The Laffer Curve Turns 50 – How One Napkin Illustration Changed the World: Jonathan Williams on American Radio Journal
In only 50 years since its creation on a napkin at the Hotel Washington, the Laffer Curve has changed how policy makers have thought about taxes.
Fifty years ago on September 13, 1974, economist Dr. Arthur B. Laffer sat down for lunch with Dick Cheney and Donald Rumsfeld at what was then called the Hotel Washington, across the street from the White House in Washington, DC. Of course, Cheney would go on to serve as Secretary of Defense and be elected to Congress and then the vice presidency. Don Rumsfeld, who had been a congressman, would go on to serve as prominent CEO of G.D. Searle company and then defense secretary. But the most important product of that lunch in 1974 was a simple illustration that Dr. Laffer drew on his napkin that would go on to become one of the most important illustrations in modern free market economics.
That chart, now known as the Laffer curve, summarizes lessons from Dr. Laffer’s work on taxation, the theory of incentives and productivity. The curve begins with a simple observation that at a 0% tax rate, government would obviously collect no revenue from that tax but it would also collect no revenue at a 100% tax rate in the long term, with 100% tax on income, the government would confiscate every single dollar of a worker or business earns, eliminating the incentive for work and productivity altogether in the prohibitive range of the Laffer curve. When it comes to high marginal tax rates, increasing taxes will not raise the revenue forecast by static economic models used in Washington in the vast majority of state capitals, and it may actually decrease government revenue.
How can this be?
Well, as it turns out, people don’t work for the privilege of paying taxes. They work for the after-tax income that enhances well-being for themselves and their posterity. These concepts, the Laffer curve, captured in one simple napkin in 1974 have had an incredible influence on economics and public policy. Dr. Laffer served as an advisor to President Ronald Reagan when he signed the landmark tax cuts of 1981 and the tax reform of 1986 these tax changes dramatically lowered federal income tax rates, allowing Americans to keep more of what they earned in fueling the great American economic boom for the late 20th century.
For 50 years, the Laffer curve has given economists a common sensical but important tool to explain the damaging effects of taxes in the economy. Laffer has been since credited as the father of supply side economics and was awarded the prestigious Presidential Medal of Freedom due to his incredible contributions in the field. His latest book, Taxes Have Consequences, co-authored with Dr. Brian Domitrovic and Dr. Jeanne Sinquefield, breaks down the history of the income tax in the United States. In the conclusion of that book, Laffer and his co-authors write that “the evidence indicates, again, in case after case, that lower tax rates have resulted in economic growth, employment and the broadening of economic opportunity.”
This is what the Laffer curve is all about. For 17 years, Dr. Laffer, Stephen Moore and I have co-authored the Rich States, Poor States, ALEC- Laffer, State Economic Competitiveness Index. This report takes the lessons from the Laffer curve and applies them to economic policies in the states. Nearly two decades of our analysis have consistently found that Americans vote with their feet by moving to the states that embrace low tax burdens or other pro-growth economic policies. Those competitive states have attracted millions of new residents over the years who are now new taxpayers and have brought in countless new tax revenues to the fisc that pay for core public services and of course, can be used to reduce tax burdens on hard working taxpayers.
Again, this is the virtuous cycle of economic competitiveness. Other states learned the lesson of the Laffer curve the hard way. They think they can tax their residents into prosperity, but instead, they found that those policies only slow economic growth and drive people out of their states, losing their economic contributions and tax revenue, in many cases, forever.
In only 50 years since its creation on a napkin at the Hotel Washington, the Laffer curve has changed how policy makers think about taxes. Dr. Laffer’s work has inspired the historic tax relief during the presidencies of Ronald Reagan and Donald Trump, and countless works of economic research and analysis, not to mention scores of states that have cut taxes and become more competitive. In the decades to come, the lessons from that napkin will undoubtedly continue to influence tax and economic policy, enabling greater prosperity around the country.