The Laffer Curveball

"It ain't necessarily so." -- from Porgy and Bess, by George and Ira Gershwin

"It's a long, long time, from May to December." -- September Song, by Maxwell Anderson and Kurt Weill
　
   One of the key concepts of supply-side economics is the Laffer Curve, which illustrates the tradeoff between tax rates and revenues. The idea itself is not new -- Professor Arthur Laffer himself has pointed out that it goes back at least to the 14th Century. The curve shows that as tax rates go up, so do government revenues, but at a slower rate. Eventually, a boost in tax rates produces zero additional revenue, so at that point -- according to supply-siders -- the way to increase revenue is to reduce taxes.
   The catch is, however, that supply-siders focused solely on that latter part, that the way to increase revenue is to reduce taxes. And much to Professor Laffer's dismay, that was the part that got all the attention.
   The story goes back to 1974, when a Wall Street Journal editor named Jude Wanniski attended a dinner with Laffer, of the University of Chicago; Donald Rumsfeld, then chief of staff with President Gerald Ford; and Dick Cheney, a member of Rumsfeld's staff. Laffer outline the concept for the others, and Wanniski later (1978) wrote a magazine piece extolling the virtues of tax cuts to boost revenues.
   This is the part that conservatives to this day hold dear -- that raising taxes reduces economic activity and eventually erodes government revenue. Therefore, the way to encourage economic growth and boost revenue is to cut taxes, especially at the top, and the benefits will -- eventually -- trickle down to the rest.
   Any excuse to reduces taxes.
   The part they leave out is the part that says there is no rule that a tax cut will increase revenues. Instead, the curve notes that a reduction will bring only a smaller loss in revenue.
   So the trio of conservatives -- Rumsfeld, Cheney and Wanniski -- picked up the idea and threw a curveball. Tax cuts pay for themselves, they and their followers chant. It ain't necessarily so, as the song goes. It's possible that reducing a tax can result in economic growth, more employment and higher income for workers. But it may take a while, and there are no guarantees, especially since the beneficiaries of the tax cuts are likely to keep the extra cash for themselves, and not pass on the benefits in the form of investment in more production and employment.