The Great Curve

The world moves on a woman’s hips, says David Byrne ^[1], or maybe it was the Weymouths but we know what they are talking about. That taper, swell and taper is hypnotic, notoriously it is used in advertising and product design to subliminally trip primordial triggers. Is it no more than vestigal reproductive instincts? Science seems to demonstrate this geometric construct to be nearly a bedrock of reality; not quite as solid as the speed of light but close enough to earn the name Normal or Standard Deviation ^[2].

And it isn’t just solar intensity or SAT scores that follow this template. Like so many other aspects of finance and economics, a Standard Deviation is historically demonstrated in the relationship between tax rates and tax revenues.

This is the famous/notorious Laffer Curve, the basic foundation of Supply Side Economics. The X axis, along the bottom is your income tax rate. Obviously at a rate of 0% you collect no revenue. But at a rate of 100% you also collect nearly no revenue. The why of that seems plain but perhaps it is not. If there is a 100% rate on income, guess what? then there is NO income. If the taxpayer is going to earn no income from a certain professional action then they will not take that action and the income will never be realized either to that rich bastard or gub coffers. And this is not just theoretical. Those with longer memories may remember a rather bitter ditty for the Beatles, called The Taxman ^[3]. When McCartney complains the taxman offers one for you nineteen for me, a 95% tax rate he was premature. The UK actually had some special rates for performers and other high earners that amounted to rates OVER 100%. This didn’t last long but not because of any principled case against it in British politics, rather it was found through hard experience that these nasty rates did not accomplish the goal of increasing Crown revenues but worse, drove high earners of all stripes to other shores. If you ever wondered why so many Brit-poppers at the highest levels become US citizens in their Golden Years, the burdensome tax structure that yet exists in Blighty is most of the reason.

So zero rates get us zero revenue. And 100%+ rates get us no revenue or even harm existing revenue. What is happening in between? Anyone who works with numbers can make a good guess. It is a bell curve. Revenue rises as rates rise, peaks and then declines. This is not a theory, it is an observation and it is one that obtains through other sorts of taxes like tariffs and sales taxes as well as commercial, non-coercive transactions like prices. If the goal of the Treasury is to maximize its revenue, even if there is NO other consideration like GDP growth or general prosperity or any of that claptrap, then they would still, rationally, want to set rates at the peak of the curve. Where that may be is imprecise and it probably moves marginally with other events but the highest revenues as a fraction of GDP have been reaped around the 30-35% mark.

Some will be more familiar with this concept through the sticky nickname given it by Bush the Elder in his primary struggle against Ronald Reagan. That, of course, is Voodoo Economics.

This gassy dismissal from Bush Pere has never left the national stage. We may hope that it was a cynical, tactical ploy and not the actual view of Bush Sr, especially as he served Reagan’s administration without public qualm on the actual fiscal policies, but who knows? In any case it is always Exhibit A in any pushback on Supply Side policies; a damaging Admission Against Interest from the demonic Republicans. Okay, this prominent spokesmodel is on the record, once and in a primary slugfest, dismissing the Laffer Curve and all its implications. Is that all there is?

Just about, yes. Can anyone dispute that at higher prices fewer goods are sold? Well, income taxes are the price of income. Increase the price and you will have less income. Lower the price and you will get more. Yes, this is the mechanism, hotly debated and derided, that Reagan claimed would “pay for” the tax cuts, meaning that they would not, on net, cost the gub money but MAKE it money. On the timeline this is what happened, not only from the Reagan tax cuts but also the Kennedy tax cuts and other historical instances of taxcutting. As the rates reduce we move to the left on The Great Curve, increasing the tax take because there is that elusive thing everyone now seeks; economic growth.

For the anti-Reagans, this is an insulting fraud. Everyone knows ^[4] Reagan was just lucky. The economy was coming back…. it’s all cyclical, and he just happened to be the dude (or dud) in office. Generally assertions like this are not subject to serious testing, only serious screaming, but we are about to embark on a serious test of the existence, relevance and Greatness of the Laffer Curve.

The Supply Siders assumed we were on the right-hand slope of the curve. If we can move rates down, they surmised, revenues will increase, and so they did whether due to these actions or no. Obama is about to move us (or just allow us to fall, more his style) down the DESCENDING slope of the curve that predicts that higher rates not only will fail to produce proportionate revenue improvements but will collapse revenue. And the beauty is that he need do absolutely nothing to set this in motion. One of the most putrid legacies of the late and unlamented Bush the Younger is those Bush Tax Cuts, universally rebuked in media and academe. These were so controvertial, even with a Republican Congress, that they were enacted only with a sunsetting clause. These rates, which were those in place when we had four percent growth and five percent unemployment, will automatically be raised to their previous level come January 1st, 2011.

Now, neither Obama, Pelosi or any other Democrat will call this a tax hike. No no no no no. This is a repeal of an unjust and irresponsible tax CUT! Okay, let us abandon the semantic ground. That doesn’t change one damn thing mathematically. That doesn’t change the fact that those lucky enough to HAVE legit jobs with 401ks, overtime and witholding will see their checks pruned right after next New Year. That isn’t me, by the way. One mystery not yet answered is whether those lower earners who were completely relieved of income tax liability by the Bush pallate of tax cuts will be re-encumbered but they haven’t been excluded so almost certainly they will. Electoral tactics and ideology aside, is this genius politics? Genius economics?

We shall see but The Great Curve has proven to be just about indestructible up to now. Perhaps it will be more amenable to persuasion going forward.

Hope.