1 00:00:00,390 --> 00:00:04,720 Let's discuss an important concept from economics, the Laffer Curve. 2 00:00:04,720 --> 00:00:10,020 This concept is named after the man who developed it, Arthur Laffer, a major American economist 3 00:00:10,020 --> 00:00:14,560 who has taught at the University of Chicago, University of Southern California, and elsewhere. 4 00:00:14,560 --> 00:00:19,779 The Laffer Curve illustrates the two most important things we need to know about taxes: 5 00:00:19,779 --> 00:00:24,970 how much money the government can raise from taxes and at what level of taxation the government 6 00:00:24,970 --> 00:00:28,650 might start getting less, not more, revenue. 7 00:00:28,650 --> 00:00:33,530 The Laffer Curve is illustrated here by a two-dimensional graph. The horizontal line 8 00:00:33,530 --> 00:00:37,760 is the tax rate that the government chooses, and the vertical line is the revenue that 9 00:00:37,760 --> 00:00:40,399 the government receives from that tax rate. 10 00:00:40,399 --> 00:00:47,109 First, because zero times any number is zero, if the tax rate is zero, the government receives 11 00:00:47,109 --> 00:00:52,519 zero revenue. Accordingly, zero-zero is our first point on the curve. 12 00:00:52,519 --> 00:00:58,109 Now suppose the government chooses a very small tax rate, say 1 percent. The government 13 00:00:58,109 --> 00:01:02,789 will then begin to receive some revenue from citizens. This means that another point on 14 00:01:02,789 --> 00:01:05,339 the curve must be something like this. 15 00:01:05,339 --> 00:01:12,599 Now suppose the government charges a 2 percent tax rate, then, everyone would agree,that it will receive even more revenue 16 00:01:13,020 --> 00:01:16,920 -- which means that another point on the curve must be something like this. 17 00:01:17,200 --> 00:01:21,280 And if the government keeps raising the rate, then revenue will continue to go up. 18 00:01:21,280 --> 00:01:25,210 at least when we're in the low-tax-rate part of the graph. 19 00:01:25,210 --> 00:01:29,680 This means that if we fill in the curve, it has an upward slope -- at least when 20 00:01:29,680 --> 00:01:33,229 we're in the low-tax-rate-part of the graph. 21 00:01:33,229 --> 00:01:40,090 Now suppose the government charges a 100% tax rate. If this happens, then no one would work. 22 00:01:40,090 --> 00:01:44,390 Why would anyone work when the government is going to take all the money that they make? 23 00:01:44,390 --> 00:01:49,979 And if no one works, then the national income will be zero. This means that government revenue 24 00:01:49,979 --> 00:01:56,130 will be 100% of zero, or zero. This means that another point on the curve must 25 00:01:56,130 --> 00:01:57,950 be here. 26 00:01:57,950 --> 00:02:03,930 Now let's complete the curve. And when we do, we see that the curve must have a hump. 27 00:02:03,930 --> 00:02:10,930 That is, it could look like this, or this, or this. But it has to have a hump -- because 28 00:02:11,320 --> 00:02:16,800 This is simply because the revenue line has to go up in the low tax rate part of the graph 29 00:02:16,900 --> 00:02:22,040 and has to start going down to reach the point we drew at the 100 percent tax rate. 30 00:02:22,040 --> 00:02:27,580 But if the curve slopes downward it implies something remarkable -- something that few 31 00:02:27,580 --> 00:02:32,700 of those who push for higher and higher taxes want to admit. It means that when tax rates 32 00:02:32,700 --> 00:02:39,409 are high, if you make them higher, you'll actually bring in less revenue to the government. 33 00:02:39,409 --> 00:02:43,500 This has in fact occurred in practice. For instance, during the Great Depression, when 34 00:02:43,500 --> 00:02:48,879 Congress passed the Hawley-Smoot tariff bill, although the bill raised taxes on imported 35 00:02:48,879 --> 00:02:54,030 goods, the revenue that came from those taxes actually decreased. A more recent example 36 00:02:54,030 --> 00:02:59,030 occurred in the early 1980s. After President Reagan and Congress drastically reduced the 37 00:02:59,030 --> 00:03:05,099 tax rates on the rich, the tax revenue that came from the rich actually increased. 38 00:03:05,099 --> 00:03:10,480 All economists -- even the most leftwing ones -- agree that the true Laffer Curve, the one 39 00:03:10,480 --> 00:03:16,269 that reflects real life, has a hump, and that therefore the curve has a downward sloping 40 00:03:16,269 --> 00:03:22,959 part, meaning at some point tax revenues start going down when you increase rates. 41 00:03:22,959 --> 00:03:29,030 So where, then, do economists disagree? They disagree about exactly where the hump occurs. 42 00:03:29,030 --> 00:03:34,129 When I took my first economics class, in 1984 at Stanford University, the textbook said 43 00:03:34,129 --> 00:03:41,000 that the hump occurs somewhere around the 70% tax rate. But apparently I was taught something wrong! 44 00:03:41,240 --> 00:03:46,220 New evidence from an unexpected source suggests that the hump occurs at a much lower 45 00:03:46,220 --> 00:03:50,379 tax rate, something around 33 percent. 46 00:03:50,379 --> 00:03:55,760 That source is a study by Christina Romer and her husband David Romer. Both are economics 47 00:03:55,760 --> 00:04:01,209 professors at University of California Berkeley. Christina Romer was the chairman of President 48 00:04:01,209 --> 00:04:06,709 Barack Obama's Council of Economic advisors. In other words, the study was written by one 49 00:04:06,709 --> 00:04:11,200 of the most influential liberal economists in the United States. And it was published 50 00:04:11,200 --> 00:04:15,360 in the American Economic Review, the most widely respected economics journal in the 51 00:04:15,360 --> 00:04:16,150 world. 52 00:04:16,150 --> 00:04:22,190 This study examined how national income responds to tax rates. But as far as what concerns 53 00:04:22,190 --> 00:04:28,280 us here, the key point is that, if you do the math, the results imply that the hump on the Laffer Curve 54 00:04:28,480 --> 00:04:34,320 occurs where the tax rate is around 33 percent -- much lower than economists previously thought. 55 00:04:34,320 --> 00:04:39,900 Let's now put these findings into political terms. They suggest, that no matter what your politics, 56 00:04:40,120 --> 00:04:46,900 you should not want tax rates to be above 33 percent. Obviously, conservatives and many moderates think 57 00:04:46,910 --> 00:04:51,830 rates should be lower than that. But even if you are an extreme leftwinger and your only 58 00:04:51,830 --> 00:04:57,910 goal is to make government as big as possible -- you should still oppose a tax rate higher than 33 percent 59 00:04:58,200 --> 00:05:01,720 The reason is that, as the Romer & Romer study suggests, 60 00:05:01,960 --> 00:05:06,300 when tax rates go higher than that, the government actually gets less money. 61 00:05:07,200 --> 00:05:13,460 Everyone of every political persuasion should pay attention to the Romer and Romer Study and its important implications. 62 00:05:14,240 --> 00:05:21,020 They suggest that if we decrease tax rates, government revenues might actually rise. 63 00:05:22,500 --> 00:05:26,680 I'm Tim Groseclose, professor of political science and economics at UCLA for Prager University.