Economists don’t like the Laffer curve
Economists tend to roll their eyes when the Laffer curve is mentioned. A panel of elite academic economists across the political spectrum found in 2012 that none of its respondents agreed that the United States was on the wrong side of the curve. Even George Stigler, a leader of the Chicago School of Economics who disliked taxes at least as much as Laffer, described the Laffer curve as “more or less a tautology.”
Yet the idea has been influential for more than 40 years. The Laffer curve did not begin as a formal economic theory, but as a simple depiction of the relationship between tax rates and government revenue. Legendarily, perhaps apocryphally, it was scribbled onto a napkin after dinner.
The concept is simple enough. As tax rates increase, people’s incentives to work and make investments decrease because they make less money from them. Above some rate, taxes become so onerous that total revenue goes down because people aren’t as economically active as they would be in a world with lower taxes. The big question is what that rate — the tipping point on the Laffer curve — actually is.
Laffer may have named the curve, but the idea was not original to him. As proponents in the late 1970s liked to point out, the general idea dates to the Arab social theorist Ibn Khaldun, who wrote in the 14th century, “At the beginning of a dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.”
Conservative politicians loved it
Yet it was Laffer’s variant that caught the ear of Republicans in the late 1970s, just as they were shifting from a position as the party of balanced budgets to the party of tax cuts. Indeed, the Laffer curve was a way to say, “Why not both?” One influential ear Laffer caught was that of Wall Street Journal associate editor Jude Wanniski, who made the curve a centerpiece of his 1978 book, “The Way the World Works.”
Laffer and Wanniski had a champion in Congress as well, in former Buffalo Bills quarterback Jack Kemp. In April 1977, Kemp introduced a bill to cut income tax rates by 30 percent across the board. He started talking about the Laffer curve in October and over the next year mentioned it several more times in Congress.
But it was only with the June 1978 passage of California’s Proposition 13, which slashed property taxes, that the Laffer curve argument exploded into the mainstream. In this new atmosphere of “tax revolt,” the Laffer curve came up 128 times in the Congressional Record in less than four months. During this period, it was debated respectfully by both parties, even if they disagreed on its implications. But discussion temporarily ended with passage of the Revenue Act of 1978, which slashed the capital gains tax, though not income tax.
President Ronald Reagan championed it
It was not until June 1980 that the nomination of Ronald Reagan, a champion of Kemp-style tax cuts, returned the Laffer curve to the center of political attention. In this round of debate, it took on a distinctly different meaning. While Republicans referred to the curve in positive or neutral ways, Democrats took the idea less seriously, calling it “crazy” or “Alice in Wonderland economics.” Mentions waned again, however, after Reagan’s tax cut passed in August 1981.
The Economic Recovery Tax Act did not lead to promised revenue increases. Federal receipts fell by an average of 13 percent in the four years following the passage of the Economic Recovery Tax Act. For Democrats, this represented a decisive rejection of the Laffer curve argument, and it became an ironic, cautionary tale of the Reagan administration: a “joke,” “nonsense” and — commonly — a “laugher.”
Though the concept is now highly politicized, it took several years for Democrats to move from taking the Laffer curve seriously to dismissing it as a joke. In today’s environment — more partisan and with a faster news cycle — one can imagine such a process taking place over weeks, rather than years.
We are again in a period where economic ideas from beyond the academic consensus have gained political traction on the left and the right. The discipline of economics may dismiss such ideas in the short run, but political influence does not require academic support. If policymakers take such ideas seriously, we can expect academics to respond. One way or another, such once-marginal ideas will make it back to the center of academic debate.