Serious economists must be laughing at Wall Street Journal attempt to use Laffer Curve to support tax cuts

Wall Street Journal editorials often twist facts, leave out key facts, make incorrect inferences from facts or just plain get the facts wrong.  But the editorial titled “Britain’s Laffer Curve” shows that sometimes the editorial writers simply have no idea what the facts are saying.

In this editorial, the Journal wants to show that cutting taxes leads to increased tax revenues and invokes the notorious Laffer curve to do so. Laffer Curve theory has been around for ages but is associated with right-wing economist Arthur Laffer who supposedly drew it on a paper cocktail napkin for some government luminaries during the 1970’s.  When I interviewed Laffer in 1981 for a television news report, he denied the myth.

What the Laffer Curve postulates is that as taxes are raised, less money circulates in the economy and rich folk are less likely to invest to make more money, since they are keeping so little of it. Research suggests that neither of these statements are true, but by assuming that they are true, one could imagine a situation in which taxes are so high that by lowering them, you raise the amount of revenue that is raised by the government.  Laffer Curve theory proposes that there is a theoretical point at which the tax rate is at a level that produces the most revenues possible from an economy. Laffer Curve theory also predicts that there are occasions when raising taxes will indeed raise significantly more revenue and lowering taxes will indeed lower revenues—it depends on whether we are on the upward or downward slope of the imaginary Laffer Curve.

President Ronald Reagan and a slew of right-wingers since him have used the theory of the Laffer Curve to justify cutting taxes. They assume that no matter what the conditions are, we are always on the side of the imaginary Laffer Curve on which a cut in taxes always leads to an increase in revenues.

The Journal of course takes it for granted that taxes are always too high, especially on businesses, even though they are currently still much lower than during most of the last hundred years and certainly far lower than when Laffer supposedly took Mont Blanc to napkin.

The editorial in question proudly states that since Great Britain cut its corporate tax rate from 28% to 22% in 2010 the British Treasury has gained from 45 cents to 60 cents in additional taxes for every one dollar of revenues lost by cutting the tax rate. In other words, economic growth (or more people paying all their taxes) compensated for 45%-60% of the revenues lost through the tax cut.

Now that may or may not prove the existence of a Laffer Curve that can describe the relationship between tax revenues and taxes collected. But it does prove that you cannot use Laffer Curve economics to justify a tax break.   Even after the Laffer Curve effects, the British government is still 55%-40% in the hole, meaning it must find other sources of revenues or cut government spending by that amount.

And where did the shortfall go? To businesses and their owners, AKA rich folk, who history suggests will invest their additional wealth in the secondary stock market and luxury goods, neither of which really help the economy to grow.

The Journal wants us to believe that the experience of Britain should make us want to cut taxes to raise government revenues. But what the example shows is that cutting taxes leads to a loss of government revenue and a net transfer of an enormous amount of wealth from the poor and middle class to the wealthy. It’s as if the editorial writers have looked at a blue sky and declared, “Look at that blue sky. It proves that the sky is always yellow.” They see the facts, but that doesn’t persuade them from believing what they want to believe is true.

Real economists the world over must be laughing at the Journal and its editorial board’s gross misinterpretation of the facts. Except, of course, those economists in the pay of right-wing think tanks.

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