The Laffer Curve: A Silly Idea that Just Won’t Die

Today in class I was baffled by a professor bringing up the Laffer curve to argue that taxes should be cut. I had assumed people dismissed the idea that the United States was on the “wrong side” of the Laffer curve as nonsense years ago.

The Laffer curve is a model that claims that governments can increase revenue by cutting taxes. This works because people are motivated to work harder when they keep more of their money. If the tax rate is 0%, the government earns no revenue and if the tax rate is 100% the government earns no revenue because nobody has any motivation to work. Therefore, the optimal tax rate for maximizing revenue is somewhere between 0 and 100%. It is possible that a government would tax too much and be on the “wrong side” of the Laffer curve – in other words, by cutting taxes people would be more motivated, work harder, produce more, and earn more, increasing government revenue over all. The Laffer curve has been used to justify cutting taxes in order to increase revenue.

The problem with the Laffer curve is that while it is conceptually logical, it is not really applicable to the United States given our current tax rates. A basic (vastly simplified) example demonstrates this:

Say Bob earns $100,000 per year and is taxed at 35% annually. The president, in a desire to raise revenue, cuts Bob’s rate to 25%. Under a 35% tax rate, the government earned $35,000 off of Bob. At a 25% rate, Bob would have to earn $140,000 for the government to get the same amount of revenue. He would have to work 40% harder (assuming effort is correlated linearly with salary). If Bob used to work 50 hour weeks, he would suddenly start putting in 70 hour weeks.

What makes this so implausible is that Bob’s sudden increase in effort would have to be motivated solely by the tax cut. Even if it was possible for people to suddenly accomplish 40% more, it seems extremely unlikely that a tax cut alone would suddenly turn people into workaholics. There is plenty of motivation to work hard already, such as a desire to eat, give children a good life, and care for parents. The idea that citizens will suddenly get off their lazy butts and start working 40% harder just because they got a tax cut is somewhere between ridiculous and insulting.

It is even more ridiculous/insulting that Laffer logic is typically used to justify tax cuts for the very rich. If Bob is making a million dollars a year, why would he suddenly work extremely hard for extra money that he doesn’t need to live a good life? Is Bob just that motivated by tax policy? Admittedly, the Laffer curve makes sense at extremely high tax rates. If Bob’s rate drops from 90% to 80%, the government breaks even if Bob works 12.5% harder. It certainly seems plausible that Bob would work slightly harder since he is keeping twice as much per dollar as he used to.

In the United States however, the Laffer curve is, well, laughable. Under even elementary scrutiny, the idea that cutting taxes increases revenue falls apart.