The Laffer Curve and the Failure of Stimulus Spending

Abstract

If there is a Republican administration after the November presidential elections, we can expect a significant change of policy on tax, spending and stimulus. There is a rich variety of data from the USA that demonstrates that raising tax rates often reduces revenues and vice versa. This is especially so when raising taxes from the high rates that we currently have. There are many examples over the last century when tax rates were reduced, economic growth increased and the proportion of the tax take from rich people increased. So-called fiscal stimulus policy does not work. A stimulus has to be financed and the income effects on those benefiting from the stimulus are cancelled by the 'destimulus' from those financing it. To make matters worse, a fiscal stimulus will normally raise taxes – at least in the long term – and may well be used to provide benefits to those not paying taxes. This reduces work incentives, gives better off people incentives to hide income by avoidance and evasion and reduces economic growth. The better off are particular adept at finding ways not to pay taxes. During George W. Bush’s last two years in office the USA had the biggest ever increase in federal government spending in peacetime – from around 21 per cent of GDP to 27.5 per cent of GDP. The Great Recession began in that period.