Laffer Curve Laughs

The Laffer Curve, simply, attempts to demonstrate the relationship between tax rates and total tax revenues.

At a tax rate of zero percent, of course, total tax revenues would be zero. At a tax rate of 100%, the hypothesis states, tax revenues would also be zero, as no one would engage in work if 100% of their product were absorbed by taxes.These two extreme zero points represent either end of the Laffer Curve. The shape of the curve in between these two points, and the “optimal rate of taxation,” are the subject of endless theorizing and policy wrangling.

Generally, the debate is whether higher or lower tax rates will produce the greatest overall tax revenues. Conservatives tend to argue that higher tax rates will actually lower overall tax revenues – a condition described by a curve shaped like this:

The theory is that the higher a person’s tax rate, the less they will be motivated to work. There is some intuitive appeal to this argument. At an extreme tax rate of 100%, for example, it seems easy to conclude that no one would continue to work.

A look at our own history, and at other economies around the world, however, suggests something different. A federal income tax only finally took hold in the United States in 1913, at rates ranging 1% and 7%. Since then income tax rates have grown substantially, up to a top rate of 93% as recently as the Eisenhower administration. Yet we have not seen a decrease in tax revenues: people have not gone on strike, and our economy has not collapsed. Many countries in Europe have substantially higher tax rates than the US, yet people not only continue to work, but enjoy an enviably high standard of living.

As another extreme example, most people in the world earn less than $3 per day. One might argue that no reasonable person would labor all day for such a minimal return. Yet people have always labored for even minimal returns; they do so today, and they'll continue to work for a pittance tomorrow and into the future.

People will always be compelled earn a living, and their willingness to tolerate ever higher taxes and ever lower returns is described more by a curve shaped like this:

Certainly most people have an emotional aversion to higher taxes. But the idea that this emotional aversion will drive people to go on strike, quit their jobs, and stop earning livings doesn’t seem to be substantiated (yet – although a spontaneous taxpayers revolt would certainly liven things up).

Most people are remarkably compliant. For the bulk of the world’s populace, the pragmatic considerations of earning a living and feeding one’s family will always trump a righteous indignation – right through war, discrimination, civil oppression, and right up through a tax rate of 99%.