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Laffer Curve

The Laffer Curve is an interesting little bit of graphing. The idea, is that taxation over a certain level actually reduces receipts and is thus not only useless but actually counter productive.

Represented at 100% is the highest revenue that can be generated from a given economy. One either side of roughly 27-33% you see the line drop off, indicating reduced revenue. But increasing the tax rate would always increase revenues right? And decreasing the rate would always decrease them! Nate you’re crazy, this is obviously nonsense.

It’s not though. It’s pretty logical.

I’ll start on the uphill side, since that’s where I’d like us to be. If you increase taxes from levels anywhere on this side you get increased revenues. That makes perfect sense. What doesn’t make sense is when the tax rate is increased revenues don’t increase at a uniform rate. The reason is simply that as tax rates increase, an incentive is given for people to hide more income or put it places where it isn’t taxable. Every increase on the uphill side will lead to a decrease in revenue untill we start sliding back down the other side.

On the downhill side, here is where tax cuts “pay” for themselves. By reducing the tax rate there is a lesser incentive to hide income. A tax cut on this side of the hill actually increases revenues.

The equilibrium is typically found (there are a lot of charts) around 30-35% taxation. That doesn’t mean this is where taxes should be, it just means this is the point where incentives to pay and incentives to hide balance each other out. What you don’t see here is growth, and that’s an entirely different post, so forget it for now, it just complicates things, but there is a correlation between taxation and maximum growth.

This is much of the reason a flat tax is favored by many who actually know what they are talking about. A flat tax gives many incentives to just pay. There is the simplicity, the lack of loopholes, and a lower overall rate on the uphill side. With a flat tax you would actually expect that equilibrium point to slide further right, to areas of higher taxation. The reason for that owes to the two previous points, simplicity and lack of loopholes (and deductions and credits).

To recap, tax cuts (for anyone regardless of income) can actually increase revenues if on the downhill side. On the uphill side they will decrease revenues, but with respect to growth. If the cuts improve the growth of the economy, than revenues would also go up.

The point is the highest tax bracket is near this equilibrium point already. An increase would probably prove counter productive. If tax increases are sought to grab more money from the people than it’s going to have to be on the lower brackets. Or we can scrap the whole ball of wax for a better tax system, a flat one.

 

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