The wrong spot on the Laffer curve

For those of you who don’t know, the Laffer curve is based on a simple premise:

  • If there is a 0% tax rate the government collects $0
  • If there is a 100% tax rate the government collects $0 (nobody does any work so there is nothing to tax and everybody starves to death)
  • Somewhere in the middle the collected revenue is maximized.

There have been many theories on where the curve is maximized ranging from 33-70% marginal rates (according to Wikipedia).  I am not as concerned with the rate that generates maximum revenue, but rather the maximum possible revenue.  Since the end of WWII marginal rates have jumped around all over the place, but the Federal revenue as a percentage of GDP since WWII has moved in a much smaller band (20.9% in 1944, 14.4% in 1950 here ).  So, while the exact tax structure that maximizes revenue may be difficult to determine the maximum federal rate is probably only sustainable below 20%.  Since 1979 the combined Federal, state, and local receipts only varied from 24.2-29.5% here .  What I think this means is that no matter what we try to do revenue can only increase by 20% on what the government is currently collecting (16.7% of GDP at the Federal level), which is a problem for two reasons

  1. We currently borrow 40% of what we spend (far above the 20% possible increase)
  2. We have promised to raise spending in the future (looming entitlements and state/local retiree benefits)

Democrats often claim that there will need to be revenue increases.  Fine.  Let’s grant every revenue increase that can be had.  That still won’t cover existing  spending, much less future promised increases.

Our current level of spending is unsustainable without continuous increases in debt.  Our promised future spending is impossible no matter what, since entitlements will have to be paid out of printed money stoking inflation which automatically increases entitlement payouts (since they are indexed to inflation) and the increased entitlement payments will have to be paid with printed money stoking inflation… See the problem?

If the Laffer curve has a broad flat plateau that generates revenue varying only between 24.2-29.5% of GDP regardless of the structure and we agree to perpetually spend 45% of GDP through the government there will be a problem, and no amount of tax raises can fix the problem since you cannot extract more than 30% of GDP from the American populace no matter what.  Spending needs to be cut by at least 30% (an amount equal to all of social security plus all of medicare plus the federal portion of Medicaid) even if taxes are raised to the point where they can be raised no more.

Raising taxes to 30% of GDP is itself be a terrible proposition.  During WWII revenue increased from 7.1% to 20.9% in 5 years.  Let’s imagine taxing at 30% and a war breaking out.  There would be no possible increase in revenue since we were already at 30%.  If we want to have the ability to fight the Germans and Japanese simultaneously we need to cut Federal spending by roughly 75%, or the combined total of Social Security, Defense, Welfare, Medicare, and Medicaid leaving only non-defense discretionary spending.  If we wanted to maintain an army half our current size our non-defense discretionary spending would also need to be cut in half.

Some what cannot be continued will stop.  Some day the Chinese and Japanese will end their purchase of T-bills (very soon for the Japanese who will soon need to sell the T-bills to pay their for their own demographic time bomb).  Some day we will not be able to borrow 40% of outlays, and the inability to raise revenue beyond 30% will become painfully apparent to all sides.  We will only have two choices (and one is only possibly temporarily)

  1. Massive inflation (which also cannot continue forever)
  2. Reduction in the 75% of our budget that is military and wealth transfer payments

Even if we concede all the revenue the Democrats want their dreams cannot be fulfilled.