The Laffer Curve

A model showing that there is such a thing as too much

Through an Open Source Defense article I've been made aware of an important economic concept known as the Laffer Curve that I believe we should all be familiar with. Of course I'm no economist but I don't believe you have to be one in order to learn from economic principles, especially when we apply them to things outside the economy which I plan to do.

On a winter night in 1974 Arthur Laffer found himself at dinner with Donald Rumsfeld and Dick Cheney, two men quite high up in President Ford's administration. At the time the Ford administration was planning to increase taxes and Arthur Laffer was there to persuade them not to. Legend has it that Laffer took a napkin and drew what came to be known as the Laffer curve on it to convince the two men of his argument.

Whenever the government raises taxes their purpose in doing so is to increase tax revenue (the total amount of money they steal from everyone). They may try to guilt you into thinking otherwise but this is their true goal. Anyways, back to the story, Laffer drew a simple graph with a bell curve with one axis representing tax revenue and the other representing the tax rate. He explained to Rumsfeld and Cheney that if the tax rate was zero then tax revenue would obviously be zero and if the tax rate was one hundred then tax revenue would also be zero because nobody would have the incentive to work if the government took everything. Of course as the tax rate rose from zero the tax revenue would rise but Laffer pointed out that there must be some point between the tax rates of zero and one hundred where raising the tax rate would cause overall tax revenue to go down because it would be harming the economy, companies and individuals become less motivated to grow the economy as the government takes bigger pieces of their pay checks.

To understand this let's think up a simple example with some unrealistic yet easy to understand numbers. Imagine a company, we'll call it Simple Co., that has a gross income of ten billion dollars per year and their tax rate is 20%. Let's also assume that they are running on fairly tight margins so they can't really grow with the other eight billion dollars they aren't forced to hand over to the government because it is all going towards manufacturing their product. In this scenario Simple Co. can't really grow because they don't have any funds left to invest in new equipment or innovation. Now let's say the government decides to cut taxes and Simple Co. now only has to pay 10% of their gross income in taxes. This frees up a billion dollars for Simple Co. and they can now invest that money into new production techniques and products. Let's say this investment ends up being successful and they figure out a new manufacturing technique that allows them to triple their output with the same cost, so the next year they make thirty billion dollars and with just a ten percent tax rate the government takes tree billion dollars rather than the two billion dollars they were getting before when Simple Co. was making less money.

Now let's fastforward a few years and see that Simple Co.'s income settles around forty billion dollars a year with tight margins and we get new people in government that decide they want to raise taxes and they begin taxing Simple Co. twenty-five percent. Now all of a sudden Simple Co. has to cut six billion dollars out of their budget, this forces them to cut back on product development and maybe even shut down a factory. Without this extra cash Simple Co. falls behind on innovation over the next year or two and all of a sudden Complex Co. from overseas comes in with a better product than the one Simple Co. sells and Simple Co. is unable to compete because the higher tax rate crippled them and over the next year their income drops to just twelve billion dollars and the government went from collecting four billion dollars from Simple Co. with a ten percent tax rate to just three billion dollars with a twenty-five percent tax rate.

Again this is of course an oversimplified example with unrealistic numbers, I'm sure if an economist read this they would have plenty to critique since the real world is much more complex, but I trust that you understand the concept. Increased tax rates do not always cause increased tax revenue, the results of America's 20th century tax cuts support this claim, and of course this principle applies to lower and middle class tax rates as well.

Now of course we as citizens shouldn't care too much about tax revenue, our individual tax rate is much more important to us than the country's tax revenue. But, as I said before, economics is not the only place where we can learn from the Laffer Curve, especially when it comes to public policy.

Since this article was inspired by Open Source Defense, let's take a look at gun control first. The more well intentioned and naive supporters of gun control believe that the main objective of gun control is to protect people, (rather than disarm the population) in their eyes more gun control should leave to less violent crime. But how much gun control is too much?

The most popular form of gun control is conducting background checks, background checks are conducted in every state for every legal gun sale, I believe this has been the case since the 90s and any politician who claims otherwise is lying to you. Now, you could probably make an argument against the constitutionality of background checks, but from a public safety perspective it's hard to claim that background checks are a bad idea assuming they're carried out in a speedy fashion (meaning in less than an hour). Everybody agrees that people with a recent history of violent crime or a drug addiction shouldn't be allowed to buy a gun. Of course criminals will always manage to get their hands on guns through illegal means but as long as it is easier for a law abiding citizen to legally acquire a gun than it is for a criminal to to get one then the inconvenience of a background check shouldn't be too big of a problem.

Now I haven't looked at any numbers on this, but for the sake of discussion lets assume that background checks are effective in reducing violent crime, we haven't gone over the peak of the Laffer Curve with just implementing background checks. So what happens if we start conducting them retroactively? That is essentially what red flag laws are (although the criteria for getting flagged by one of these laws is much looser than that for failing a background check). Twenty-seven states have a red flag law of some sort, and I have seen data on how that turned out, researchers have concluded that red flag laws have failed to reduce violent crime, in fact you can argue that they have been detrimental to public safety because they've disarmed innocent people who are now powerless to protect themselves from violent criminals. Red flag laws push us over the gun control Laffer Curve.

Let's take a look at a different form of gun control. The National Firearms Act was passed in the early 20th century. It's original purpose was to make it incredibly difficult for people to buy pistols and machine guns because those were the guns being used in crime most often. Lobbyists were successful in getting the restrictions on pistols out of the bill but restrictions on short barreled rifles and shotguns (which was wording added to prevent people from converting normal rifles and shotguns into pistols) were overlooked by the lobbyists and were left in the bill when it was passed.

So where does that leave us now? For the sake of discussion let's assume that a civilian having possession of a machine gun is incredibly bad for public safety. In the 60s the federal government passed a law which prohibited civilians from buying any machine guns newer than whatever date that bill was passed which means these days a civilian can still legally own a machine gun but they either have to be a firearm manufacturer or pay tens of thousands of dollars for one, so for common folk like you and me owning a machine gun legally isn't very attainable.

Short barreled rifles are much easier to get legally, because they are not as expensive, except there is a waiting period to get them and it typically takes over a year to get approval to buy one. But up until recently one could buy an AR pistol with a pistol brace attachment and those would function good enough for the people who didn't want to jump through those hoops and that is what millions of people did. (I am not one of these people)

Within this past year the ATF has decided to unconstitutionally classify AR pistols with a pistol brace attachment as short barreled rifles (something only congress can do). This turned millions of people into felons in possession of illegal SBRs overnight. Now, what I'm about to say is not legal advice, nothing in this blog is but especially this next point because it is obviously illegal and not something that I'd ever do. Looking around online you see a lot of people coming to the conclusion that possessing an illegal SBR and an illegal machine gun are identical crimes with the same punishment. So if these people who the ATF decided were felons overnight are already guilty of that crime, what is the legal incentive for these people not to produce an illegal machine gun? It doesn't really exist. Of course people online who would encourage you to do such a thing are probably feds trying to get you in trouble so don't start making illegal machine guns but I have a feeling that a lot of people are going to look at this logic and start doing it. Banning pistol braces in the way that the ATF has will likely result in more illegal machine guns out in the wild, they've clearly gone beyond the peak of the Laffer Curve with this decision, they changed the laws drastically enough that people who would have previously complied now may not.

Now let's step away from gun control and talk about education. We should all of course know that increased spending on education does not produce better education results and in some cases will cause worse outcomes so the Laffer Curve definitely applies there but let's take a step further and get ourselves away from public policy and talk about grading scales and homework policies instead.

The math department at my high school was fairly centralized in the sense that every math class had the same grading scale and every teacher assigned homework every night, homework also never accounted for a large portion of one's grade, in fact there was one year where it was only worth five percent of a student's final grade. Homework assignments would typically take thirty minutes a night and were often incredibly repetitive filled with simple problems that didn't challenge the mind too much. When I got into high school I quickly realized that math homework was not worth my time, I was gifted at math so I didn't have to worry about failing tests and enough extra credit was offered that doing the extra credit assignments more than covered for the homework that I didn't do.

Now not everyone was as gifted as I was with math but there were plenty of people who came to the same conclusion that I did regarding homework and also chose not to do it. These people suffered when tests came around because they wouldn't have a good grasp on the principles being tested due to their lack of practice. The teachers would of course blame the failures of the students on the students but I don't think it was entirely their fault, the teachers pushed their homework assignments beyond the peak of the Laffer Curve because they demanded too much. Had they been more careful with their homework policy they would have had better results.

I don't have to look very far to prove this point either. The calculus teacher at my high school was the black sheep of the math department, he had a PhD and mostly just taught the smart kids so the department let him do what he wanted with his grading scale. If I remember correctly homework in his class was worth thirty percent of your grade (so skipping all of it wasn't an option) but it wasn't assigned daily, I don't remember how often it was assigned but I don't think we ever had more than three in a week, two might have been the average. His homework assignments were also much better designed, they respected our intelligence, rather than taking ten simple questions out of a book the government wasted money on where you basically did the same thing ten times in a row with different numbers he wrote his own assignments. They had fewer questions but the questions were a bit harder, they didn't waste your time by drilling the same thing into you over and over, they were enough for you to know you knew what you were doing and once that happened they moved on. I did my homework in this class as did everyone else and there were much less people who struggled when test time rolled around. Less homework in this case resulted in better student performance, had the entire math department adopted this approach it would have been much more effective.

The Laffer Curve demonstrates a principle we should all be aware of, there are a lot of situations where less is more. Of course it does not apply everywhere, a performance gain in software development is always a good thing. A part of the mystery of the Laffer curve is that we will never actually know where its peak is nor how steep the slope is, we will never truly know what the optimum tax rate to produce the best tax revenue is, but we can see that if we set the bar too high we will end up hurting our chances of getting our desired outcome.