The Laffer Curve
Donald Trump has proposed a huge tax cut, up to 25%, so business can breathe and flourish again. His corporate income tax drops the 35% tax to a 15% tax. The marginal tax also drops significantly according to the Tax Foundation.
There is concern from the left and some on the right that Trump’s tax cuts are too significant and will lead to major deficits or the Trump administration will have to cut programs. Trump has already committed to the latter with his infamous “Draining the Swamp” line.
This concern of deficits and spending cuts leads to a lesson in the Laffer Curve and Bastiat’s “What is Seen and Not Seen”. The Laffer Curve is an economic belief that the tax rate and federal revenue graph is not a straight line from zero to one hundred, but rather there is a vertex of the graph. It states that higher tax rates may negatively affect federal revenue at a certain point. Most economists accept this but the disagreement is where the vertex is. Some say the rate is as high as 70% and others say it lays at 20-30%.
Why is this the case? Bastiat’s what is seen and not seen can give an answer. As so eloquently worded by Bastiat, “When an official spends for his own profit an extra hundred sous, it implies that a tax-payer spends for his profit a hundred sous less. But the expense of the official is seen, because the act is performed, while that of the tax-payer is not seen, because, alas! he is prevented from performing it.” For every dollar spent by the government, is a dollar that can’t be spent in the private sector. Therefore taxes inhibit private spending and growth. When taxes are cut and the money is brought back to the private sector, business can spend that money in new labor and projects. This creates growth which in turn results in more wealth. Now when taxes come around the next year, even though the tax rates are lower, there is a more abundant supply of wealth which possibly means the same amount of revenue as the last year.
Applying this to a hypothetical situation leads to Joe S., a construction business owner. He has 10 workers and his business makes 1 million dollars annually. He pays 35% of this in taxes which leaves him with 650,000 dollars after taxes and 350,000 in federal revenue. The next year corporate income taxes are 15% which means Joe S. Construction has 850,000 dollars after taxes. With this new money can invest in new labor and equipment. With this new labor and equipment Joe S. Construction can take on more jobs and earn more money. The next year comes around and Joe S. Construction makes 1.5 million dollars in revenue. When taxes come around the 15% tax turns into 225,000 dollars in revenue. The federal revenue may not equal the previous revenue but Joe S. Construction has grown in capital and now has 1.275 million dollars after taxes. This allows Joe S. to invest in even more labor and projects than before which generates more wealth. This cycle continues until Joe S. Construction goes out of business or tax rates are increased.
Fullerton, Don (2008). “Laffer curve”. In Durlauf, Steven N.; Blume, Lawrence E. The New Palgrave Dictionary of Economics (2nd ed.). p. 839.
Bastiat, Frederic. “The Essential: Frederic Bastiat”. What is Seen and What is not Seen. p.82
This was written by P.L. who can also be found @_Southern_Conservative_ on Instagram. His opinions are his own and do not necessarily represent the rest of the writers or the blog as a whole.