Redstate

This is a great catch and a good point.  I would recommend the diary if it had a bit more analysis (such as a brief explanation of the Laffer Curve).  Nevertheless, it is another reminder that a booming economy is the #1 cure for most problems.

Since the states did not cut taxes (and many increased taxes), their increased revenue over last year is just because the economy is stronger than it was last year.  It has nothing to do with the Laffer Curve.

smack that title down.  

Heres a few questions that anyone should be able to answer if they use the term 'Laffer curve' in an arguement.

What will the revenue be if the effective tax rate is 100%?

What will the revenue be if the effective tax rate is 0%.

So we've established the ends of the curve at least.  Now for the question that, if you can answer it, will make you rich beyond the dreams of mortals:

What does the curve look like?  Where are the local maximums?  

and the biggest one:

how does the curve depend on the state of the economy and time? (e.g. what does the Laffer manifold look like).

If I hear one more idiot say 'see, that proves (or disproves) the laffer curve', I'm going to go nuts.

If the marginal tax rate on a person is lower, they are likely to work more.  The economy does better and tax receipts rise.  Since tax cuts took affect, the economy is doing better (3.5% growth in Q1), and tax receipts are rising.

The difference between federal and local taxes is not that important here.  It is the overall marginal rate that matters.  That rates is lower for the vast majority of Americans than it was in 2000.

Its not that simple, revenues are up because the economy is up.  That does not equate to, revenues are up, because the economy is up, because taxes were lowered.

Laffer Curve proponents assert that we are right of the peak on the Laffer Curve, which means that tax revenues overall rise after tax rates are cut.  It is common practice to assume that revenue losses are somewhat mitigated by increased economic activity, but this is a small effect so revenue still drops.

Frankly, I see little correlation between tax rates and economic performance:

In 1993, taxes are raised, the economy has strong growth, and revenues increase.

In 2001, taxes are cut, the economy has gradual growth, and revenues decrease.  Revenues dropped not only from 2000 to 2001, when there was recession, but from 2001 to 2002 and 2002 to 2003.

The evidence indicates we are to the left of the peak in the Laffer Curve.  Bush's own budget proposals put us left of the peak in the Laffer Curve as well.  It is wishful thinking to believe we are right of the peak in the Laffer Curve when evidence and mainstream economic thought disagrees.

explanation either.  Mightn't the continual increase in Federal spending also be stimulating the economy?  Maybe Clinton did trigger the recession, by running a surplus?

Thanks Doverspa for the suggestions, too bad I read the diary tip guide after I posted. I might re-post this with my full thoughts (or if I could figure out how to edit, just repost here), but for now I'm going to do so through the comment section.

To elaborate with some analysis (forgive me on my first diary post that this was not included in the top section)

To those not familiar with the Laffer Curve, in a nutshell the LC states that if tax rate is too high then a cut in taxes will result in greater tax revenue (think of a store that has a sale, you cut prices to stimulate shopping activity). Conversely, if tax rates are too low, then cutting taxes will result in lower tax revenues. Please note, that not all tax cuts are created equal, some are supply-side (tax cuts passed in 2003, marginal rate cuts) and some are not (tax cuts passed in 2001, AKA the rebates). Boiled down, the LC is a study in the law of diminishing returns. The law of diminishing returns simply means that once you pass a certain point in anything you do that seems pleasurable, the pleasure diminishes.

My favorite food is pizza, I usually have it about once a week. I look forward to having my pepperoni or Hawaiian, however, as much as I love pizza, if I eat pizza every day the pleasure in eating it diminishes rapidly with each subsequent slice. Raise taxes too much and economic activity will be subdued so that tax revenues will decline. At that point a reduction in tax rates will stimulate economic activity and tax revenues will grow.

Tax rebates, of the kind passed in 2001 by the Bush administration, had no supply-side effects, and in fact were designed by the President's chief economic counselor, a conservative Keynesian, Lawrence Lindsey. The 2003 tax cuts were supply-side.

Focusing on the 2003 supply-side cuts one finds this:

CBO link

Year    Revenues   Outlays    Total

2002     1,853.2    2,011.0    (157.8)

2003     1,782.3    2,159.9    (377.6)

2004     1,880.1    2,292.2    (412.1)

The tax cuts in 2003 should have caused revenue to decrease in 2004 if we were on the wrong side of the Laffer Curve, but yet, the CBO shows an increase of $100 Billion.

Whew, now to the substance of this article.

It looks like the stimulus at the federal level has `trickled' down to the states (although it's more like it opened the flood gates, but I don't know of a better word to substitute for trickle). The supply-side tax cuts of 2003 provided stimulus that pumped economic activity (and job creation) that has now fueled booming revenues for the states. The three and a half million new jobs added since the 2003 marginal tax cuts not only have increased revenues for 2004 at the federal level, but all those new employees are paying state taxes as well. Without getting into a state by state comparison (given the limited info in the article about specific states and my desire NOT to look up all 50 states), in general the additional revenue is widespread among the states.

This leads me to conclude that the stimulus was created outside the individual states' control at the Federal level. "Nearly every state is at or above what they expected to get in revenues," says Arturo Perez, a budget analyst at the National Conference of State Legislatures.  (emphasis added). Since individual states made different decisions - some raised taxes and some lowered taxes, one would expect to see increased revenue in the states which raised taxes or conversely we would see lower revenue for states that cut taxes. This is not the case.

I am sure that I am missing points here, but then again, I'm doped up on Benadryl with my allergies kicked into high gear this spring.

The Laffer Curve is not bell shaped, therefore, saying we are to the right or left of the curve is inaccurate.  It is 'D' shaped. http://www.polyconomics.com/searchbase/Laffer2.gif Tax revenue at 100% or 0% rate would be zero.

Please see my post for further explanation of the Laffer Curve.

That is exactly what Doverspa said. State tax recepits are up because the economy is up, but the economy is up because of federal rate cuts.

That is the point of the Laffer Curve. It is called the wedge model. Higher tax rates drive a wedge between economic transactions, making those at the margin uneconomical. Shrinking that wedge allows for greated activity.

If not try rotating that image 90 degrees counter-clockwise.  Now what is the shape of the curve?

Here are a few excerpts that I wrote a while ago that explain the issues you have.

Clinton

Clinton's first term continued to chip away at Reagan's economy. He immediately failed to follow through on his tax cut when the Omnibus Budget Reconciliation Act of 1993 (OBRA-93) was signed into law in August, pushing the top income bracket up to 38%, a 23% increase. However, nothing he did was seriously damaging, but it didn't help the economy either. Clinton only managed to slightly stall the building economic recovery by stunting projections, leading to decreased liquidity demand and a 10% currency inflation.

This view was further supported by Polyconomics, a supply-side advisor house, who didn't predict anything terrible happening. The Reagan marginal rate cuts were only five years removed, and the size of them gave quit a bit of room for further policy errors.

Clinton also paid for this in the midterm elections when Repubs took control of both Congressional arms for the first time in 40 years.

However, Clinton did reduce taxes. While income and sales taxes are taxes on economic activity within the country's borders, trade barriers like tarrifs are a tax on economic activity that crosses national borders. Clinton's free trade legacy did reduce taxes on international activity.

The Clinton economy didn't really take off until his second term.

The bipartisan Taxpayer Relief Act of 1997 (TRA-97) would be signed into law in August 1997, but it was anticipated all year long. Its focal point was the lowering of the capital gains tax back down to 20%. The rate was going to be lowered; it was just a matter of which proposal. In early February, Rep. Bill Archer (R-Tex), upon seeing Clinton's original proposal, commented that "it needs to accomidate broad-based capital gains relief." By July, Citizens for Tax Justice, a group that seems to be entirely created to perpetuate class warfare, was already criticized the legislation, predictably calling it "corporate welfare."

...

In July 1999, an Investor's Business Daily survey of 200 CEOs and CFOs from the largest companies were asked what was responsible for their growth. Productivity, Fed monetary policy, information technology, restructuring, and globalization were the top five. Next on the list with 26% was Reagan policies. It seems that Clinton's policies had not had much effect yet, as only 8% cited them as a reason.

Bush 43

The first and most important thing to know about Bush is that he isn't a supply-sider. He is empirically a conservative Keynesian, and the 2001 tax legisation was died in the wool Keynesian demand management. The tax rebates, child tax credits, and creation of a new 10% bracket were all meant to drive consumption to draw down inventories.

The only good thing about it was the marginal rates cuts at the top, but even then there were not marginal cuts at the midle to lower end of the ladder. And those were only phased in over five years. Coincidentally, a (NBER?) study came out shortly after describing how these kind of phase-ins actually have a short-term negative effect on the economy as people put off economic activity until the cuts are fully realized.

If anything, the supply-siders hates the 2001 tax package. Larry Lindsay, the architect of it, was asked if there ware any supply-siders in the administration, and he replied, "No. We are all demand-siders here."

The 2003 packages was different. It was done by Glenn Hubbard, an actual supply-sider, and withing the confines he was given, he created a more supply-sider friendly piece of legisation: accelerated the marginal cuts, capgains cut, dividend cut, etc.

Since the the economy has done much better.

Don't listen to all the bad, bad reporting of supply-side economics. It isn't synonymous with tax cuts, and most Republicans are still not supply-siders, and there are a few Dem supply-siders.

Remember, the Laffer Curve is a pedagogical device similar to the supply and demand curves. It's shape isn't really as important as the concept that it teaches.

One of the big attacks on the Laffer Curve was that the shape of the curve in real life was too complex to know and hence useless. It was parodied in the media by what looked like a jumble of string twisting and turning.

This same attack might as well be used against the basic supply and demand curves.

The Laffer Curve is just a picture of a already well known principle. Reagan quoted Ibn Khaldun, a 14th century Islamic scholar, a couple times: "At the beginning of a dynasty taxation yields a large revenue from small assessments. At the end of the dynasty taxation yields a small revenue from large assessments."

I just wanted to repeat this since I didn't want this important piece of the supply-side puzzle to get lost in the other longer comment I wrote:

Supply-side doesn't mean simply tax cuts. Supply-sider economics talks about marginal tax rate cuts, not effective tax rate cuts.

A $500 flat tax credit isn't part of a purely supply-side agenda. And backwards looking tax rebates are not either.

Stop comflating any tax cuts as supply-side.

as proving or disproving any economic theory or principle, only evidence that "could" suggest.

However, a good state by state analysis seems to suggest that state revenues were derived mainly from real estate sales tax from a booming real estate market country-wide. Interest rates that are unprecedented in their numbers makes borrowing money by the individual a very attractive option currently and international banking and loans are looking very strong because of the same in the private sector.

Continued low interest rates are more to do with Greenspan and his management to keep the economy from going into a recession than any other factor.

If high fuel cost that are now just beginning to find their way to the individual consumer through their purchases of other goods continues even a small amount longer, there is a real risk of some substantial inflation showing signs of it's existence in the not so distant future.

Fuel cost will drive interest rates up to control the inflation, when that happens the real estate market will stablize and perhaps even make a slight downward adjustment. When that happens the money you speak of in tax revenues for almost stops. It will be at this time that the theory can be so called "proven" or "disproven".

I was just giving unsolicited advice.  My girlfriend says I should do that less anyway.

I see that a kind soul has added a graph.  And I see  you added a much more detailed explanation.  Very well done!  Thanks for the update.

First, the Laffer Curve is about marginal tax rate, not effective. Imagine a marginal 100% tax, but the government also gave $100,000 back to everybody. That isn't a 100% effective tax rate, but it still wouldn't bring in any revenue since there is no incentive: You get $100,00 regardless of what you do.

Second, the Laffer Curve is a pedagogical device. It teaches a principle. The is the same as the supply and demand curves. They cannot be easily determined and are far more complicated than the simplist lines drawn although Econ, yet I don't hear anybody calling for tossing out of those valuable teaching tools.

Before you start calling everybody else "idiots" maybe you should learn a little first.

You forgot the two major tax reductions on real estate: the $500,000 exclusion for home sale and the capital gains reduction to 15% from 28%.

The capital gains tax is the one that shows Laffer Curve effects most dramatically too since it is essentially a voluntary tax.

Continued low interest rates are more to do with Greenspan and his management to keep the economy from going into a recession than any other factor.

This isn't true when some bad columnist writes it, and it isn't true now. Many are actually baffled since Greenspan's actions should be increasing interest rates, but that isn't happening. They are sinking despits Greenspan. The answer is that long-term rates are set by the market, not the Fed. If they were set by the Fed, the inverting the yield curve wouldn't happen.

If high fuel cost that are now just beginning to find their way to the individual consumer through their purchases of other goods continues even a small amount longer, there is a real risk of some substantial inflation showing signs of it's existence in the not so distant future.

Oil prices have been in the economy for a while now, however oil prices don't drive inflation. A dollar spent on oil means a dollar not spent elsewhere. With the dollar on an absolute tear for the last six months, it would be a little backwards to prediction inflation.

Fuel cost will drive interest rates up to control the inflation, when that happens the real estate market will stablize and perhaps even make a slight downward adjustment.

Huh? Feul costs have an effect on interest rates? Besides that non-sequitor, I thought you just said in the previous paragraph that "there is a real risk of some substantial inflation" from "high fuel costs"? Now you are saying that feul costs will control inflation? Maybe I'm not understanding or you mistyped something?

High fuel cost will, by this summer begin to show up in your supermarkets, the brick yards, the paint stores and everywhere else you buy products or services.

You will see dramatic increases in price indexes for finished goods.

You will see an increase in interest rates

You will see the economy, not burp, hickup or stub it's toe, it will throw up.

If you have a job, or can get one the next year or so, keep it.

Then after that it will adjust back up slowly under steady but not very impressive conditions for the next 20-30 years or so.

Just my thoughts.

Ok. I am a supply sider. Supply siders believe actions should be taken to help encourage improvements in production and remove obstacles that hinder our ability to grow. Supply siders tend to support the following policy objectives:

1. Increase educational quality
   
   
2. Increase competition in the marketplace.
   
   
3. Increase investment spending
   
   
4. Increase the creation of new businesses
   
   
5. Increase the supply of those willing to work.

All of these increase the supply of goods and services in our economy and lead to a better standard of living.

Supply siders support tax cuts because high tax rates reduce peoples' incentive to work, invest or to start new businesses. For example, suppose you are considering risking $10,000 of your money on an idea I have for improving internet service. If I hope to turn your 10K into 110K, that is 100K in profits, but after taxes you only get to keep 50K in profits (or less), you may decide it is not worth the risk. As a result, less economic activity would result and the market would not get the benefit of my new improvement to internet service.

Therefore, from the Supply Side view, if the government collects taxes to pay for some program, the increase in taxes may hurt the economy more than the government program helps it.

Now suppose the government decides the program is so needed it must spend the money. The question at this point is whether it is better to raise taxes, cut spending on other programs or pay for the program with government borrowing (deficit spending). Since taxes may adversely change peoples' behavior, the economy may be hurt less by paying for the increased spending by borrowing the money rather than raising taxes. (Just imagine the damage that would be done to our economy if every time a state government wished to build a new road, it had to pay for the projects out of current tax collections rather than paid for by issuing bonds)

Finally, is supply side tax policy absolutely proven? This is a chicken and egg problem. Did the tax cuts stimulate economic activity and thus tax revenues OR did a growing economy independent of the tax cuts result in higher tax revenues. For example, Clinton supporters argue his tax rates increases reduced government borrowing, freeing this money for use by the private sector, leading to the strong economy of the 1990s and the surpluses that followed.

However, it could also be the case that the creation of the internet spurred economic activity, the higher economic activity resulted in higher tax revenues; but the economy would have grown even faster if it were not for the tax increases. This latter explanation is the position taken by the 2004 Nobel winner in economics --Edward Prescott. He reviews international evidence to demonstrate that high tax rates encourage unemployment and drive workers into the underground economy.

and months for fuel to show in costs?  It's been quite a while since I've read a Beige Book from the Fed but I've never heard of a lag in such a direct cost.  Hell, Dominoe's has been hitting me with a surcharge since last year.  And from what I've seen gas has dropped about 20 cents in the last few weekss so....

"Since the states did not cut taxes (and many increased taxes), their increased revenue over last year is just because the economy is stronger than it was last year.  It has nothing to do with the Laffer Curve."

I dissent.

I will agree that some states raised taxes, but this was just a handful. And I will further stipulate that many other states did not cut taxes.

However, due to the tax cuts enacted a few years ago, the overall tax burden on people in all states has decreased. The result has been an increase in economic activity, which has subsequently spurred increases in tax revenues-- even at the state level.

There typically is a delay in price increases resulting from cost increases. This is one reason for the two measures most common measures of inflation--the consumer price index and the producer price index. The consumer price index measures inflation at the consumer level and the producer price index measures prices at the wholesale level.

While some products prices do immediately change with cost increases, others do not. Economists have many explanations for this behavior, but the simplest explanation is that consumers are reluctant to pay higher prices and so for a while the firm is better

off absorbing the higher costs rather than passing the price increase onto the consumer.

The Laffer curve is almost certainly irrelevant to this phenomenon; the original tax rate was too low.*  What's more likely is that (1) lower taxes have spurred faster growth, thereby resulting in higher earnings and higher tax revenues and/or (more ominously) (2) the current highs (bubble?) in home sales has resulted in greater consumer confidence and therefore greater consumer spending.

von

*Lawrence Lindsey found evidence of a "Laffer curve effect" (to coin a phrase) only in Reagan's cuts to the top tax rates, which (IIRC) were hovering around 70%, pre-cut.  The other empirical evidence for the Laffer curve comes from 70s Sweden (again, 70-80% top tax rates) and (again IIRC) 20s U.S. tax policy.  There's no evidence of a Laffer curve effect for tax rates under 50%, SFAIK.

BTW, my econ degree is an undergraduate one and almost a decade old.  So correction/expansion from a real economist would be greatly appreciated.  

This is why I usual refuse to get into these economic debates.  A national economy is as complex a theoretical model as the weather, especially with the increasing globalization of trade.  Whether the Bush tax cuts are responsible for "increases" in state tax revenue is an almost impossible question to address.  Even if we found a such a relationship, at best, it could only be responsible for a portion of the economic growth.  

What I'm getting at is that economic policy is important and good, but quite a bit of it has the same effect as seeding clouds for rain.  If it rains, people say "cloud seeding is great!"  If it doesn't, people say "cloud seeding is stupid!"  But the thing is, sometimes, it just rains or doesn't regardless of the effort.

What is particularly annoying are the cure political reindeer games we play about economies.  The Reagan Boom.  The Bush recession.  The Clinton Boom (no, no, that was caused by Reagan, Clinton just didn't screw it up too much).  The Bush recession (No! That was the Clinton recession.  It started on his watch.  Plus, Bush had 9/11, so it's not his fault, blah, blah).  I think each of those presidents played a role in the economies of their presidencies, but how much credit do they really deserve, and how much of it is the luck of the business cycle?  Seriously, during the tech boom, would a tax increase really have had much impact on the growth in the technology center?  Really?  Reality didn't seem to interfere much, how could taxes?

You're an econ grad student, right?  My econ degree is a decade old and has been mostly unused, but my recollection -- confirmed by a glance at an old textbook* -- is that Lindsey's comprehensive study of the Reagan tax cuts determined that a Laffer curve effect was present only for the top tax rates.  Is there some reason to doubt it?  

*I'm taking my data from Barron/Lynch's Macro/Micro textbook from '93, which, ahem, was not a best seller; my recollection is from Barro's Macro book of the same era, which was my undergrad econ textbook.  Unfortunately, though, I sold the Barro book for beer money sometime in the fall of '93.

Presidents can not affect the economy to nearly the extent that voters and the media give them credit for.

That being said, the general overall economic climate is definitely affected by economic policy.  The best way to see this is by looking at countries with big, regulatory, welfare states and those with smaller, nimbler, welfare states (since no non-welfare states exist in the developed world).  The US, Estonia, Ireland, and a few other Eastern European nations fall in the smaller category while France, Germany, Italy, and the Scandanavians fall in the larger one.

The smaller governments (i.e. lower marginal taxes, less regulation) in general grow faster and this growth compounds on itself.  A good resource for seeing that effect is the Index of Economic Freedom which is a Heritage publication.  I helped research the 2003 Index while at Heritage.

So my take on recent economic history is that the Reagan and Thatcherite reforms were major and far-reaching.  Reagan dropped the marginal tax rate from 70% to roughly 30%.  These changes have not been altered significantly in either Britain or America for better or for worse.  Mr. Bush's 3% cut in the top marginal rate may have helped get through the recession and may bring in some more revenue through growth, but it is likely to have only a small (.1% - .5%) effect on overall growth*.

The other political economy issue is that Presidents don't have full control over the budget or economic policy.  Democrats were in office and helped pass Reagan's economic plans and Republicans were in Congress when the "Clinton boom" happened.  I think looking at the policies is more important than the person in these cases.  For example, NAFTA helped boost the economy in addition to welfare reform and the new Reagan-level marginal tax rates.  So pick which reform you want, but those three items all push up the long-run average growth rate (which seems to be 3-3.5% in America and 2% in Europe).

Finally, your point on the tech boom is spot on.  No matter who was in office or what minor policies changes took place that speculative boom was going to crash at some point.  Blaming Clinton or Bush for that recession is generally unfair although how one handles it can be judged.  President Bush ran a deficit, cut taxes while Chairman Greenspan cut interest rates quickly.  Those are the Keynesian ideals for fighting a recession and the recession was mild compared to other historically (as was the 1991 recession).

*These numbers are totally made up, I have no research to back them up.  That is my feeling for the level of the effects.

I don't think the Laffer curve can be applied here no matter what.  

This is state tax revenues which would have a different curve than the Federal tax revenue Laffer Curve.  In addition to the Federal Laffer curve magine a state Laffer Curve.  Also imagine a curve which plots overall productivity (measured as GDP or whatever is appropriate) on the y-axis, and marginal tax rate from 0% to 100% plotted on the x-axis.  The curve should look something like a typical demand curve, high prodution at or near 0% dropping to 0 production at or near 100% tax.    Theoretically, any cut in the marginal Federal tax rate will increase people's incentive to work and start new businesses shifting us up the curve in terms of GDP.  

If the states keep their tax rates constant, say 7%, then their revenues will increase as their fractional portion of GDP increases, no matter which side of the Federal Laffer Curve we are on.  We can cut the Federal marginal tax rate all the way to 0 and it will ALWAYS increase state revenues (as long as cutting marginal rates actually increases economic activity).  So if cutting taxes increases economic activity, all Federal marginal rate cuts will increase state revenues regardless of whether the Federal tax rate is "too high" (on the right of the LC) or "too low" (on the left of the LC).   So you can't use these data as evidence of the Laffer Curve operating in principle.  

No matter which side of the maximum we are on in the Federal or the "overall" Laffer Curve the best thing for states tax revenues is to cut federal rates.  That does not make Federal tax rate cuts a good policy for the country.

This is not evidence of the Laffer Curve in operation.

$1.80 nationally for over a year.  Atleast.  Probably closer to two.  I know there's a lag in most things but I've never heard anyone say or read anywhere that crude/pump prices lag that long.  It's a component noted in Beige Books all the time and if you two are going to contend that the lag can be 12+ months then Greenspan should probably edit out his whole "bricks and mortar" tea leaves.  People have been blowing the "gas prices means inflation" bugle since 2000.  Remember the "jawbone" remark?  Five years...and not once has the CPI topped 3.5%.  

I will be a grad student starting in the Fall although my undergraduate study was in International Political Economy so I had a good bit of economics.

I have not seen read academic research on the Reagan cuts beyond the supply-side introduction in my undergrad courses.  It would make sense to me that this would only apply to the top tax bracket.

Suppose you make $50,000 and pay a marginal tax of 25%.  Each additional dollar gains you 75 cents.  If you increase your pay to $80,000 and jump to the next bracket (say 50%), each additional dollar gains you 50 cents.  Finally you hit the old top bracket of 70% when you make $120,000 and each dollar your salary increases, you only keep 30 cents.  Well the last person has the least incentive to work an additional hour.  So lowering the rates for all 3 to 20%,30%,40% would give the last person the most incentive to work more.  If the economy is efficient in pricing wages those who make the most are also producing the most.  Thus, increasing their work increases the GDP the most.  This is also known as "tax cuts for the rich."  If the step-by-step, marginal tax description was remedial I apologize.  Bottom line, the marginal tax rate matter the most when one is deciding how much to work.

I have not seen read academic research on the Reagan cuts beyond the supply-side introduction in my undergrad courses.  It would make sense to me that this would only apply to the top tax bracket.

Well, not necessarily.  As I mentioned downthread, I think Sweden saw some significant effects across multiple tax brackets in the 70s.

BTW, (and, again, IIRC), don't discount the reduction in "cheating" that occurs with a tax cut.  A wealthy individual facing a top tax rate of 90% has an incentive to take additional compensation subject to that rate as nontaxable income (nicer office, company car, first class travel, better healthcare, etc.), to put more into assets that are not taxed (home, retirement accounts, trusts) and, in some cases, to actually cheat by hiding income.  When top tax rates decrease, it become more attractive to take extra compensation as cash and put more money into taxable assets.  Actual cheating also becomes less attractive as the benefit-to-risk ratio changes.

Second, the Laffer Curve is a pedagogical device. It teaches a principle.

What principle does the Laffer Curve teach?

I think it is an interesting device, and as a general matter I am all for lower tax rates, but I cringe when I hear people refer to the Laffer Curve as justification.

The Laffer Curve has two known points: 0% and 100%. But that is nothing more than an exercise in stating the obvious. The entire substance of the issue has to do with the shape of the curve between those points, and that is a topic about which we know virtually nothing.

"I sold the Barro book for beer money sometime in the fall of '93."

demonstrates market efficiency.

One of the big attacks on the Laffer Curve was that the shape of the curve in real life was too complex to know and hence useless

No, that's wrong.

The shape is not particularly important. The only important question (as it relates to potential tax policy) is "where are current marginal tax rates relative to the curve's inflection point?".

On one side, lowering taxes will increase revenue. On the other side, lowering taxes will decrease revenue.

But we absolutely do not know what side of the inflection point (or points. It may be a compound curve) we are on. Pulling pictures of Laffer Curves out of textbooks is not instructive.

Suppose you make $50,000 and pay a marginal tax of 25%.  Each additional dollar gains you 75 cents.  If you increase your pay to $80,000 and jump to the next bracket (say 50%), each additional dollar gains you 50 cents.  Finally you hit the old top bracket of 70% when you make $120,000 and each dollar your salary increases, you only keep 30 cents.  Well the last person has the least incentive to work an additional hour.

It is disturbing to me that this sort of high-school economics is even a part of this discussion.

Do you seriously believe that human behavior is so simplistic?

The problem with these simple economic models is that they are completely ignorant of psychological and sociological considerations. In the classic economic model, person "A" exerts 100 units of labor and gains 1000 units of reward. Person "B" exerts 500 units of labor and gains only 4000 units of reward. We are to conclude, therefore, that "B" is less inclined than "A" to engage in the incremental unit of labor.

As with so many concepts in high school economics, this is simultaneously completely true (within the closed system of economic thought) and completely meaningless (in any context other than the close system of economic thought).

 is fruitless, however, since it's human nature to pay as little in taxes as you can get away with. Lowering tax rates means only that people will continue investing into tax-free assets and reduce their tax bill at the same time. Unless, of course, you're saying that underreporting income is widespread.

That is a very lucid description of the Laffer Curve.  Kudos.

I would add two things:

1. A corrolary to the Clinton Boom debate is that the highest marginal tax rates were still much lower than in the pre-Reagan era.  Thus pre-1983 and post-1983 economics are different in America and the post-1983 economy is stronger even despite the slight increase under Clinton.
   
2. Your last sentence is what I hope to research in graduate school.  Developing countries especially try to implement all of the regulations of a developed country and in doing so make it impossible for anyone to open a business.  You have to pass health inspection, meet a minimum wage, get permits from a dozen agencies, and bribe a good number of officials to start a "legitimate" business.  Thus countries like Nigeria drive 70% of the economy into the underground market.  Hernando De Soto writes on how to bring underground economies above ground (mainly through deregulation).

between federal ans state taxes, see above.

State revenues are up because of inflated residential real estate prices.  Many states rely on real estate tax as a major source of revenue and the real estate bubble is providing cash windfalls.  When the RE  bubble bursts then the states will be in for it and the nation as a whole will again be in recession.

The tax cuts are horse hockey.

As Von has mentioned in several places both the US and Sweden saw results in line with being to the "right" of the maximum of the Laffer Curve when they lowered taxes from the 70% range.  One must remember that U.S. federal taxes are supplemented by state income taxes, so a person facing a 70% bracket federal is probably paying 75-80% overall in income taxes.  Yes, that has a lot of distortionary affect on the market.  It makes the incentive to cheat very high.  It makes the incentive to hide money offshore or other legal but iffy mechanisms very high.  It lowers the incentive to work more and increases the likelihood of early retirement or other ways to work less.

Since we are in the 30-35% national range now and the 35-45% overall marginal tax rate (state and federal), there is a strong argument that we are not to the "right" of the maximum on the Laffer Curve.

Finally, I don't have to believe "human behavior is so simplistic" to understand that a 75-80% tax will discourage work.  It doesn't mean every person will stop working or that any single person will work less.  It does mean that the incentive to work is diminished.  One can argue about the effect that has and what other options a worker has to choose, but the incentive to work is lowered.

I'm not disagreeing, just several people are saying it, where can I find the data?

"there is a strong argument that we are not to the "right" of the maximum on the Laffer Curve"

We may even need to raise taxes.

It's not a shock that "classical econ models are too simplistic"; they're supposed to be simplistic.  Indeed, all of economics can be summed up as:  Assume man is a fallen, greedy creature.  What result?  OK, now, assume man is a fallen, greedy creature, but this time express the result on graph paper.  See?  Very scientific.  

I mean, c'mon:  There's a reason why experimental economics is the "hot field" (or was in the early 90s), and it has everything to do with the fact that folks don't walk around knowing their precise "util" count at every given moment.  Some economists (led by recent Nobelist Vernon Smith) eventually came to the conclusion that it might be nice to figure out what some folks are actually thinking when they make market decisions.

But don't confuse simplicity with falsehood.  Economic models contain certain broad truths; one is that if top tax rates go up, it reduces the incentive for folks to earn dollars subject to those rates.  Thus, you get deferred compensation, tax sheltering, and cheating.  Do higher tax rates reduce the incentive for them to work?  Probably not (though high tax rates have myriad other negative effects).  But it does reduce the incentive for them to earn money that can be taxed, which effect is expressed in the Laffer curve (among other things).

I'm in a, let's say very high tax bracket, well above the 120 discussed. The tax rate on my personal income can be and has been stagering. For all those who really want to do more than just hold a job and end up and a income rate at or above 120 the incentives are apperciated when seen.

However, I am not really in that bracket. I am ina bracket that is much higher. My options for tax relief are very promising currently, I have multitudes of options and can actually manage, with the help of those on my payroll to pay a tax rate that is significantly lower than 15% overall. The corporation owns much of my trasferable assests that can be transfered to me virtually tax free, once my contract is bought out and severence in offered.

They are my companies, but I'll do what just about everybody else does and take advantage of those tax utilities. The corporation itself can do very well as long as I stay out of those states that seek to suppliment their tax base through my operations on a level that is not attractive to me.

State competition normally goes through the special tax incentives that are given by them first when considering doing business in or from any particular state. A free market within the states so to speak, based on tax incentives models.

It is not only possible for medium to good sized corporations and their executives to pay very little tax, it is in fact the norm. However, I do expect that my productivity will be rewarded either by myself or those areas where I do business because I know I out produce many of my competitors several times to one, people that do that deserve a incentive.

But, the level of loopholes available are probably a little too extravagant at current and there should be an adjustment to that since most of the end figures normally shown do not include those adjustments.

Actually, your point is well taken. One truism in economics is that inflation is and always has been a monetary phenomenon. In other words, prices on certain goods can rise in response to higher oil prices, but if the money supply is kept under control, prolonged inflation will not occur.

In the current case, economists are arguing that the reason prices have not risen, as much is the declining importance of oil to our national output because of our move into an information based economy. This may explain part of the reason why prices have not adjusted significantly.

In addition, even for goods that require transportation, the effect of an increase in gasoline prices may not be a significant increase. For example, a study of Carolina cattle prices (Rathwell, Hupp, Clements) shows an increase in gasoline prices from $1.25 per gallon to $2.50 per gallon, would increase transportation costs from the Carolina to Kansas from $30.51 to $34.84 per head. Given the price per head is somewhere around $500 per head. This amounts to less than a 1 percent increase in the price per head even if the purchaser paid the entire cost increase.

However, higher gas prices could eventually lead to more significant price increases:

"For some people this potential price decrease is not alarming. It isn't very large. But is this increase in transportation costs just a start? Fertilizer, chemicals, electricity, i.e., are made from petroleum. Increases in petroleum prices will ultimately affect the price cattle producers pay for these products, too." (Rathwell, Hupp, Clements)

Link to Rathwell, Hupp, Clements study:

http://cherokee.agecon.clemson.edu/mmm396.htmfrom

A tax rate that has far more tier's in it to income base on holdings rather than just income would be a much more fair way to do things for the backbreak wrokers of our country.

First 100,000 should be divided by 5. every 20,000. then by every 50,000 after 100,000. After 1,000,000 by every 100,000.

The tax brackets should be much more tiered to be fair, and tax incentives that help those on the lower tier's that have the internal motivation to do more and actually do so should also be made available.

This would also complete the economic curve of which you believe as well as lay incentives for much more lower level growth while maintaining the higher levels, equalizing the distribution of wealth, and being far more fair to those who think they see the "Tax break for the rich".

Although many of those tax breaks will still be there, the rich will pay a higher level as they become more wealthy, this serves the common good and economic stability of the nation over a long run the most, I think...

Although I understand something like that could prevent me from becoming filthy rich, there's really no need for more money than can really be used, and concentrating wealth over a long period can be very damaging to the economy, that's what I believe. So I would give that possibility away to ensure long term economic stability, while still having an extremely comfortable life.

to believe the OP's prognostications about the impending summer's dramatic CPI increase.

Yes, I understand small increases can compound.  One of my first jobs was doing intracompany transfers for the oil field(lignosulfates and such) so I get this.  Talk about a vicious circle...crude price increases...price for raw materials for extraction increases...crude price increases...rinse, repeat.

I have a doctorate in economics (completed in 2002). The most important advice is: Have your data in hand (or know specifically how you can obtain it) for whatever research you conduct. It took me a year longer to complete my dissertation because I needed one piece of information I thought could easily obtain. I finally got the data I needed from an anonymous source.

to this phenomenon because by that model all cuts in the federal marginal tax rate would result in an increase in state tax revenues.  

Thus, these data cannot be used to support the notion that the marginal rate cuts have moved us closer to the maximum point on the federal LC nor the aggregate LC.

But yes I agree with you, that even if we see an increasein federal tax revenues there are other variables that make it impossible to tell where we are on the LC and whether the tax cuts are responsible for revenue increases.

and you are just arguing to argue.

What i said is not what dspa said.  

In other words:

"That is the point of the Laffer Curve. It is called the wedge model. Higher tax rates drive a wedge between economic transactions, making those at the margin uneconomical. Shrinking that wedge allows for greated activity."

that is the assumption, it is not proven.  My original post makes, in an admittedly condensed way, the points that are made in many of the subsequent posts:

That the shape of the laffer curve is not known, but it is not a simple quadratic as drawn, and its not constant with time.

That our position relative to any local maxima, much less the absolute maxima, is not known.

and therefore, simply saying revenues went up because the economy did better because taxes went down, it must be the laffer curve working, is bunk.  It is identical to somone saying the converse during the clinton tax increase.  You have a constantly changing economy which fluctuates, and you are taking a convienent fluctuation and subscribing the entirety of that change on one factor that changed at some (arbitrary) delta t in the past, and saying, ah, there, that is the cause. BS.  That might be the cause, but there are many other possible (and likely) causes, all of which no doubt had an effect.

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and to tflan below, as it related to this line, you really know how to miss the point of the arugement dont ya?

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finally back to jjayson.  You have twice jumped to the defense that yes you know that the laffer curve is not really d shaped, its a 'teaching tool' and then try to play this game that 'the shape isn't important, its the concept it teaches' and that we are all missing that concept because we don't think that a tax cut automatically = revenue gain.  Uhhuh.  If you don't know the shape, you dont know where you are on the curve, and thus the pedalogical impact of the teaching tool is useless in real life.  Raising taxes might increase revenue.  We might be right on the maximum already!  Who knows.  And worse yet, the shape of the curve changes with time and the total state of the economy.  

You are arguing this weird mix of Keynesian cost-push inflation and classicalist monetary inflation. Then after that you go on to say that oil costs don't add much to overall prices when your original point was that it did.

This is state tax revenues which would have a different curve than the Federal tax revenue Laffer Curve.  In addition to the Federal Laffer curve magine a state Laffer Curve.

No, it's the same curve, not two different ones. The federal and state tax rates just add to each other. They both drive a wedge between economic transactions, and when one of the rates is cut, the wedge shrinks and both the federal and state government gain from that increased economic activity.

To undersand this consider a state with a 5% tax and a federal tax of 10%. Revenue flows into state coffers b/c of economic activity. For every $100 transaction, the state takes $5 and the fed takes $10, leaving $85 for the parties of the transaction. Now, what would happen if the fed increased their rate to 95% and the state didn't touch theirs. That would be a 100% rate and economic activity would dry up. State revenues would disappear even though it was a federal rate change. Do you now see how both rates are just additive to the same curve?

<strike>I'm having a real hard time understanding your third paragraph, sorry.</strike&gt

After rereading your third paragraph, I understand what you are saying. Yes, state revenue increases doesn't provide direct evidence of greater federal tax receipts. The state inflows only shows more economic activity.

This is not evidence of the Laffer Curve in operation.

While I agree with your assessment of this not being a straight forward application of the Laffer Curve, I do not think it is totally irrelevant. Growth is an important part of effect the Curve tries to diagram.

Do you also cringe when people talk abstractly about shifting supply and demand curves? Those two devices are equally as unknowable.

Was that entire post directed at me, is it misplaced, or is it maybe a couple posts mixed into one?

However, I don't think I every claimed or came close to saying "a tax cut automatically = revenue gain." Nobody outside of politics claims that.

After reading your other comments and now these two, I do think that isn't the strongest evidence of the Laffer Curve.

It is or could be evidence that tax cuts spur growth, and that is a foundational principle of the Laffer Curve, but isn't exactly the Curve itself.

Russia, Ireland, and the like sill provides some of the best recent evidence of the Laffer Curve.

add to each other.  They are from different sources.  A cut in the Federal rate does not mean that there will be a cut in the state tax rate.  Hence cuts in the federal tax rate will always produce an increase in state tax revenues because of the (presumed) increased economic activity.

"The state inflows only shows more economic activity."

Right, if the cut in federal taxes does in fact produce an increase in economic activity, then state tax revenues will increase.  It does not matter where we are on the Laffer Curve(left or right of the absolute maximum), state tax revenues will always increase.

Thus, this data is indicative of nothing WRT where we sit currently on the Laffer Curve.

Nobody is talking about the behavior of any specific individual, but their aggregate behavior.

Your critique could equally apply to the basic supply and demand curves that are not just used in basic Econ course, but all the way up through the subject. Nobody knows their indifference curve and goes to the story and calculates what to buy based on it, but it still exists.

One of the most interesting phenonmenon I think is how aggregate behavior makes sense, even though individual behavior appears contradictory. There are numerous version of the story where people try to guess the weight of a animal or the number of gumballs in a jar. Each individual guess appears very far off from the actual answer. However, when all the gueeses are averaged together, that aggregate guess is close to the correct answer. All those dumb guesses individually have a tremendous amount of error, but collectively the errors cancel each other out and produce a good answer.

I'm pretty certain I am correct.  I wish I could draw pictures then I'm sure you could understand what I am trying to say.

I perhaps mixed some of your comments in with other posters.  I wake up this morning and the thread has jumped from 5 posts to 45+.

If I attributed something to you that you that wasn't yours, I appologize.

A 50% rate from the state plus a 50% rate from the feds will cease all (above ground) economic activity. They are both part of the same wedge that blocks commerce.

I just don't know if I'd go as far as to say it is "irrelevant" to the Laffer Curve.

I am and would hope that everybody else here has thicked skin than that and also understands how posts can get mixed up in an online forum.

taxation.  It's what is in the middle that counts.  And any cuts that any president have proposed have not entailed proportional cuts at the states.  And no states are anywhere near 50% I presume (or else there would be an Exodus of Biblical proportions).

So let's just consider the scale of current federal tax cuts and current state tax rates.

Under conditions resembling reality, I suggest that all federal rate cuts (that result in increased economic activity) will result in state tax revenue increases.  I will leave criticism of the Laffer Curve to the others who have offered it and merely say that this data could be expected from any federal marginal tax rate cuts regardless of where we are on the federal tax LC or on an "aggregate" curve including all taxation.

People used to maximizing quantities point to the peak point of the curve and say "that's where we want to be."  

Well, no, we don't.  That is the point of maximum tax collections.  What isn't shown by this curve is that as you approach the maximum, the tax rates are increasing depressing the economy.  Giving up a very small amount of tax revenue will increase the economy by quite a bit, unlike at the leftmost edge, where increasing government revenue by quite a bit doesn't affect the economy that much.

(We'll ignore the difficulty of actually knowing the rate that produces the maximum revenue.)

The only reason you would want to aim for the top point was that you had a President and Congress that were runaway spendaholics.

Oh, right.  Carry on.

I am arguing from the Monetarist viewpoint. I was careful in my original post to indicate that cost increases lead to PRICE increases and increases in the MEASURES of inflation--not inflation itself.

An example will illustrate my point. Suppose there is a decrease in our productive capacity causing cost of production to rise. In the Monetarist view, using the quantity theory of money: MV=PY where M is money supply, V is velocity, P is price level, and Y is the capacity of the country to produce. With a decline in Y, and if the monetary authority does not take action, M and V remain constant (This is the extreme Monetarist position that money supply is exogenously determined); then price level has to increase. Now this rise in the price level is not inflation, but it will cause the measures of inflation to rise (CPI, PPI, etc.) Once the economy is at the higher price level, there is no reason for further price increases to continue, however, the time needed to reach the new higher price level could be significant and thus appear as if a cycle of inflation is occurring.

In the Keynesian view, an increase in costs will cause firms to increase prices in an attempt to maintain the real value of their profits. Workers seeing prices increasing respond by demanding higher wages causing firm costs to rise again and causing a cycle of inflation.  

The point of my second post was to explain why we have not observed prices rising dramatically in response to higher oil prices. I can also add that the Fed has engaged in tighter monetary policy (Driving down M), worker productivity has increased, and world trade has continued to grow (Both increasing Y). These factors mitigate the effect of the higher gasoline prices.

Also, I am arguing from the Monetarist viewpoint. I was careful in my original post to indicate that cost increases lead to PRICE increases and increases in the MEASURES of inflation--not inflation itself.

An example will illustrate my point. Suppose there is a decrease in our productive capacity causing cost of production to rise. In the Monetarist view, using the quantity theory of money: MV=PY where M is money supply, V is velocity, P is price level, and Y is the capacity of the country to produce. With a decline in Y, and if the monetary authority does not take action, M and V remain constant (This is the extreme Monetarist position that money supply is exogenously determined); then price level has to increase. Now this rise in the price level is not inflation, but it will cause the measures of inflation to rise (CPI, PPI, etc.) Once the economy is at the higher price level, there is no reason for further price increases to continue, however, the time needed to reach the new higher price level could be significant and thus appear as if a cycle of inflation is occurring.

In the Keynesian view, an increase in costs will cause firms to increase prices in an attempt to maintain the real value of their profits. Workers seeing prices increasing respond by demanding higher wages causing firm costs to rise again and causing a cycle of inflation.  

The point of my second post was to explain why we have not observed prices rising dramatically in response to higher oil prices. I can also add that the Fed has engaged in tighter monetary policy (Driving down M), worker productivity has increased, and world trade has continued to grow (Both increasing Y). These factors mitigate the effect of the higher gasoline prices.

Also jjayson, in your post you argue that a dollar spent on gasoline is a dollar not spent elsewhere in the economy. While this is obviously true, it focuses solely on the demand side. A crucial point to consider is that higher gasoline prices can cause the supply of goods to decline. This would cause prices to rise and the measures of inflation to rise.

If I read (and remembered) correctly in another thread, you have a PhD in Econ? Just making sure I understand the basic discourse level between us. (I'm a derivatives and bond trader and have written various pieces of software, including an inflation model that projected price ripples from currency movements.)

I am arguing from the Monetarist viewpoint. I was careful in my original post to indicate that cost increases lead to PRICE increases and increases in the MEASURES of inflation--not inflation itself.

Well, I wouldn't say you are necessarily being monetarist in your thinking. While Friedman did say that inflation is anways and everywhere a monetary phenomenon, that is a statement any classicalists (from modern supply-siders to Marx himself) would agree with -- nothing specifically monetarist about it.

And I would agree that inflation isn't the same as price increases, but what perplexes me is that you seem to place inflation as something that happens after prices increases, citing the CPI and PPI as measure of inflation after prices rise. Inflation is a decline in the value of the dollar, and that results in prices increases that are shown by the PPI and CPI (and before that in commodities and other currencies). Inflation is something that happens before, and prices rise as an effect.

Now this rise in the price level is not inflation

I'm just not following this seemingly nonsense. Wouldn't a monetarist define inflation as a decline in the value of the dollar from printing too much money? Or there is the Keynesian understand of inflation being a rise in the general price level. You seem either have some weird mix of views or just a use of terminology that I haven't come across, and I cannot determine which it is.

Either way, it probable doesn't matter since for monetarism is essentially dead, especially have Friedman's Atlantic interview a few years ago where he calls the experiment a disaster.

Also jjayson, in your post you argue that a dollar spent on gasoline is a dollar not spent elsewhere in the economy. While this is obviously true, it focuses solely on the demand side. A crucial point to consider is that higher gasoline prices can cause the supply of goods to decline. This would cause prices to rise and the measures of inflation to rise.

But why would prices rise if gasoline is soaking up those dollars that other good would have? That is the reason those good stopped being made in the first place.

It really doesn't matter, I guess. I think I have a handle on what you are saying, even if I cannot figure out what you mean by inflation.

This is the same reason some of more traditional small government Reagan econ advisors didn't like the supply-siders. They saw them as giving justification and even aiding in the enlargement of government.

Wouldn't a monetarist define inflation as a decline in the value of the dollar from printing too much money?

This is exactly my point. If there is a decline in the productive capacity of the nation, the price level has to increase for a given money supply, but monetarists would not like to describe this as inflation.

But why would prices rise if gasoline is soaking up those dollars that other good would have? That is the reason those good stopped being made in the first place.

I hope you agree the productive capacity of a nation is reduced when the supply of oil is reduced. Therefore, are you arguing an increase in the price of gasoline will cause demand in the economy to fall by the same amount as the decrease in supply and therefore, the relative positions of demand and supply are unaffected?

If so, I am not sure there is evidence of this behavior.

folks don't walk around knowing their precise "util" count at every given moment

That's right. In fact, there is a lot of research to suggest that folks don't have any idea what they really want.

My theory on this (completely unsupported by anything than my own speculation) is that we have come so far down the path of wealth that incremental utils produce neary chaotic results. 200 years ago, for example, each incremental util was close enough to the util that kept you from starving that the individual's response to it was consistently positive.

Today, each incremental util is so far removed from the util that keeps you from starving that there is no predicting the psychological consequence of its consumption. That is why, for example, over the last 30 years wealth has about doubled while broad measures of "satisfaction" and "happiness" remain flat.

Your critique could equally apply to the basic supply and demand curves that are not just used in basic Econ course

Not true.

We can say that "supply" and "demand" intersect without infering anything about the shapes of either curve, or the elasticity of demand for a particular product, or anything else.

The Laffer Curve, on the other hand, is really "the two obvious Laffer Points and the unknown curve between them". Actually, I'm not sure that at 100% tax, revenue would be zero. Some people might work out of boredom. But that's not important.

One of the most interesting phenonmenon I think is how aggregate behavior makes sense, even though individual behavior appears contradictory

Your examples (eg, guessing the number of gumballs in a jar) are off topic. There is no component of motivational behavior implied in them.

The problem I have with the Laffer Curve, and with high-school economics in general, is that it starts with the assumption that everyone (or at least society in aggregate) will always want more "utils". I don't think that assumption is valid. More to the point, I don't think any theory that starts with that assumption can be accepted until that assumption is tested.

To wit: There are numerous studies that show that the overall level of satisfaction and happiness in the US has stayed flat over the past 30 years, while wealth has doubled. Those are aggregate measures, not individual.

I knew this was gonna happen. Here I am on the verge of becoming a Zen master, and now I find out that there is no utility in self-actualization. In fact I won't even be able to tell whether I am enlightened unless I also get lightened by about 50 pounds. I should have known there was some reason you never see The Fat Buddha around the Zen temples.

In the mean time, here are some articles and references you might enjoy:

A good article from the New Yorker

One example of this phenomena is the Peak/End Rule

The guy that dominates this field is Daniel Kahneman

Loss Aversion is another critically important factor.

Barry Schwartz has a book (The Paradox of Choice) that provides a very approachable view of these concepts.

Here's an interesting interview with Kahneman

Not true. We can say that "supply" and "demand" intersect without infering anything about the shapes of either curve, or the elasticity of demand for a particular product, or anything else.

But knowing that they intersect doesn't really give the supply and demand curves any descriptive power. That power comes from understanding what their movements mean. This is just like the Laffer Curve. We may not know the exact values or shape of the curve, but it still diagrams how dimishing return applies to taxation. We do not know the exact values or shape of the supply and demand curves, but they still teach how changes in supply affect production and price.

Just like you argue that their could be a local minimum along the Laffer Curve ruining its explanatory power, the same could be said of the supply surve.

These plots take general ideas and give them spacial representation.

Your examples (eg, guessing the number of gumballs in a jar) are off topic. There is no component of motivational behavior implied in them.

No, they are quite relevant to the topic b/c you were complaining about how individuals don't follow precise economic models when they act. You trued to say this meant that any model based on that was flawed. (This is more than just an assult on our limited discussion of taxation, but really an attack of all of economics -- modern and classical.)

The point of the guessing story wasn't literal, but required a little more thought on your part. It was to explain how individual action in aggregate can still follow a rational theory even if individuals do not. The story itself wasn't important, but the idea behind it.

The problem I have with the Laffer Curve, and with high-school economics in general, is that it starts with the assumption that everyone (or at least society in aggregate) will always want more "utils". I don't think that assumption is valid. More to the point, I don't think any theory that starts with that assumption can be accepted until that assumption is tested.

So you do just have a problem will almost all of economic thought. Honestly, I think most psychologists are full of crap. I'd had to deal with a number of them, and I would never trust any to base policy on.

You seem to keep falling for the idea that just because individuals don't always act rationally, then their collective behavior can't.

There are numerous studies that show that the overall level of satisfaction and happiness in the US has stayed flat over the past 30 years, while wealth has doubled. Those are aggregate measures, not individual.

Citation please? And not some moronic paper that just asks people to gauge their own satisfaction.

I already knew about the Peak/End rule, and about the inability to predict what will make us happy.

Blondes, for example, have frequently looked like just the thing to make me happy. However, I have found that many blondes only create the illusion of happiness, because maintaining them pushes me in the direction of starvation. So the next util, if I may call it that, seems like a big deal.

Also, it's true that years later, the only things I remember are the peaks, and how it ended.

It's not clear to me, though, how people's inability to predict what will make them happy affects the economists' assumption that they will move toward those things. Just because some blonde turns out to be more trouble than she's worth, that doesn't mean the next fool isn't going to seek her out, because he doesn't know that yet.

Of course, it might be that blondes are the wrong thing to use to explore the 'rational man' hypothesis.

It's not clear to me, though, how people's inability to predict what will make them happy affects the economists' assumption that they will move toward those things

But the context of the discussion is public policy. If we know that aquiring more blondes will not actually satisfy, does it make sense to promote their aquisition through economic policy? To the point, should our public policy at least be "blonde aquisition" neutral? Does it make sense to have a public policy that is committed to incenting you to aquire blondes?

There is an interesting paper by Richard Easterlin called Building a Better Theory of Well-Being. From the abstract:

mainstream economists' inference that in the pecuniary domain "more is better," based on revealed preference theory, is wrong. An increase in income, and thus in the goods at one's disposal, does not bring with it a lasting increase in well-being, because of the negative effect on utility of hedonic adaptation and social comparison.

That's interesting stuff. And it brings into question what our public policy goals should be.

Too much of our national debate starts with the unquestioned assumption that more wealth is better than less. What if that isn't true? Or, more precisely, what if we have reached a point where incremental national wealth is no longer worth the effort it takes to create it?

"more is better," based on revealed preference theory, is wrong. An increase in income, and thus in the goods at one's disposal, does not bring with it a lasting increase in well-being

It is one o'clock, so I am going to beg your forgiveness for not having read the linked-to article. If this is explained in there, I apologize.

Is the point here that the utility curve shifts over time, or is this just another artifact of utility curves being curved, i.e. that continued acquisition of more of anything asymptotically approaches satiation?

For example, upon acquiring the Mercedes, there is perhaps a month's worth of "Whoop-dee-doo, I have a Mercedes" in it. We all know (everyone here has had a Mercedes, right? You are Republicans, right?) that the Whoop-dee-doo goes out of it after a while. Is that because the utility of having a Mercedes changed, or because the longer we have it, the more "I have a Mercedes!" we acquire and we get to the point where we've had enough of being jazzed about it? If it's the latter, I don't see this as any new revelation.

To get back to the real subject, which was blondes, Donald Trump is now on his — what — fifth stunning blonde? My hunch is that the zap of having a stunning blonde has gone out of it for him, and now he needs to trade them in because if they aren't stunning, he can't even, ya know... buy the property, so to speak. But I would argue that's because he has acquired more than his fair share of stunning-blonde-zap already, and so the marginal utility of blonde-zap is not what it was for him. (For scientific reasons I am ignoring possible actual shifts in his utility curve regarding blonde-zap that might be caused by his becoming an old fart).

influential "deregulation" of the Reagon era on the long term economy? I realize your gett ing you graduate degree, so here's a tough one not to answer accurately, and without party affiliation bias. Included in the era is the pre-1983 model as you note and the later Bush years as it was nothing more than an extension of the Reagan years, as 89-91 are very imortant years to note when including the term "deregulation".

In fact I'm fairly certain that one specific deregualtion shifted about 1.1 trillion dollars rather quickly. I'll let you tell me which way that 1.1.

There were a few other noteworthy deregulations.

I have run into so many very well thought out economic models and principle theories that attempt to outline the impact of the Reagan administration years and some others that pre-date that which directly affect what he did and was able to do as well as not.

He did very well when considering who was calling the shots in the Senate and the House and the adjustments and consessions that were drafted from those bodies go relatively unnoticed.

Before Reagan, in the 70's there were some simply amazing economic models and theories that forecasted everything from the "New Global Roman Empire" to "The economic overtaking of the U.S. by Japan".

Even a new stock trading model based on new theory was developed. A huge financial company rose up from this one particular trading theory and was going through the roof with profits, holdings, assest, new customer base and on and on and on.

The basis of one model that comes to mind was one that calculated how the Japanese could not be beat with the model they were using for international trade. Everything look exactly as if all the new theories were correct.

But, there was one man from Chicago, relatively well respected economist that disagreed with theories and speculated that in the end the Japanese worker could not out produce the American.

His theory was that productivity was the key and that the American worker had a far more established work ethic in it's social system  and fabric than did that of Japan. I think you know being a graduate student who ended up being correct.

Productivity against cost I believe was one of the very first considerations for Reagan. In one instance, that productivity was put to use in the rearmament program (starting 1981, before 1983). The cost savings was a gamble that the Soviets could not keep up and it would break them economically and strain their workers. No viable Soviet Union, no more Cold War expense. Who knew? He did apparently.

That I believe was his biggest economic impact over the decades. An impact that Clinton sure seemed to take advantage of when he slashed defense spending, giving him a lot of extra loot for budget consideration and incentive programs that oddly enough, concentrated on productivity.

OK, I am now awake and I have had some coffee, and I see that you were trying to go on about public policy. Such as whether it makes sense to have policies that promote the acquisition of blondes.

I think we had that discussion in the context of homosexual marriage, and the consensus was 'yes,' mostly on the grounds that we should not be fruitful but multiply.

That, however, does not explain why our actual public policies discourage the acquisition of blondes. If the 'rational man' hypothesis were actually true, no man would ever get married in this society. We all know the horror stories; suffice to say it would be cheaper if each adult male simply selected a woman at random, bought her a house, and then went on his way.

So the more interesting question is how a set of policies designed to make marriage both onerous and terrifying came into being when virtually no one wants that.

As for Mr. Easterlin, I dismiss him as just another university-based Marxist quack, although I give him credit for wearing cloven hooves to disguise his webbed feet.

If I may further summarize the abstract, he would make us all happier by pushing us farther back on the treadmill and increasing its slope. This would attenuate our ability to acquire "useless stuff," thus making us happier with such stuff as we do acquire. In other words, it's an argument for higher taxes, and for having university professors decide what 'to each according to his need' means.

I also reject out of hand his assertion that "There is need to devise policies that will yield better-informed individual preferences." This is duck-speak for "the enlightened need to guide the masses in the selection of their wants, for they are too stupid to know what is good for them."

I recently had the pleasure of sitting through one of those "eat your spinach" classes given by a known dietician, whose only concern was our health and well-being. She was all agog about the new Department of Agriculture guidelines, which specify that we should all eat several cups of fruits and vegetables every day.

So here is Professor Easterlin's dream come true: taxpayer dollars expended to "better inform" individual preferences.

OK, my preferences are now informed. However, I still think that vegetables are what food eats, and I still don't like spinach, which she tried to pass off as a "green, leafy vegetable." When challenged on this, she suggested collard greens as an alternative. Collard greens!

If you ask me, Easterlin is just trying to hide Tyranny By The Elite in some new costume so that he and his fellow professors can continue to push it in a world where the 'stoonts' aren't buying it anymore.

That aside, this raises the question of whether we do know what we want. In some areas of life, I submit that we do, and that it does not matter how much income or material goods are involved. This was proven to my satisfaction by Bush-41, who explained that he did not like brussels sprouts, and now that he was President of the United States he was not going to eat them.

This reflects my own attitude toward spinach, and I do not believe that becoming 'better informed' about spinach, my health, or what a bunch of vegans at the Department of Agriculture thinks, will change it.

I also wonder whether there isn't utility in finding out that consumerism is empty. It is a weakness of human beings that we would not listen to Easterlin anyway, even if he could prove mathematically that a Mercedes will not make us happy. One actually has to acquire the Mercedes, and have it turn out to be just another pile of sugar, before the lesson sinks in.

The next question is what we do then, and it is here that current public policy does play a role. A person confronted with the Eternal Truth that money does not buy happiness can go one of two ways, toward spirituality or toward hedonism.

This society prefers that people turn to hedonism, and we know that because our public policies discourage expressions of spirituality and protect expressions of hedonism.

Which brings us full circle, i.e. back to blondes. Which is why I think that until we have a General Theory of Blondes, we cannot understand economics. Take Easterlin. If he had a blonde, he would not be spending his time trying to cram Marxism down into the crevices of economic theory where the stoonts can't see it. He would be engaging in hedonistic activity that occasionally turned spiritual. And he would be a lot happier.

You seem to keep falling for the idea that just because individuals don't always act rationally...

I don't think we even know that. If there is a safe Fundamental Assumption, it is that human beings do not know the future until it happens. While in hindsight we might be able to say, "That behavior was irrational," the person who made that choice did not know how it would turn out, and may well have been trying to make a rational choice.

So it may still be true that the person was seeking increased utils. They just didn't know that there weren't any utils in that direction. An important point is that quite often no one else knew either, and so there was no source of "better information" that might have altered the decision.

I think the point you raise — that quite often "markets" collectively know things that individuals do not, supports the idea that inside their heads, the individuals are trying to maximize utility. If that were not the case, the collective wisdom would be no better than any one randomly-selected guess. Which is not what we observe.

Let's assume for the moment that it is true that "the overall level of satisfaction and happiness in the US has stayed flat over the past 30 years." Does this tell us that "more utils" are of no util, which appears to be the Anti-Tautology, or that resources are increasingly (assuming positive growth) being directed toward the production of goods and services that do not deliver what people assume they will deliver, i.e. that human beings are once again guessing wrong about what will happen if they do X?

If the latter is true, then we would expect to find some extra-market force — such as government, or media, or both — working to suppress the market success of something that does deliver the increased utility that people seek.

Let us admit one psychologist into the discussion: Maslow, and his heirarchy of needs. Maslow would tell us that at some level of physical comfort, the next places to find high marginal utility would be the areas of spirituality and self-actualization.

Yet we do not observe people who seemingly have "enough stuff" gravitating toward these things.

At this point an economist would ask whether something is artificially increasing the price of these items, or banning them outright. Because otherwise we would expect to see them succeeding in the market.

For example, we could look to a recent dispute in the U.S. Senate concerning the confirmation of certain judges to see if we can identify any extra-market forces that are trying to raise the price of, or ban, spirituality.

We could look in the media to see if such items are being unfairly represented, savaged in reviews, or condemned as requiring too high a price.

If we were to observe such things empirically, then there would be no need to revise our assumptions to incorporate the seemingly-implausible "Brownian man" who behaves like a random-number generator. We could dismiss such a theory as an artifact of Gramscian determination to render all things senseless.

If not for the fact that Soviet spending on the military actually slowed after Gorbachev took power, which kind of kills the cherished theory that Reagan worshipper's theory that the defense buildup was really designed as a sneaky form of economic warfare not a paranoid reaction to an overrated Soviet threat.

Face it the Soviet Empire collapsed from within.  It had very little to do with Reagan or the actions of the west but was primarily caused by the inefficiency and oppression of the system itself.

citation please

I've only got a moment, so here are a couple of books you might consider (I trust these do not qualify as "moronic papers"):

David Myers has an interesting book on the subject called The American Paradox: Spiritual Hunger in an Age of Plenty

Robert Lane's contribution is a book called The Loss of Happiness in Market Democracies

So you do just have a problem will almost all of economic thought. Honestly, I think most psychologists are full of crap. I'd had to deal with a number of them, and I would never trust any to base policy

I don't have a problem with economic thought. I have a problem with public policy ideas being defended by reference to grossly over-simplified high-school economics. Read the literature today, and you will see that the ideas I am advocating (the decreasing impact of marginal utils on happiness, etc) are in the mainstream of economic thought.

I cannot find a single thoerist that had produced a single piece of worthy information as far as the Reagan economic strategy was concerned and his economic theories.

Although interesting at first, the vast majority of my business associates and friends, many of which have or had holdings, positions or some other interst in the majority of fortune 500 companies, don't see it just exactly the way many Republican's seem to like to. Additionally, I have close frineds in dozens of privately owned companies that feel similarly.

Except for those who really enjoyed the deregulation of the Savings & Loans and how that tied into the real estates funds, and military contractors and associates, I don't know many others that made any money.

He made available all sorts of tools I took advantage of as far as maintaining wealth, (tax breaks, deferals, inheritance law changes etc.). We can't say we see any long term sustained growth for the Reagan expenditures, as we ended up far further in debt with the exception and(extermely large and looming) consideration about Cold War expenditures.

Yes, it's clear the Soviets were already in some financial hot water, but that was no public secret, the weekly "bread line" reports on our evening news drove that point home. I'm not saying he knew the outcome, I'm saying this "WAS" the outcome. All this other speculation as to what motivated I just do not have enough information on to make such an evaluation. However, Clinton clearly understood, he no longer had the world-weight bearing cost of having to maintain the military in it's form at the time. This is a clear and undeniable conclusion since they themselves say it is, this is what happened and what was done, I'm not making anything up new here.

Reagan killed the expense, Clinton took advantage, as he should.

As far as any other factor actually truly affecting the economic growth of the country since his term, I remain unconvinced, but willing to learn more.

The Laffer curve relates tax revenue to tax rates.  You don't want to have tax rates that are too high because it will harm tax revenue generation in the long run.  But that doesn't mean that you want to maximize tax revenue either for a set of economic conditions.  And it doesn't deal with enhanced economic growth that can result from lower tax rates, which can lead to higher tax revenues down the road than for a higher tax rate that maxmimizes revenues in the near future.

Thanks everyone for the posts.  I'm pretty new here and this was my first chance to read any economic stuff.  

I have one MAJOR beef with how people use the Laffer Curve and one beef with the contention of this diary.

First I think that too many people use the Laffer Curve purely for political purposes.  Let's assume that the Laffer curve exists.  Why is it that alleged supply-siders(in contrast to ACTUAL supply-siders) ALWAYS maintain that lower taxes will yield higher tax receipts and higher productivity?  That certainly isn't what the Laffer Curve suggests.    In this thread I saw a lot of people extolling tax cuts and dismissing the "anomoly" of the Clinton tax hikes.  That seems to be based more on philosophical desire than economic anaysis.

Secondly I think that too many people want to credit the tax cuts for the current increase in tax receipts but are ignoring the huge discretionary deficits the Federal government has been running the past 4 years.  If the Federal government is running 200-500 Billion dollar deficits annually it stands to reason that the State's will see a increase in tax revenues from THAT.

I want academic, not pop books about po p life. The American Paradox isn't even about economic thought.

Real evidence please.

First, you said you wanted references, but not references to "moronic papers".

So I provided you with two books.

Your response is that they are "pop books about pop life", and that you want "real evidence".

Sorry, I'm not going to play any more.

There is a ton of research on this subject out there. Lots of it is on the net. Google "subjective well being" to get started.

When I said not moronic papers, obviously the point was not anything moronic. Not some n of 1 case study and not some soft work that just relied on surveying ppl of different generations.

No bad papers, no bad books, no bad anything. Get me something real.