Laffer Curve July 12, 2012

This is the original graph that Art Laffer wrote on a napkin. There is nothing wrong with this graph, but we want to make it easier to understand, because graphs can become confusing.

The only thing the Laffer Curve addresses is the tax rates. The only thing the Laffer Curve addresses is the tax rates.

Economics is very complicated because it is effected by many factors, such as: Economics is very complicated because it is effected by many factors, such as: Tax Rates Tax Rates Regulations Regulations Deductions Deductions Exemptions Exemptions Stability of Currency Stability of Currency Total Spending Total Spending Tax credits. Tax credits.

What is Taxable GDP? Taxable GDP stands for Gross Domestic Product that is taxable. Taxable GDP stands for Gross Domestic Product that is taxable. Taxable Gross Domestic Product is all the product made and services provided for a country in a given year that can be taxed. Taxable Gross Domestic Product is all the product made and services provided for a country in a given year that can be taxed. In the Laffer Curve we only talk about taxable GDP. In the Laffer Curve we only talk about taxable GDP.

What is Taxable GDP? Taxable GDP is the money you make that can be taxed by the government. This does not include income that is deducted, exempted, or labor you do yourself.

These numbers are the tax rates. Tax rate Taxable GDP This line is the taxable GDP. This graph is saying that the taxable GDP will stay the same as the tax rates increase. The Laffer Curve does not assume this.

This line represents the amount of money government is getting from taxes. The Laffer Curve does not assume this. Tax Rates Taxable GDP This assumes that tax payers thoughts and actions do not change with changing tax rates. Congressional Budget Office (CBO) uses this chart. This graph is saying that the taxable GDP will stay the same as the tax rates increase.

The Laffer Curve believes that tax payers thoughts and actions do change with changing tax rates. The Laffer Curve believes that tax payers thoughts and actions do change with changing tax rates.

As the Tax Rate increases, the benefit of the profit is reduced; thus entrepreneurs are less likely to start, expand, or might even close a business.

Pros of a Business 1. Profits As tax rates increases, the weight or worth of profits are greatly reduced. Cons of a Business 1. Your own labor and time 2.Expenses

Back to the Basics A trade of product or labor only happens when two people agree on a mutual cost that benefits both people. A trade of product or labor only happens when two people agree on a mutual cost that benefits both people. If they both decide that it’s fair to trade ten chickens for ten stalks of corn, and the government has a 50% tax rate, then each person will give ten of their items away, and only receive five of the other persons product. If they both decide that it’s fair to trade ten chickens for ten stalks of corn, and the government has a 50% tax rate, then each person will give ten of their items away, and only receive five of the other persons product.

Back to the Basics The government is taking the other five products from each person. The government is taking the other five products from each person. The more the government taxes, the less people are willing to trade. The more the government taxes, the less people are willing to trade. If people stop trading completely, the governments income would cease to exist. If people stop trading completely, the governments income would cease to exist.

Now we are going to look at the logic of the Laffer Curve. Now we are going to look at the logic of the Laffer Curve. Its shows us that people’s thoughts and actions do change with increasing tax rates. Its shows us that people’s thoughts and actions do change with increasing tax rates.

The higher the tax rate, the less willing people are to work. Taxable GDP Lets first look at this line so that the Laffer Curve makes a little bit more sense. Labor you do yourself is not taxed. Buying things is important, because it allows people to focus on one thing and get good at doing that. When tax rates increase, people do not see worth in buying goods and services. So, they try to do things on there own, which is not nearly as productive. This is comparable advantage. 100 represents the maximum amount of taxable GDP without the affect of tax rates. Zero represents when government taxes 100%. So, we are no longer willing to work. Unlike the other graphs, this graph is what the Laffer Curve assumes. Tax Rates Taxable GDP The reason why the taxable GDP line is diagonal is because people’s willingness to work is increasingly less as the government taxes us. If the tax rate stands at 40%, $60 is the full taxable GDP. People will have a hard time seeing the potential unrealized.

Shows the income from the taxes. This is the actual Laffer Curve. We have already talked about the blue diagonal line. It shows us how willing we are to work when the government taxes us. Taxation by the government The green line shows us how much money we get to keep after the government taxes us. Lets look at the math! We are going to take the amount of taxable GDP we are willing to make. Then subtract the percent that the government is taxing us. After that we will be left with the money the people get to keep. 0% of $100=$0 30% of $70=$21 70% of $30=$21 100% of $0=$0 At 0% taxation rate you are willing to make $100. 0% of $100 is $0. We get to keep $100 Tax Rates Taxable GDP Income We Keep At 30% taxation rate you are willing to make $70. 30% of $70 is $21. We get to keep $49. At 70% taxation rate you are willing to make $30. 70% of $30 is $21. we get to keep $9. At 100% taxation rate you are willing to make $0. 100% of $0 is $0. Both the government and us only keep $0

Lessons Learned We have to know when to stop taxing. We have to know when to stop taxing. As we saw, if the government taxes us too much, then it is no longer worth working. As we saw, if the government taxes us too much, then it is no longer worth working. People then start trying to do things on their own. People then start trying to do things on their own. This is not nearly as productive. This is not nearly as productive.

Lessons Learned The higher the rate of welfare, the less economic activity. The higher the rate of welfare, the less economic activity. If the government gives us things, we are less willing to work for it. If the government gives us things, we are less willing to work for it. The total amount of people in America on welfare is approximately 15,000,000 people! The total amount of people in America on welfare is approximately 15,000,000 people! $132 billion are spent on welfare alone each year (not including food stamps or unemployment)! $132 billion are spent on welfare alone each year (not including food stamps or unemployment)! This forces the tax rate higher, thus reducing GDP. This forces the tax rate higher, thus reducing GDP.

Lessons Learned Exemptions and deductions are counterproductive. Exemptions and deductions are counterproductive. Exemptions and deductions are when government makes exceptions on what GDP is taxed and what is not. Exemptions and deductions are when government makes exceptions on what GDP is taxed and what is not. When government makes exceptions on too many circumstances, they realize they aren’t getting enough tax revenue. When government makes exceptions on too many circumstances, they realize they aren’t getting enough tax revenue. So, they raise tax rates. So, they raise tax rates. Now, as we learned, they aren’t going to raise enough tax revenue. Now, as we learned, they aren’t going to raise enough tax revenue.

Lessons Learned If you have 30% taxation rate and you have a taxable GDP of $70 the government collects $21. If you have 30% taxation rate and you have a taxable GDP of $70 the government collects $21. If you then exempt 50% of the GDP, the governments income drops to $ If you then exempt 50% of the GDP, the governments income drops to $10.50.

Lessons Learned You will never be able to raise rates high enough to get back to $21 because the taxable GDP drops as you raise the rates. You will never be able to raise rates high enough to get back to $21 because the taxable GDP drops as you raise the rates. It is far superior to lower tax rates instead of using deductions and exceptions. It is far superior to lower tax rates instead of using deductions and exceptions. Having progressive tax rates are similar to large deductions. Having progressive tax rates are similar to large deductions.

Income We Keep Taxable GDP Tax Rates One low, flat rate with no exemptions or deductions will result in a much higher GDP This will result in higher employment and higher pay.