The above graph is the Laffer Curve, named after economist Arthur Laffer. This graph demonstrates that when tax rates are increased past a certain rate, tax revenues will decline.

The important aspects of the Laffer Curve are:

• At a 0% tax rate, tax revenues are $0
• At a 100% tax rate, tax revenues are also $0
• No one works when the government takes 100% of his/her earnings
• Businesses will close operations and move offshore
• “Taxes don’t redistribute income, they redistribute people”–George Gilder
• People may work enough for basic sustenance, but they will likely report no income to the IRS
• The revenue maximizing rate is represented by the green dot at the peak of the curve
• The exact revenue maximizing rate is subject to strong debate
• When the tax rate rises above the maximum point, tax revenues will decrease
• By having more and more of their money taken away from them, people will become discouraged and will not work as long or as productively
• The horizontal line running through the two blue dots shows that an equal amount of revenue can be raised at two different tax rates–a low rate and a high rate
• Between the high rate and the low rate, Congress should set taxes at the low rate because the higher rate will constrain economic growth

Arthur Laffer and Stephen Moore (from the Wall Street Journal) have a new book called “The End of Prosperity–How Higher Taxes Will Doom the Economy, If We Let it Happen.” It is an excellent read and explains how lower taxes and other supply side principles fuel economic growth. It is available through the Recommended Books link above.

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Tax reform is almost always a topic during presidential elections. This post will discuss some concepts and ideals of tax fairness. The following principles are usually debated in discussing fair tax policy:

• Simplicity
• the tax rules should be simple
• Transparency
• the amount of tax paid should be visible to taxpayers
• for example, when you buy a $20,000 car, the $1,200 of sales tax is visible to the buyer on the car invoice
• Stability
• the tax laws shouldn’t constantly change
• constantly changing tax laws increase complexity and reduce predictability
• Growth Promotion
• taxes should raise revenue for necessary government expenses and should consume as small a portion as possible of national income (GDP)
• Neutrality
• taxpayers with equal amounts of income should pay equal amounts of tax–tax policy should not subsidize/penalize different types of income and deductions

For those who are interested in learning more about Senators Obama’s and McCain’s tax proposals, there are a couple of tax think tanks that have published studies of the impacts of both plans. The Tax Policy Center (which is slightly left leaning), is a joint venture of the Urban Institute and Brookings Institution released an updated study on September 12 on the tax plans. The Tax Foundation, which is a slightly right-leaning think tank, also released a study on September 19. The Tax Foundation also explains how both candidates misstated tax facts during the first two debates.