Another Look at the Laffer Curve

Washington Post columnist Ezra Klein has posted the results of a rather interesting survey of economists and policy advocates regarding the “correct” place to be on the Laffer Curve.

I’ve heard the 70% figure quoted before, and I’ve heard the 20% figure quoted, but now I know why there’s a discrepancy. The 70% figure is the short-run revenue-maximizing tax rate, whereas the 20% figure is the growth-maximizing tax rate.

In other words, if you set the rate on the top tax bracket to 70%, you will maximize your government’s revenue as a percentage of GDP. However, that does not take into account the effects on GDP growth. In the long term, the slower economic growth brought on by high tax rates will have the government collecting much less revenue than it could be, as an absolute figure, a decade later. On the other hand, if you set the rate on the top tax bracket (or indeed, all tax brackets) to 20%, then growth in absolute revenue is maximized, as the GDP rises. This latter strategy means the most productivity and prosperity in the long run.

Making this distinction effectively explains the results of the Australian experiment I’ve described in the past.

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