Let's Talk About Laffer

I recently cross-posted one of my blogs here on Facebook, and inevitably the one person I knew would comment did.  “M,” as I’ll call him, used the following to deride my view that taxes are a dis-incentive to work:

My question is whether any proposed tax cut on businesses would constitute a large enough amount of money to permit the hiring of new workers. Surely, some would be hired, but I’m reluctant to buy fully the idea that all economic ills are cured by tax cuts.

Reason being: There’s been a perversion of the idea that tax cuts yield benefits. Like the way the Laffer curve is used by politicians to say, without any qualifications, that lower taxes cause increases in revenue. Well, in that case, let’s lower them to 0% and watch the cash stream in. It’s a pathology that consumes much of the right: lower taxes will in all cases yield a stronger economy.

So let’s talk about this liberal talking point:  That if the Laffer Curve is true, we could lower taxes to 0% and watch the money roll in.

M sees this as a critical failure of conservative/libertarian thinking, but in reality only shows how specious is liberal reasoning.  Mathematically, if you multiply something by zero, you have zero.  If you add zero to zero, you have zero.  If you subtract zero from zero, you have zero.  Zero is by definition nothing, and you cannot get anything from nothing.

Liberals don’t understand that mathematics and economics also have limits.  These are not limits to capabilities to describe the universe, which is the purpose of both of these sciences, but rather limits are boundaries within the science.  Why can’t we divide by zero?  Because dividing by zero gives you infinity.  In calculus, we learn that the point where a function (math term for result of an equation) reaches infinity, there is a “limit.”  This limit indicates that, no matter how big or small the number placed in the variable, it will never reach that limit.  The speed of light is an example of limits:  No matter how much energy one expends, one can never propel a spacecraft to the speed of light (let’s ignore quantum theories for the time being:  I’m talking “big particle” physics).

Economics also has this type of limit.  Many call it the “law of diminishing returns.”  Economists call it “diminishing marginal utility.”  Whatever the name, the concept is that eventually for each unit of resources (amount of money or time) expended or invested, the return on that expenditure or investment is zero, perhaps less.

Think of it this way:  I might spend one dollar on a chocolate bar.  I enjoy this chocolate bar tremendously.  So I spend another dollar and eat another chocolate bar.  I still enjoy it, but the sweetness of it isn’t quite as nice.  Still, I spend another dollar and eat another chocolate bar.  This time, the taste of chocolate is practically making me sick.  I still enjoy it, but only barely.  If I eat another chocolate bar, I’m likely to not enjoy it or to just make myself sick.  If I don’t enjoy it, my dollar was wasted.  If I get sick, I have less as I expel all the chocolate I enjoyed.  Either way, I don’t want any more chocolate.  I have reached my “limit” of enjoying chocolate.

(My apologies to my girlfriend, who states that there is no “limit” to the enjoyment of chocolate!)

Let’s get back to Laffer.  Arthur Laffer popularized the well-known but often-ignored idea that increases in taxes do not necessarily mean increased tax revenues.  Tax rates that are too high will discourage productive economic activities, slowing growth.  Conversely, Laffer also proposed that by lowering taxes, one could encourage economically productive economic behavior.  This was nothing new.  Keynes discussed this idea in his works, but Laffer gets credit for popularizing the effect of lowering taxes.

Eventually, the return on any continuation of a given action results in diminished returns.  Raising taxes 1% might increase revenues by 1%.  Raising taxes a total of 2% might then increase revenues by 1.9%.  Raising taxes 3% might then increase revenues by 2.5%.  A 4% increase results in 2.7% more revenue.  5% might result in only 1.7% more revenue since economic productivity has been discouraged, and a 6% increase would be revenue-neutral.  The increased tax rates have discouraged productivity to the point where the economy starts to shrink.  These numbers are, of course, imaginary and based on no mathematical, economic or historical principle.  They are illustrative only.

Similarly, lowering taxes by 1% might increase revenues by 1% due to increased incentive to produce.  Lowering by 2% might result in 1.9% greater revenue, 3% results in 2.5%, and so on again until a 6% reduction in taxes becomes revenue-neutral.  The amount of additional productivity no longer keeps pace with the reduction of tax rates resulting in revenue losses.  With regard to this discussion and because the numbers are imaginary, I am keeping the numbers on each side the same to avoid any claim of bias.

Again, the reason for this is the concept of limits.  At some point, increasing or lowering the tax rate has little to no effect on revenues or productivity, or may even have a negative effect.

The kind of liberal thinking espoused by M shows just how desperate the Left is to undermind those who think critically.  Specious reasoning is, by definition, reasonable in the moment but upon critical reflection understood to be laughably stupid.  This criticism of Laffer and the idea of stimulating economic growth by lowering taxes (and the related increase in tax revenues) is just that.  We hear it on talk radio and on television.  We see it in blogs and newspaper columns.  It is stuipid and needs to stop.