Who’s Laffing now?

In the folklore of economics, the famous Laffer curve made its first appearance in the mid-1970’s on a dinner napkin. US economist Arthur Laffer was sketching out to his dinner companions the relatively simple proposition that if taxes are raised too high, at some point revenue from taxes will actually fall. With exceptionally high taxes, people will avoid them by cutting back on the activity being taxed or by moving such activities “underground”.

Among economists, there is little question that something like a Laffer curve for a given tax exists. If all income was taxed at 95%, this would certainly affect the incentive to work. Similarly, “sin taxes” on goods like alcohol and tobacco are explicitly designed as measures to reduce harmful activities. Set high enough, taxes will discourage the activity being taxed, though by how much depends on what is being taxed. Some goods like insulin or gasoline are considered “inelastic”, meaning people will not consume that much less even with a rather large increase in price, for a variety of reasons.

Anyhoo, the Wall Street Journal posted a graphic recently to “demonstrate” the Laffer curve – using multiple countries as data points. Several economists have debunked it, but Brendan Nyhan does a pretty nice job by fitting the lines more appropriately than the scandalous misrepresentation the WSJ cooked up. It makes for a humorous read.