I think it’s great that Alistair Darling – the British Chancer of the Exchequer – has raised enough money to have something done about his eyebrows. It would have been painful to watch him give his Budget Speech and keep a straight face - with him looking like Groucho Marx while sounding like the other Marx Brother Karl. But good on the fella for getting his eyebrows shaved and sparing us all a chuckle. Luckily what he had to say was very funny and we all had a good laff.
Then thinking about having a laff it hit me like a smackerel. Chancer Darling has never heard of Laffer. Otherwise he wouldn’t be making such a pratt of himself. For those who don’t know, Laffer is an American economist who hypothesized about a curve detailing the differential curve between tax rates and tax takes. If a government taxes at 0% - no revenue. If it taxes at 100% - also no revenue and everyone would tell it to sod off. Between 0 and 100 there’s a curve that describes the different tax takes at different tax rates. See the diagram.
The Laffer curve is used to illustrate the idea that increases in the rate of taxation do not necessarily increase tax revenue. It was popularized by Arthur Laffer (b. 1940) in the 1980s. However, the idea is not new to him, nor did he claim as much: it dates to the 14th century North African polymath Ibn Khaldun, who discusses the idea in his 1377 Muqaddimah. More recently, in his General Theory of Employment, Interest, and Money, John Milton Keynes described how past a certain point, increasing taxation would lower revenue and vice versa.
Simple arithmetic shows us that the optimum tax rate occurs at what Laffer calls T*. At T* the government doesn’t take too much money and people are left with enough money of their own to encourage hard work. Above T* the economy as a whole suffers as people slack off and decide its not worth working very hard. Of course not all parts of the economy suffer. At rates above T* it pays to be a bookie.
But there are other points on the curve too that Laffer didn’t push as much as the singularity at T*.
F* for example is the point on the Laffer Curve where we start to see the implications of Fiscal Drag where the impact of moving allowances upwards actually has a negative positive effect in net revenues raised through taxation. K* also is a point on the curve that represents the median point between 0 at T* where the curve slopes away faster that 45% and is the point where the economy can be said to be out of the control of the central government.
Now let’s call the point on the curve where Alistair Dalek has chosen to tax the British public. We’ll call that the D* point. At this point the net impact on the economy can be calculated with the formula:
UK(GDP) = F*K*D
Ever more fascinating is the impact that such a taxation level will have on the chances of the economy recoving during a single generation which will be the sum of the impact on all sectors of the economy:
Or if divided by the mean total number of voters eligible to cast a vote in the election, also known as the Universal Plébiscite (UP) then we can show that the chances of either Brown or Dalek getting re-elected are:
So there you go. That’s how the Laffer Curve works. Next time we'll discuss the macroeconomic double-bell curve and use that to show how Jacqui Smith was chosen as a Minister.