and declare that “I gotta make my nut” and so work longer hours at a higher tax rate. This is the income effect.
We’re near all affected by one or the other at certain times and income/tax levels. A very few are affected only by one or the other. The Laffer Curve is the effect of both over the population.
We’ve seen hte substitution effect as doctors refuse to work extra NHS shifts as their tax bills rise to monstrous levels – the interaction with their pensions and the limits upon what you can have in one. So, it’s nice to also see the income effect:
Alfan, 25, was one. When the light turned red, he walked in silence, barefoot, and stood in front of the stopped traffic. He bowed deeply for a few seconds and then struck a pose like a statue: standing straight, he raised his right hand to his temple and gave a salute in silence for about a minute without blinking.
At the end of his brief performance, Alfa gave another deep bow and approached the riders and drivers for a donation.
“I’ll go home when I have got enough money. The other day I got 80,000 rupiah ($5.70) before 10pm, so I went home,” Alfan said after he returned back to the footpath.
Alfan, who has two young children, is one of many cash-strapped Indonesians who have taken up the street art of manusia silver, or silvermen, to make ends meet during the pandemic.
I’ve made my nut now I’m going home. It’s exactly that that can make people work more hours when income taxes rise.
We can now see the two basic causes of the Laffer Curve out there in the wild. So, perhaps, we can put an end to the claims that it doesn’t in fact exist?