The Laffer Curve: Taxes and Economic Output

The Laffer Curve: Taxes and Economic Output

Economics Without The B.S.**: 

[**  Double entendre intended.]

With the Trump Tax Cuts/Reform now before the nation in Republican hands in Congress, let's look back on a discussion item from the Reagan years when tax cuts were discussed, the Laffer Curve.

The Laffer Curve displays the relationship between tax rates/revenues and economic output (GDP).

Taxes are just transfer payments. Tax cuts are transfer payments from the government to individuals and businesses. Tax increases are the reverse: transfer payments to government from individuals and businesses.

While the Laffer Curve drew the Tax Rate on the y-axis and Tax Revenues on the x-axis, the x-axis can be a representation of economic performance (GDP) with optimum economic output yielding optimum revenues from a desired tax rate that does not hamper productive incentives. If the tax rate is too high it will dampen the initiative of individuals and businesses to engage in commerce. If the tax rate is too low it will stifle the government from providing the services and investment needed by society.

Vic Volpe Retweeted Vic Volpe

Arthur Laffer's napkin tax curve

For the nation to derive an economic benefit from either tax cuts or tax increases for this transfer of money between the government and individuals/businesses, the question is, Who benefits? Where is the greatest return? So, how is the money spent if individuals/businesses get the money versus how is the money spent if government gets the money?

One key is the Savings/Investment versus Consumption expenditures -- Consumption expenditures by government would be the welfare function while Investment could be defense spending, R&D, infrastructure, government plant and equipment, NASA projects, etc. And on the other side of the economy, the private sector of individuals and businesses, personal consumption expenditures account for approximately 70% of GDP.

During the 1960s, with tax cuts in 1964, Gross Private Domestic Investment doubled; and during the 1990s tax increases Gross Private Domestic Investment also doubled. During the 1990s the tax increases went toward paying down the Federal Government debt while budget deficits were reduced and small budget surpluses were being produced during the latter 1990s, all helping to increase the Savings/Investment Ratio.

https://fred.stlouisfed.org/graph/?g=fpmg

During the Bush Tax Cuts 2001/2003 investment increased but more moderately and only for 5 years; as a result, economic recovery peters out. The same was true for personal consumption.

So tax cuts/increases in and of themselves don't make the economy better or worse -- it is what is done with the money, consumption versus investment. And even with consumption versus investment, it is what would benefit the economy more; what is the multiplier that will ripple through the economy and act as a driver for good broad economic growth.

And here is the economic performance. [Hasn't been a good trendline since the 1960s, has it?]

https://fred.stlouisfed.org/graph/?g=fpmG

The Monetary Policy Quagmire

The Monetary Policy Quagmire

Economics Without The B.S.**: 

[**  Double entendre intended.]

The Monetary Policy quagmire: right now the Fed is pondering how to revive our economy from its real GDP growth of 2%.  Monetary Policy is a blunt instrument whereas Fiscal Policy can be a surgical knife.  Our $20 trillion economy is big and diverse; and, right now uneven in performance among productive sectors and geographically. 

The economy needed restructuring (put emphasis on design, R&D, innovation) after 2008; instead Obama/Democrats patched up the old economy.  And Republicans, with their Laissez Faire ideology, have never understood how to get good growth out of our economy.  Their "starve the beast" ideology, running up the Federal Government debt so that no further fiscal spending can be accomplished, has put our economy in a stagnant growth cycle of real GDP growth between 2% to 3% instead of 4% to 5%.

Fiscal Policy can be directed at specific sectors of the economy and specific geographical areas of the country. Monetary Policy cannot.  It is difficult for Monetary Policy to work in an uneven economy because Monetary Policy involves broad applications, not specific fixes.  Today Fiscal Policy advocates have weak policies and applications -- e.g., infrastructure funding, tax reform. incentives that are too general. 

Conservatives with their Laissez Faire policies is like an 8-cylinder car running on 6-cylinders. That's why we have economic growth at a real GDP of 2% to 3% instead of 4% to 5%. The 1960s was over 5%; almost three times more than what we have been since 2000.  An economy like ours, $20 trillion, can still grow without Federal Government intervention, but it is growing on inertia instead of being driven by a dynamo.

Republicans cannot advocate for Fiscal Policy because Government would be an interventionist in the economy and Republicans are for limiting Government not enhancing it.  Democrats/Progressives fail to make an argument for good economic growth. Their other issues (environment, anti-gentrification, etc.) get in the way.  Our democratic process needs/thrives on a vibrant economy, not economic stability. Full employment is when all can realize their skill potential.

Let's have that political fight that Bannon wants: within each political party

Let's have that political fight that Bannon wants:

within each political party

Economics Without The B.S.**: 

[**  Double entendre intended.]

Steve Bannon wants Republicans to have a fight.  
https://www.usatoday.com/story/news/politics/2017/09/29/steve-bannons-breitbart-going-war-against-gop-incumbents/717724001/

Matt Schlapp, American Conservative Union, says Republicans need to have that fight over direction of Republican Party.  Yes, and Liberals and Old Style Democrats (like myself) need to have that fight: the role of Government in Society and the role of America in the World.

Role of America in the World -- We just had a Vietnam series on PBS, showing a mis-reading by Greatest Generation of conflict of ideology vs dis-establishing colonial empires after WWII. But, it is still America's role in World to set an example and help people toward self-government (a democratic process) and peaceful resolution of conflicts. That secures the blessings of liberty.

When you hear someone, of the political Left or Right, talk about America's role in the World using pejorative terms like 'nation-building' or 'policeman of the world', put these into the greater context of the previous paragraph to determine what interests are being served.  In a less than perfect world, what is the ultimate outcome trying to be achieved?  And can less than optimum solutions, while not perfect, put us in the right direction and keep us on the right side of an issue?

Role of Government in Society -- use 1960s as example, it is the best economic performing period in American history with nothing close to it (within 40% of economic growth of this 10 year period):  so, get Federal Government spending and revenues within 15% to 17% of GDP (has been over 20% since 2008) and real GDP (inflation adjusted ) sustained broad-based economic growth up to 3% to 4% (has been no better than 2% since 2001).  Get the national (public held) debt-to-GDP down to 40% (currently over 100%). With that our society can afford to have a social-welfare function of Government and support programs like Social Security and Healthcare for all.  And it can also support an activist international function (both economic and diplomatic) supplemented with strong military involvement.

Simply speaking about the nation's debt without taking into account the level of debt in relation to the overall economy or the rate of growth of the debt in relation to the rate of growth of the economy becomes a meaningless discussion unless its purpose is to stir up political pointers.  The same can be said for proposing new spending programs, however beneficial, without taking into consideration what they will do with the performance of the overall economy.  And the same can be said with cutting taxes and what effect that will have on revenues.

A nation's priorities are determined by people and their leaders as to what role they want to play in the quest for human progress.  America has always looked upon itself, since very early in our history, as a leader in that quest.