| As Arthur Laffer has noted, "There are always two tax
rates that yield the same revenues." When an aide to President Gerald Ford
asked him once to elaborate, Laffer (who is Professor of Business Economics
at the University of Southern California) drew a simple curve, shown on
the next page, to illustrate his point. The point, too, is simple enough
-- though, like so many simple points, it is also powerful in its implications. |
| When the tax rate is 100 percent, all production ceases
in the money economy (as distinct from the barter economy, which exists
largely to escape taxation). People will not work in the money economy
if all the fruits of their labors are confiscated by the government. And
because production ceases, there is nothing for the 100-percent rate to
confiscate, so government revenues are zero. |
| On the other hand, if the tax rate is zero, people can
keep 100 percent of what they produce in the money economy. There is no
governmental "wedge" between earnings and after-tax income, and thus no
governmental barrier to production. Production is therefore maximized,
and the output of the money economy is limited only by the desire of workers
for leisure. But because the tax rate is zero, government revenues are
again zero, and there can be no government. So at a 0-percent tax rate
the economy is in a state of anarchy, and at a 100-percent tax rate the
economy is functioning entirely through barter. |
| In between lies the curve. If the government reduces
its rate to something less than 100 percent, say to point A, some segment
of the barter economy will be able to gain so many efficiencies by being
in the money economy that, even with near-confiscatory tax rates, after-tax
production would still exceed that of the barter economy. Production will
start up, and revenues will flow into the government treasury. By lowering
the tax rate, we find an increase in revenues. |
| On the bottom end of the curve, the same thing
is happening. If people feel that they need a minimal government and thus
institute a low tax rate, some segment of the economy, finding that the
marginal loss of income exceeds the efficiencies gained in the money economy,
is shifted into either barter or leisure. But with that tax rate, revenues
do flow into the government treasury. This is the situation at point B.
Point A represents a very high tax rate and very low production. Point
B represents a very low tax rate and very high production. Yet they both
yield the same revenue to the government. The same is true of points C
and D. The government finds that by a further lowering of the tax rate,
say from point A to point C, revenues increase with the further expansion
of output. And by raising the tax rate, say from point B to point D, revenues
also increase, by the same amount. Revenues and production are maximized
at point E. If, at point E, the government lowers the tax rate again, output
will increase, but revenues will fall. And if, at point E, the tax rate
is raised, both output and revenue will decline. The shaded area is the
prohibitive range for government, where rates are unnecessarily high and
can be reduced with gains in both output and revenue. |
Tax rates and tax revenues |
| The next important thing to observe is that, except for
the 0-percent and 100-percent rates, there are no numbers along the "Laffer
curve." Point E is not 50 percent, although it may be, but rather a variable
number: it is the point at which the electorate desires to be taxed. At
points B and D, the electorate desires more government goods and services
and is willing -- without reducing its productivity -- to pay the higher
rates consistent with the revenues at point E. And at points A and C, the
electorate desires more private goods and services in the money economy,
and wishes to pay the lower rates consistent with the revenues at point
E. It is the task of the statesman to determine the location of point E,
and follow its variations as closely as possible. |
| This is true whether the political leader heads a nation
or a family. The father who disciplines his son at point A, imposing harsh
penalties for violating both major and minor rules, only invites sullen
rebellion, stealth, and lying (tax evasion, on the national level). The
permissive father who disciplines casually at point B invites open, reckless
rebellion: His son's independence and relatively unfettered growth comes
at the expense of the rest of the family. The wise parent seeks point E,
which will probably vary from one child to another, from son to daughter. |
| For the political leader on the national level, point
E can represent a very low or a very high number. When the nation is at
war, point E can approach 100 percent. At the siege of Leningrad in World
War II, for example, the people of the city produced for 900 days at tax
rates approaching 100 percent. Russian soldiers and civilians worked to
their physical limits, receiving as "pay" only the barest of rations. Had
the citizens of Leningrad not wished to be taxed at that high rate, which
was required to hold off the Nazi army, the city would have fallen. |
| The number represented by point E will change abruptly
if the nation is at war one day and at peace the next. The electorate's
demand for military goods and services from the government will fall sharply;
the electorate will therefore desire to be taxed at a lower rate. If rates
are not lowered consistent with this new lower level of demand, output
will fall to some level consistent with a point along the prohibitive side
of the "Laffer curve." Following World War I, for example, the wartime
tax rates were left in place and greatly contributed to the recession of
1919-20. Warren G. Harding ran for President in 1920 on a slogan promising
a "return to normalcy" regarding tax rates; he was elected in a landslide.
The subsequent rolling back of the rates ushered in the economic expansion
of the "Roaring Twenties." After World War II, wartime tax rates were quickly
reduced, and the American economy enjoyed a smooth transition to peacetime.
In Japan and West Germany, however, there was no adjustment of the rates;
as a result, postwar economic recovery was delayed. Germany's recovery
began in 1948, when personal income-tax rates were reduced under Finance
Minister Ludwig Erhard, and much of the government regulation of commerce
came to an end. Japan's recovery did not begin until 1950, when wartime
tax rates were finally rolled back. In each case, reduced rates produced
increased revenues for the government. The political leader must fully
appreciate the distinction between tax rates and tax revenues to discern
the desires of the electorate. |
The easiest way for a political leader to determine whether
an increase in rates will produce more rather than less revenues is to
put the proposition to the electorate. It is not enough for the politician
to propose an increase from, say, point B to point D on the curve. He must
also specify how the anticipated revenues will be spent. When voters approve
a bond issue for schools, highways, or bridges, they are explicitly telling
the politician that they are willing to pay the high
tax rates required to finance the bonds. In rejecting
a bond issue, however, the electorate is not
necessarily telling the politician that taxes are already
high enough, or that point E (or beyond) has been reached. The only message
is that the proposed tax rates are too high a price to pay for the specific
goods and services offered by the government. |
| Only a tiny fraction of all government expenditures are
determined in this fashion, to be sure. Most judgments regarding tax rates
and expenditures are made by individual politicians, Andrew Mellon became
a national hero for engineering the rate reductions of the 1920s, and was
called "the greatest Treasury Secretary since Alexander Hamilton." The
financial policies of Ludwig Erhard were responsible for what was hailed
as "an economic miracle" -- the postwar recovery of Germany. Throughout
history, however, it has been the exception rather than the rule that politicians,
by accident or design, have sought to increase revenues by lowering rates. |
Work vs. productivity |
| The idea behind the "Laffer curve" is no doubt as old
as civilization, but unfortunately politicians have always had trouble
grasping it. In his essay, Of Taxes, written in 1756, David Hume
pondered the problem: |
| Exorbitant taxes, like extreme necessity, destroy industry
by producing despair; and even before they reach this pitch, they raise
the wages of the labourer and manufacturer, and heighten the price of all
commodities. An attentive disinterested legislature will observe the point
when the emolument ceases, and the prejudice begins. But as the contrary
character is much more common, 'tis to be feared that taxes all over Europe
are multiplying to such a degree as will entirely crush all art and industry;
tho' perhaps, their first increase, together with other circumstances,
might have contributed to the growth of these advantages. |
| The chief reason politicians and economists throughout
history have failed to grasp the idea behind the "Laffer curve" is their
confusion of work and productivity. Through both introspection and observation,
the politician understands that when tax rates are raised, there is a tendency
to work harder and longer to maintain after tax income. What is not so
apparent, because it requires analysis at the margin, is this: As taxes
are raised, individuals in the system may indeed work harder, but their
productivity declines. Hume himself had some trouble with this point: |
| There is a prevailing maxim, among some reasoners, that
every new tax creates a new ability in the subject to bear it, and that
each increase
of public burdens increases proportionably the industry of
the people. This maxim is of such a nature as is most likely to be abused;
and is so much the more dangerous as its truth cannot be altogether denied:
But it must be owned, when kept within certain bounds, to have some foundation
in reason and experience. |
Twenty years later, in The Wealth of Nations,
Adam Smith had no such problem: In his hypothetical pin factory, what is
important to a nation is not the effort of individuals but the productivity
of individuals working together. When the tax rates are raised, the workers
themselves may work harder in an effort to maintain their income level.
But if the pin-making entrepreneur is a marginal manufacturer, the increased
tax rate will cause him to shift into the leisure sphere or into a lower
level of economic activity, and the system will lose all the production
of the pin factory. The politician who stands in the midst of this situation
may
correctly conclude that the increase in tax rates causes
people to work harder. But it is not so easy for him to realize that they
are now less efficient in their work and are producing less. |
| To see this in another way, imagine that there are three
men who are skilled at building houses. If they work together, one works
on the foundation, one on the frame, and the third on the roof. Together
they can build three houses in three months. If they work separately, each
building his own home, they need six months to build the three houses.
If the tax rate on homebuilding is 49 percent, they will work together,
since the government leaves them a small gain from their division of labor.
But if the tax rate goes to 51 percent, they suffer a net loss because
of their teamwork, and so they will work separately. When they were pooling
their efforts, since they could produce six houses in the same time it
would take them to build three houses working alone, the government was
collecting revenues almost equivalent to the value of three completed homes.
At the 51-percent tax rate, however, the government loses all the revenue,
and the economy loses the production of the three extra homes that could
have been built by their joint effort. |
| The worst mistakes in history are made by political leaders
who, instead of realizing that revenues could be gained by lowering tax
rates, become alarmed at the fall in revenues that results when citizens
seek to escape high tax rates through barter and do-it-yourself labor.
Their impulse is to impose taxes that cannot be escaped, the most onerous
of which is a poll tax or head tax, which must be paid annually for the
mere privilege of living. Hume had no difficulty in pointing out the fallacy
of that line of thinking: |
| Historians inform us that one of the chief causes of
the destruction of the Roman state was the alteration which Constantine
introduced into the finances, by substituting a universal poll tax in lieu
of almost all the tithes, customs, and excises which formerly composed
the revenue of the empire. The people, in all the provinces, were so grinded
and oppressed by the publicans [tax collectors] that they were glad to
take refuge under the conquering arms of the barbarians, whose dominion,
as they had fewer necessities and less art, was found preferable to the
refined tyranny of the Romans. |
The trouble with a poll tax, as Hume noted, is that it
can be escaped -- one method being not to defend your country against an
aggressor who promises to remove the tax as soon as he has gained power.
Montesquieu made a similar observation in Book XIII of The Spirit of
the Laws:
"Because a moderate government has been productive of
admirable effects, this moderation has been laid aside; because great taxes
have been raised, they wanted to carry them to excess; and ungrateful to
the hand of liberty, of whom they received this present, they addressed
themselves to slavery, who never grants the least favor. Liberty produces
excessive taxes; the effect of excessive taxes is slavery; and slavery
produces diminution of tribute. . . ." |
| It was this excess of taxes that occasioned the prodigious
facility with which the Mahommedans carried on their conquests. Instead
of a continual series of extortions devised by the subtle avarices of the
Greek emperors, the people were subjected to a simple tribute which was
paid and collected with ease. Thus they were far happier in obeying a barbarous
nation than a corrupt government, in which they suffered every inconvenience
of lost liberty, with all the horror of present slavery. |
| Modern governments have at least abandoned the notion
of using a poll tax to generate revenues. Instead, they often go directly
to the barter economy in search of revenues. Activities previously not
admitted to the money economy and public marketplace because of public
disapproval -- e.g., gambling and pornography -- are welcomed because of
the promise of revenues. But this process tends to lower the quality of
the marketplace itself, hastening the exodus or discouraging the entry
of enterprises that have earned public approbation. |
"Cracking down" |
| Another timeless remedy of governments that find revenues
failing in the face of rising tax rates is to increase the numbers and
powers of the tax collectors. Invariably, this method further reduces the
flow of revenues to the treasury. Yet even with a thousand-year history
of failure, the policy of "cracking down" on tax evasion remains a favorite
of modern governments. Here is Adam Smith, in The Wealth of Nations,
on why such policies are doomed from the start: |
| "Every tax ought to be so contrived as both to take out
and to keep out of the pockets of the people as little as possible, over
and above what it brings into the public treasury of the state. A tax may
either take out or keep out of the pockets of the people a great deal more
than it brings into the public treasury in the four following ways. |
| "First, the levying of it may require a great number
of officers, whose salaries may eat up the greater part of the produce
of the tax, and whose perquisites may impose another additional tax upon
the people. |
| "Secondly, it may obstruct the industry of the people,
and discourage them from applying to certain branches of business which
might give maintenance and employment to great multitudes. While it obliges
the people to pay, it may thus diminish, or perhaps destroy, some of the
funds which might enable them to do so. |
| "Thirdly, by the forfeitures and other penalties which
these unfortunate individuals incur who attempt unsuccessfully to evade
the tax, it may frequently ruin them, and thereby put an end to the benefit
which the community might have received from the employment of their capitals.
An injudicious tax offers a great temptation to smuggling. But the penalties
of smuggling must rise in proportion to the temptation. The law, contrary
to all the ordinary principles of justice, first creates the temptation,
and then punishes those who yield to it; and it commonly enhances the punishment
too in proportion to the very circumstances which ought certainly to alleviate
it, the temptation to commit the crime. |
| "Fourthly, by subjecting the people to the frequent visits
and odious examination of the tax-gatherers, it may expose them to much
unnecessary trouble, vexation, and oppression; and though vexation is not,
strictly speaking, expense, it is certainly equivalent to the expense at
which every man would be willing to redeem himself from it." |
| Adam Smith's point about smuggling may now seem obscure.
After all, smuggling was something that went on in the 18th century, wasn't
it? Consider the following excerpts from a recent editorial in The Wall
Street Journal, which urged New York State and New York City to reduce
their combined cigarette tax from 26¢ to 10¢ a pack: |
| Through our browsings in the United States Tobacco journal
we have learned of estimates that half the cigarettes smoked in New York
City are smuggled in from North Carolina, where the tax is 2¢ a pack.
State Senator Roy M. Goodman, a Manhattan Republican, says the state and
city are losing $93 million a year in this fashion. The smugglers load
40-foot trailers with 60,000 cartons purchased legally at $2.40 each and
peddle them in the city via the organized crime network for $3.75, which
is $1.25 or more below legitimate retail. |
| Mr. Goodman recommends a one-year suspension of the city's
8¢-a-pack tax in order to break up the smuggling, plus an increase
in the state enforcement field staff to 250 from the current 50, plus five
years in jail for anyone caught smuggling 20,000 cartons or more. Last
year only nine smugglers were jailed, each for a few months, with the common
penalty $10 or $15. |
| If Mr. Goodman's solution were adopted, at the end of
the year the smugglers would be back, and the state would have a bigger
bureaucracy. More smugglers would be caught, more judges and bailiffs and
clerks would have to be hired, more jails would have to be built and more
jailers hired. The wives and children of the jailed smugglers would go
on welfare. |
| Cutting the tax to 10¢ avoids all that. It immediately
becomes uneconomic to smuggle. The enforcement staff of 50 can be assigned
to more useful work, the state saving $1 million on that count alone. The
courts would be less clogged with agents and smugglers, and the taxpayers
would save court costs, as well as the costs of confining convicted smugglers
and caring for their families. |
| The state and city would appear to face a loss of $50
million or $60 million in revenues, but of course smokers would now buy
their cigarettes through legitimate channels and the 10¢ a pack would
yield about as much in revenues as 26¢ a pack yields now. But that's
not all. Legitimate dealers would double their cigarette sales, earning
higher business profits and personal income that the city and state then
taxes. |
| And don't forget the impact on the millions of cigarette
smokers who would save 16¢ a pack. At a pack a day, that's $58.40
per year. At average marginal tax rates, a smoker has to earn more than
$80 before Federal, state, and city taxes are deducted to get that amount.
He can thus maintain his or her standard of living on $80 less in gross
wage demands per year, which means it becomes economic for the marginal
employer to do business in New York, increasing the number of jobs of all
varieties and reducing cost and tax pressure on social services. |
| Among other benefits, the industrious smugglers would
have to find legitimate employment. It might be argued that they would
he thrown on the welfare rolls. But it we know New York City, they are
already on the welfare rolls, and would be forced to get off once they
have visible jobs. |
| The Finance Office of New York City, unwilling to take
the advice of either Adam Smith or The Wall Street Journal, simply
rejected the idea that lowering rates would produce expanded revenues.
But Adam Smith's advice was not even taken in England at the time he tendered
it. The theory was not tested until 1827, and then only by accident, by
an Act of Parliament. Oddly enough, the incident in question involved tobacco
smuggling. Stephen Dowell gives the following account in A History of
Taxation and Taxes in England: "The consumption of tobacco had failed
to increase in proportion to the increase in the population. A curious
circumstance had happened as regards the duty on tobacco. In effecting
the statutory rearrangement of the duties in the previous year, the draughtsman
of the Bill, in error, allowed one fourth of the duty to lapse in July.
Unconsciously he had accomplished a master stroke, for his reduction in
the duty was followed by a decrease in smuggling so considerable as to
induce [Chancellor of the Exchequer] Robinson to allow his [budget] surplus,
estimated at about £700,000, to go to continue the reduction thus
unconsciously effected." |
| The Politburo of the Soviet Union has the same problem
as the Finance Office of New York City: It also rejects the idea behind
the "Laffer curve." The greatest burden to Soviet economic development
is Soviet agriculture. Roughly 34.3 million Soviet citizens, out of a total
population of 250 million, are engaged in producing food for the nation
-- and there is never enough. The United States, by contrast, employs only
4.3 million workers in food production, out of a total population of 200
million, generating an annual surplus for export equivalent to one-fourth
the entire Soviet output. The drain on the Soviet economy is not only the
low productivity of the farm sector. Because there are always shortages,
and the state puts farm goods on the market at regulated prices rather
than using the market system to allocate what is available, Soviet citizens
spend billions of hours annually waiting on lines. If food were produced
in plentiful quantities, it could still be allocated through regulated
prices in conformance with Soviet ideology, but most of the lines would
disappear, and the talents and energies of the urban work force would not
be wasted in long lines. |
| The real source of this problem is the high marginal
tax rates exacted on the state's collective farms. The state provides land,
capital, housing, and other necessities on its collectives. It also permits
the workers to keep 10 percent of the value of their production. The marginal
tax rate is thus 90 percent. In agriculture, a small expenditure of effort
might yield, say, 100 units of production; but twice the effort might be
required for 150 units, and four times the effort for 200 units. The worker
on the collective thus faces a progressive tax schedule so withering that
any incentive to expend anything beyond a minimal effort is lost. With
minimum work, he gets land, capital, housing, and other necessities, as
well as 10 units of output. By quadrupling his effort (not necessarily
physical effort, but perhaps increased attentiveness to details), he gets
the same services and only 10 more units of output. |
| Meanwhile, however, the peasants on the collective farms
are also permitted to tend private plots, the entire output of which is
theirs to keep. The tax rate on these private plots is zero. Here is the
result, as detailed by Hedrick Smith in The Russians: "Twenty-seven percent
of the total value of Soviet farm output -- about $32.5 billion worth a
year -- comes from private plots that occupy less than 1 percent of the
nation's agricultural lands (about 26 million acres). At that rate, private
plots are roughly 40 times as efficient as the land worked collectively.
. . .Peasants farm their own plots much more intensively than they do collective
land." |
| Ultimately, the Communist ideal is to have this last
embarrassing but necessary vestige of private enterprise wither away as
industrialized state farming grows in scale and output. Nikita Khrushchev,
in spite of rural roots, pursued that end vigorously and earned the enmity
of the peasantry. He cut the size of private plots to a maximum of half
an acre and made life difficult for the farm market trade. I was told by
Russian friends that Ukrainian peasants became so irate that they stopped
selling eggs as food and made paint out of them. |
| Under Brezhnev things have improved. The maximum plot
went back up to an acre and measures were taken to improve farm market
operations. Soviet figures show the private farm output grew nearly 15
percent from 1966 to 1973. |
| In terms of the "Laffer curve," what Khrushchev did by
reducing the size of the private plots from one acre to one-half acre was
to increase the marginal tax rate of the system from point C to point A.
This was undoubtedly a major cause of his political downfall. On the other
hand, Brezhnev moved the marginal tax rate of the system back to point
C, increasing output and revenues to the previous levels. This was an "economic
miracle" of minor dimensions, but it has undoubtedly contributed heavily
to Brezhnev's durability as a political leader. |
The politics of the "Laffer curve" |
The "Laffer curve" is a simple but exceedingly powerful
analytical tool. In one way or another, all
transactions, even the simplest, take place along it.
The homely adage, "You can catch more flies with molasses than with vinegar,"
expresses the essence of the curve. But empires are built on the bottom
of this simple curve and crushed against the top of it. The Caesars understood
this, and so did Napoleon (up to a point) and the greatest of the Chinese
emperors. The Founding Fathers of the United States knew it well; the arguments
for union (in The
Federalist Papers) made by Hamilton, Madison, and Jay reveal an understanding
of the notion. Until World War I -- when progressive, taxation was sharply
increased to help finance it -- the United States successfully remained
out of the "prohibitive range." |
| In the 20th century, especially since World War I, there
has been a constant struggle by all the nations of the world to get down
the curve. The United States managed to do so in the 1920s, because Andrew
Mellon understood the lessons of the "Laffer curve" for the domestic economy.
Mellon argued that there are always two prices in the private market that
will produce the same revenues. Henry Ford, for example, could get the
same revenue by selling a few cars for $100,000 each, or a great number
for $1,000 each. (Of course, Ford was forced by the threat of competition
to sell at the low price.) The tax rate, said Mellon, is the "price of
government." But the nature of government is monopolistic; government itself
must find the lowest rate that yields the desired revenue. |
| Because Mellon was successful in persuading Republican
Presidents -- first Warren G. Harding and then Calvin Coolidge -- of the
truth of his ideas the high wartime tax rates were steadily cut back. The
excess-profits tax on industry was repealed, and the 77-percent rate on
the highest bracket of personal income was rolled back in stages, so that
by 1925 it stood at 25 percent. As a result, the period 1921-29 was one
of phenomenal economic expansion: G.N.P. grew from $69.6 billion to $103.1
billion. And because prices fell during this period, G.N.P. grew even faster
in real terms, by 54 percent. At the lower rates, revenues grew sufficiently
to enable Mellon to reduce the national debt from $24.3 billion to $16.9
billion. |
| The stock market crash of 1929 and the subsequent global
depression occurred because Herbert Hoover unwittingly contracted the world
economy with his high-tariff policies, which pushed the West, as an economic
unit, up the "Laffer curve." Hoover compounded the problem in 1932 by raising
personal tax rates almost up to the levels of 1920. |
| The most important economic event following World War
II was also the work of a finance minister who implicitly understood the
importance of the "Laffer curve." Germany had been pinned to the uppermost
ranges of the curve since World War I. It took a financial panic in the
spring of 1948 to shake Germany loose. At that point, German citizens were
still paying a 50-percent marginal tax rate on incomes of $600 and a 95-percent
rate on incomes above $15,000. On June 22, 1948, Finance Minister Ludwig
Erhard announced cuts that raised the 50-percent bracket to $2,200 and
the 95-percent bracket to $63,000. The financial panic ended, and economic
expansion began. It was Erhard, not the Marshall Plan, who saved Europe
from Communist encroachment. In the decade that followed, Erhard again
and again slashed the tax rates, bringing the German economy farther down
the curve and into a higher level of prosperity. In 1951 the 50-percent
bracket was pushed up to $5,000 and in 1953 to $9,000, while at the same
time the rate for the top bracket was reduced to 82 percent. In 1954, the
rate from the top bracket was reduced again, to 80 percent, and in 1955
it was pulled down sharply, to 63 percent on incomes above $250,000; the
50-percent bracket was pushed up to $42,000. Yet another tax reform took
place in 1958: The government exempted the first $400 of income and brought
the rate for the top bracket down to 53 percent. It was this systematic
lowering for unnecessarily high tax rates that produced the German "economic
miracle." As national income rose in Germany throughout the 1950s, so did
revenues, enabling the government to construct its "welfare state" as well
as its powerful national defense system. |
| The British empire was built on the lower end of the
"Laffer curve" and dismantled on the upper end. The high wartime rates
imposed to finance the Napoleonic wars were cut back sharply in 1816, despite
warnings from "fiscal experts" that the high rates were needed to reduce
the enormous public debt of £900 million. For the following 60 years,
the British economy grew at an unprecedented pace, as a series of finance
ministers used ever-expanding revenues to lower steadily the tax rates
and tariffs. |
| In Britain, though, unlike the United States, there was
no Mellon to risk lowering the extremely high tax rates imposed to finance
World War I. As a result, the British economy struggled through the 1920s
and 1930s. After World War II, the British government again made the mistake
of not sufficiently lowering tax rates to spur individual initiative. Instead,
the postwar Labour government concentrated on using tax policy for Keynesian
objectives -- i.e., increasing consumer demand to expand output. On October
23, 1945, tax rates were cut on lower-income brackets and surtaxes were
added to the already high rates on the upper-income brackets. Taxes on
higher incomes were increased, according to Chancellor of the Exchequer
Hugh Dalton, in order to "continue that steady advance toward economic
and social equality which we have made during the war and which the Government
firmly intends to continue in peace." |
| From that day in 1945, there has been no concerted political
voice in Britain arguing for a reduction of the high tax rates. Conservatives
have supported and won tax reductions for business, especially investment-tax
income credits. But while arguing for a reduction of the 83-percent rate
on incomes above £20,000 (roughly $35,000 at current exchange rates)
of earned income and the 98-percent rate on "unearned income" from investments,
they have insisted that government first lower its spending, in
order to permit the rate reductions. Somehow, the spending levels never
can be cut. Only in the last several months of 1977 has Margaret Thatcher,
the leader of the opposition Conservative Party, spoken of reducing the
high tax rates as a way of expanding revenues. |
In the United States, in September 1977, the Republican
National Committee unanimously endorsed the plan of Representative Jack
Kemp of New York for cutting tax rates as a
way of expanding revenues through increased business
activity. This was the first time since 1953 that the GOP had embraced
the concept of tax cuts! In contrast, the Democrats under President Kennedy
sharply cut tax rates in 1962-64 (though making their case in Keynesian
terms). The reductions successfully moved the United States economy down
the "Laffer curve," expanding the economy and revenues. |
| It is crucial to Western economic expansion, peace, and
prosperity that "conservative" parties move in this direction. They are,
after all, traditionally in favor of income growth, with "liberals" providing
the necessary political push for income redistribution. A welfare state
is perfectly consistent with the "Laffer curve," and can function successfully
along its lower range. But there must be income before there can be income
redistribution. Most of the economic failures of this century can rightly
be charged to the failure of conservatives to press for tax rates along
the lower range of the "Laffer curve." Presidents Eisenhower, Nixon and
Ford were timid in this crucial area of public policy. The Goldwater Republicans
of 1963-64, in fact, emphatically opposed the Kennedy tax-rate cuts! |
| If, during the remainder of this decade, the United States
and Great Britain demonstrate the power of the "Laffer curve" as an analytical
tool, its use will spread, in the developing countries as well as the developed
world. Politicians who understand the curve will find that they can defeat
politicians who do not, other things being equal. Electorates all over
the world always know when they are unnecessarily perched along the upper
edge of the "Laffer curve," and will support political leaders who can
bring them back down. |