Tuesday, June 8, 2010

The Laffer Curve

It Should Be Called The Mellon Curve

In 1924, Secretary of Treasury Andrew Mellon wrote: "It seems difficult for some to understand that high rates of taxation do not necessarily mean large revenue to the Government, and that more revenue may often be obtained by lower rates."

Exercising his understanding that "73% of nothing is nothing", he pushed for the reduction of the top income tax bracket from 73% to an eventual 24% (as well as tax breaks for lower brackets).
Personal income-tax receipts rose from US$719 million in 1921 to over $1 billion in 1929, an average increase of 4.2% per year over an 8-year period, which supporters attribute to the rate cut.[10]


Amongst others, David Hume expressed similar arguments in his essay Of Taxes in 1756, as did fellow Scottish economist Adam Smith, twenty years later in 1776.

A similar argument was proposed in the 1880s, also by the Republican party, in the face of federal budget surpluses, due to high revenue from import tariffs, which had been raised following the Civil War (1861–1865).
The Democratic party argued that cutting tariffs would lower revenues, while the Republican party made the Laffer curve argument that higher tariffs would lower revenues by reducing imports.

A 1997 analysis concluded that the tariff rate used was less than the revenue maximizing rate.

An argument along similar lines has also been advocated by Ali ibn Abi Talib, the first Shi'a Imam and fourth Caliph of the Islamic empire; in his letter to the Governor of Egypt, Malik al-Ashtar. He writes:
“ If the tax-payers complain to you of the heavy incidence to taxation, of any accidental calamity, of the vagaries of the monsoons, of the recession of the means of irrigation, of floods or destruction of their crops on account of excessive rainfall and if their complaints are true, then reduce their taxes. This reduction should be such that it provides them opportunities to improve their conditions and eases them of their troubles.
Decrease in State-income due to such reasons should not depress you because the best investment for a ruler is to help his subjects at the time of their difficulties. They are the real wealth of a country and any investment on them even in the form of reduction of taxes, will be returned to the State in the shape of the prosperity of its cities and improvement of the country at large. At the same time you will be in a position to command and secure their love, respect and praises along with the revenues. ”

Ali ibn Abi Talib, Nahj al-Balagha, Letter 53


Laffer himself does not claim to have invented the concept, attributing it to 14th century Muslim scholar Ibn Khaldun [wiki]
[Laffer Curve - Wikipedia]


The Laffer Curve: Past, Present, and Future - The Heritage Foundation

The Laffer Curve Is Real …
How the Laffer curve really works

Defending the Arc of Laffer's Curve 

http://www.jstor.org/pss/2297970The Lucas Critique, Policy Invariance and Multiple Equilibria by Roger E. A. Farmer

Self-Confirming Equilibrium and the Lucas Critique

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