June 18, 2003

A Laffing Matter

NashvillePost.com, a business news website that regularly blows away the business section of the city's big daily newspaper, has another scoop today: the firm founded by the author of the famous "Laffer Curve" of supply-side economics fame, is moving from San Diego to Nashville. Reason: Tennessee doesn't have an income tax. Laffer Associates provides international investment advisory services to institutions and management of institutional accounts. It was founded by Arthur B. Laffer, an economist, and is now run by his son, Arthur B. Laffer Jr.

As this page explains:

The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T*) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.

Arthur Laffer's seminal discussion of the relation between tax revenues and the tax rate was an analytical cornerstone of the supply-side economics revolution during the early 1980s. The conjecture that if tax rates were reduced tax revenues would increase has become a powerful, suggestive policy stand. The surprising policy implication was that public funds could be increased without burdening the private sector by adverse incentive effects or redistributive measures. The Laffer relation provided an important theoretical ingredient for the formulation of a convincing hypothesis about the behavior of a Leviathan government in the guise of a revenue-maximizing bureaucracy.

Welcome to Nashville, Laffer Associates.

UPDATE: More thoughts on supply side economics: I don't think many on the Right ever quite understood that supply-side policies done right would result in government having more money to spend, not less. Supporters of the Reagan Revolution thought that by cutting taxes government would shrink and the economy would grow. They were only half right. The economy boomed - but that just generated a surge in tax revenue, and the federal government grew massively larger. If you wanted government to shrink, Reagan didn't cut taxes nearly enough.

UPDATE: Michael Williams has some really good additional commentary on the Laffer Curve and supply side economics.

Ideally, from my perspective, taxes would be cut down past the government-optimal point and government revenue would then continue to fall. My own optimal point is different from the government's; I don't want to maximize government revenue, I want to maximize my freedom and quality of life. I believe that eliminating many functions of government would benefit me greatly, and so my optimal tax rate is lower than the Laffer optimal rate.

In a sense, a tax rate below Laffer's optimal is "benignly sub-optimal", since the lesser government revenue isn't due to harm inflicted on the economy (and should actually benefit the economy as a whole). "Lost" government revenue that's caused by a tax rate that's too high, however actually reflects a real economic loss.