When is the last time you hurriedly drew an idea on a napkin, only to have that idea come to be a globally recognized economic concept named after you? This is what happened to economist Arthur Laffer in a 1974 meeting with Dick Cheney and Donald Rumsfeld, who at the time worked in the Ford Administration. He sketched his eponymous curve to illustrate his main premise that the more an activity such as production is taxed, the less of it is generated. Likewise, the less an activity is taxed, the more of it is generated. In other words, the Laffer curve is a representation of the relationship between rates of taxation and the resulting levels of government revenue.

Proponents of the curve point to President Ronald Reagan’s economic policy, which resulted in one of the biggest tax cuts in history. During his time in office, tax revenues received by the government increased from $517 billion in 1980 to $909 billion in 1988. However, tax expert Rick Kelo believes that while the highest point of the Laffer Curve may maximize revenue, it may have a negative impact on economic growth. An implication of the Laffer curve is that increasing tax rates too highly will be counter productive, actually hindering the goal of gaining more tax revenue. Hypothetical Laffer curves for variouRick Kelos economies have been estimated and such estimates are controversial.

Those who support the Laffer curve concept claim that it illustrates taxable income elasticity, meaning income will change according to tax rates. It assumes that no tax revenue will be raised at the extreme tax rates of 0% and 100% and that there must be at least one optimal tax rate which maximizes government revenue. The Laffer curve is typically represented as a graph which starts at 0% tax with zero revenue (non-existent), rises to a maximum rate of revenue at an intermediate rate of taxation, then falls again to zero revenue at a 100% tax rate (again, non-existent). But the shape of the curve is uncertain and disputed.

Rick Kelo is a West Point graduate, former agent of the State, and self-proclaimed “Classic Liberal and Rogue Economist”. His area of expertise is taxation. Check out some of his writings at Ceteris Paribus – Economics from the Austrian & Monetarist traditions; political philosophy from the Classic Liberal tradition.

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