Not the Laffer Curve again!

I’m a little embarrassed that my previous, rather nasty post was at the top of the home page for so long. I haven’t posted since August! The human has changed jobs and only recently acquired a new netbook that I’m now appropriating. Anyhow, I’m going to make my right-wing bashing a bit more measured going forward. And what better place to start than the Laffer Curve, that piece of economic fantasy from the 1980’s that every now and again gets dragged out and dusted off. Given the supply-side tendencies of the current US vice-presidential hopeful Paul Ryan, such theories are very much in vogue right now.

The theory behind the Laffer curve (originally, so legend would have it, drawn on a napkin during a 1974 meeting) is essentially sound, and intuitive. If you accept that a government cannot raise any revenue at a tax rate of zero percent, or at a rate of 100 percent, there must be a rate somewhere in between at which revenue is maximised. Where the fantasy comes in is with any attempt to show where this point is. Indeed, any attempts to actually plot data for any given country shows a series of disconnected dots not even resembling a curve. The problem with data of this nature is that it is very difficult to establish what effect the tax changes alone have on the economy. Any study that could actually show that the Laffer curve is more than just a warm feeling in the conservative bosom would be big news indeed, especially with the current ideological war raging in the US.

So when I saw this video, I was intrigued:

Firstly I had a bit of a chuckle over what Tim Groseclose had to say about his economics textbook from 1984. My economics textbook from the same era has this to say about it: “Again, things did not turn out as supply-siders hoped. The tax cuts of 1981 did not generate additional tax revenues. Government deficits ballooned.” Oops!

But Groseclose claims we were all misled. And the really interesting bit is that he cites the Romer and Romer study from 2007 as evidence that the curve peaks at a 33% tax rate. He makes a big deal out of the fact that Christina Romer was an economic adviser to President Barack Obama, and the Romers are liberals. Of course, the king of all arguments from authority is one delivered by your ideological foe but supporting your position. Unfortunately for Groseclose, the Romer study does no such thing.

Here’s the study. I’ve spent a few days getting to grips with it, econometrics not being my thing much at all. The Romers isolated the effects of tax changes implemented for mainly ideological reasons, and conclude that such a tax increase has a significant negative effect on GDP (the study did not cover effects on government revenues). It doesn’t show anything we didn’t already know (although it’s great to have the data), that specific, targeted tax changes can be very effective in changing economic behaviour. This is what I’ve been saying for a long time, and it’s why I support the Irish government’s low corporation tax rate; something I’ve been criticised for by some of my more left-leaning friends.

But Groseclose must have some brilliant insight that he’s not sharing with the rest of us when he claims if you “do the math” you come to 33% as a revenue-maximising tax rate. I can’t figure it out and I’m not the only one. Even his fans are scratching their heads over that one. Come on Tim Groseclose, you owe it to conservatives everywhere to show us the math and prove us supply-side sceptics wrong.