The Laffer Curve
The Laffer Curve
To the Editor:
Roger Starr’s review of Jude Wanniski’s The Way the World Works [Books in Review, September 1978] challenges the Laffer model by innuendo, not honest scholarship. . . . Wanniski’s fundamental thesis is never fully addressed by Mr. Starr. Stripped to its core, Wanniski’s argument is that production is first and foremost a function of incentive. When the incentive . . . is reduced or eliminated, production drops or disappears. . . .
Marxist countries have learned this lesson well. They fully appreciate the role of incentive in human production, and their tax systems are designed accordingly. The government may confiscate 90 per cent of the first x units of output, 50 per cent of additional x units of output, and only 10 per cent of the third incremental x units of output. A clear message indeed. The more you work, the more you receive. This system attempts to encourage additional units of output, not discourage them as the British and American systems do.
Mr. Starr continually insults the economic intelligence of the free-world “global electorate.” If the proletarian masses throughout the Marxist world intuitively understand the basis of marginal economics, why does Mr. Starr assume that the producers in the free-market economies lack the same commonsensical understanding of production and reward? These workers (myself included) express their understanding of marginal economics and progressive taxation through action rather than public-policy statements.
The empirical evidence supporting this position abounds: the emigration of many wealthy Britons and Swedes; the uncharacteristically high upper-class consumption rates in those nations with severely progressive tax structures (exceeding 100 per cent in some situations); the significant productivity declines in countries where even the lower-middle-class has been forced into higher-rate tax brackets due to inflation (see Puerto Rico and Brazil); the explosion of underground money financing unreported market exchanges. . . . The list of examples is almost endless.
Two important elements stand out. First, as the size of the wedge increases—i.e., as the gap between wages paid and wages received remains prohibitively large—workers will find leisure time less and less expensive and will thus reallocate their time away from production and toward leisure (this includes corporations which will reduce capital investment). Only those projects will be selected which promise sufficiently high returns on investment to overcome, at least partially, the wedge effects. Second, the amount of lost government revenues due to avoidance, evasion, or work/leisure trade-offs will continue to be astronomical.
Mr. Starr chides Laffer for his reluctance to locate unambiguously the coordinates of the optimal rate. However, establishing this optimal rate precisely is not the critical issue. What should be asked is: are we now in the prohibitive tax range, where any additional tax-rate increase further reduces total revenue and total output? (If Proposition 13 and the other myriad tax-cut initiatives . . . are any indication, the “unschooled ‘global electorate’” may be in the process of responding to that question.)
Finally, Mr. Starr exposes his hand when he accuses Wanniski of missing “that the growth of government’s compass is at least as important a fact of modern political life as the resistance to higher taxes.” Ah, yes, that does seem to be a problem.
David H. Wilkof
Los Angeles, California
Roger Starr writes:
I praised Wanniski’s use of the Laffer-curve concept as a device for asking the basic economic question: how is production possible? But the more Wanniski uses it to explain specific historical events, the more egregious becomes its inability to establish an optimum level of taxation for any period. If, as he asserts, high taxes destroyed the Roman empire, why did the destruction come at one level of taxation rather than another? If the New York Stock Exchange crashed in October 1929 in fear of higher tariffs, why has it survived upward tariff shifts at other times without panic, and why has it succumbed at moments when neither taxes nor tariffs were under discussion?
Since it is not I who am charged with manipulating an invisible hand, I must plead guilty to David H. Wilkof’s charge of exposing mine. But what secret shame have I revealed? That I wish taxes were lower. That I yearn for less governmental intervention in the productive process. That I believe the American public has been unable to choose between the benefits of higher disposable income in private hands and the promise of greater security and more profound social equity by continuing government absorption of that same income. Does Mr. Wilkof believe that the passage of Proposition 13 in California proved, even there, that the public has made its choice? I do not.