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The Laffer Curve: Not Just For Taxes

Posted by John Hitchcock on 2011/07/19

Legend has it Art Laffer diagrammed his Laffer Curve on a napkin. Whether this is true or not, I neither know nor care. That’s called indifferent ignorance. It’s also irrelevant. On more than one occasion, a great idea or a smash hit or profound thought or what have you has been created on a napkin, an envelop, a table cloth, the back of a receipt, etc.

And many ideas, thoughts, and suchlike are “oh, duh” moments where the ideas are so obvious it’s a wonder nobody else came up with them or verbalized them so succinctly prior. In my opinion, Art Laffer’s famous Laffer Curve is exactly that: Oh, duh! It’s so simple, it makes absolute sense. To suggest otherwise would be a fool’s errand. If a government has a 100 percent tax, that government will eventually cause the entire economy to halt, creating zero tax dollars out of that 100 percent tax. Likewise, if a government has a zero percent tax, the government will create zero tax dollars. And it’s not a binary system. It’s not on/off. It’s not either/or. It’s greyscale.

As you increase the tax rate from zero, you gain tax revenue. As you decrease the tax rate from 100, you gain tax revenue. It’s so very obvious, it’s a “duh” moment. But that means there is a point somewhere along the lines where there is a maximum revenue stream. Anything greater produces less revenue and anything lower produces less revenue. And that’s the “duh, why didn’t I think of that” moment that is the Laffer Curve.

But the Laffer Curve also works in business decisions. In my business and economics studies, I have seen the principles of the Laffer Curve but I have not seen it distilled down to the Laffer Curve. But it is very applicable. In fact, businesses which don’t account in some way for the Laffer Curve will not long survive.

Businesses are in business to make money. In that regard, they must sell something, be it a commodity or a service or information or whatever else. For a business to sell something, there must be a price set. And that’s where the Laffer Curve plays a primary role. If a business sets too high a price, nobody will buy the product. That means zero income. If a business gives away its product for free, that means zero income. That means, by definition, both ends of the spectrum produce the same result: zero income. And somewhere between both ends of the spectrum produces the desired result: maximum income.

But income is only part of the business equation. Cost of producing the product is the other part. And a major cost is payroll. Businesses want the lowest payroll possible to match the highest product price possible. This is where the Laffer Curve begins to go 3-D. This is where multiple variants come into play. But let’s look at the new variant: Payroll cost.

If a business pays zero for its labor force, there will be no labor force. Even in slave-labor societies, there is still a cost for the labor force: food and shelter. But the other end of the spectrum — too high a cost for the labor force — is 3-D. If the business pays more for its labor force than it receives in selling its product, the business goes below zero on the Laffer Curve. So, zero cost for labor means zero labor and no business; the business ceases to exist. And too high a cost for labor compared to price for product means a business loss and the business ceases to exist. Ultimately, that means there is a desirable labor cost, a salary level which brings the maximum corporate benefit.

Another actor affected by the Laffer Curve is an actor many tend to ignore. Because it is a mostly stealth actor. As such, I consider it in many ways the most dangerous and most destructive actor. That is Regulation. Government regulations on business cost money. The more regulations, the more money they cost. The more invasive the regulation, the more money it costs. Once again, this is the Laffer Curve in 3-D. Regulations affect the cost of producing the product. Those regulations affect the product itself and the labor force and everything else involved in producing the product. The regulations affect the sale of the product, the use of the product after sold, and the business that created the product even long after the product was sold.

If regulations are too numerous or too invasive or too restrictive, they drive the consumer cost of the product so high that nobody buys the product, producing zero income. And the business ceases to exist. And the government loses a source of tax revenue. And people lose their incomes. Domino. If there are no regulations, the products become completely untrustworthy, even to the point of death for some products. And trustworthy businesses will fail just as the untrustworthy businesses fail, just by being associated with the same class of unregulated product. Therefore, there is a “sweet spot” for regulations. Too numerous or too invasive and everyone suffers as a result; too few or not invasive enough and everyone suffers as a result.

The key with the Laffer Curve is to hit the sweet spot, or to come as close to the sweet spot as possible. Actually, the greatest key is to get as close as possible without going over, as in “The Price Is Right”. Going under is easily correctable. Going over is not.

If you pay your employees too little, you will have too few employees and the employees you do have won’t be the quality employees you want or need. Increase the pay level and that problem fixes itself over a short period of time. If you pay your employees so much that you are unprofitable, you cannot easily cut their pay. Cutting employee pay will destroy morale, cause a mass exodus, and possibly do irreparable harm to your business. You will not be able to achieve maximum success. Your maximum is now permanently lower than it would have been had you not been overpaying your employees prior.

If you overcharge for your product for long enough, nobody will buy your product. Even as you lower the price of your product, you will not gain the market share you could have gained had you not been overpriced in the first place. But if you undercharge for your product, increasing the price, while likely costing business in the short-term, will still give you opportunity for maximum profit in the long run.

If you overtax for long enough, the optimum tax level drops even lower. And the economic output potential also drops lower than it would’ve been had you not been overtaxing. Further, the government has already become too large and unweildy, needing even more revenue than it already receives. Lowering the taxes, while greatly beneficial to the people, will starve portions of government. And again, it will not produce as much benefit as it would have if the taxes hadn’t been set too high to begin with. Because the economy had been starved for far too long.

If you over-regulate for any duration, permanent economic damage ensues. Reducing the regulations is too late for maximum benefit.

Now, I’m not being fatalistic. I do not suggest keeping the systems too high merely because lowering them is too late for maximum benefit. Maintaining the systems at too high a level will continue to bring greater harm than reducing the systems. Reducing the systems, while too late for maximum benefit, will still produce greater benefit than keeping the systems at too high a level.

For the businesses and the half of the people who pay taxes, taxes are too high. For the half of the people who pay no taxes, taxes are too low. There are far too many regulations and the regulations are far too invasive. Examining these things based on the Laffer Curve makes it more than obvious.

Taxes and regulations drive up the labor cost to unnaturally high levels. Taxes and regulations drive up the product cost to unnaturally high levels.

Where businesses must deal with the Laffer Curve to stay in business, governments can and do ignore the Laffer Curve in its entirety. Businesses must maintain a labor force. That means paying their labor force enough to keep them and to keep the quality. Businesses must continue to sell their product, that means keeping the product price low enough that it sells.

But governments ignore all that. Democratic governments eventually devolve into feeding emotion and the greedy, lustful nature of people by giving those who do not deserve it money from people who earned it, and by creating enough regulations to allow people to not be responsible for what they do; instead making others responsible for what the irresponsible people do.

Emotionalism, irresponsibility, buying votes. That’s what keeps big-spending government types in office. And that’s what is currently destroying these United States. And that’s why the Liberal Socialists and Ruling Class Republicans need thrown out on their ears.


Posted in Character, Conservative, economics, Elections, Liberal, Over-regulation, Philosophy, politically correct, politics, society, Tax, TEA Party | Tagged: , , , , , | Comments Off on The Laffer Curve: Not Just For Taxes

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