The Laffer curve--a bell curve looking like a "McDonald's arch on its side," as the great Wall Street Journal editor Robert L. Bartley described it--remains the most recognizable economics graph of the last fifty years. Economists and non-economists alike know or have heard of it: at some point, tax rates get so high such that they produce progressively less government revenue, at which point cutting tax rates can increase revenue. The author of the curve, Arthur B. Laffer, is speaking at CU Boulder, tomorrow (Jan. 20) at 4pm in Old Main, in the Conservative Thought and Policy speaker series.
When Laffer developed his curve in the early 1970s, as a faculty member at the University of Chicago, he was working on the "substitution effects" of macroeconomic policies. These were the kinds of behavior that changed because, as was the case at the time, the dollar was unsound, taxes were increasing on account of inflationary "bracket creep," and government spending and regulation was on the march. Economic actors were "substituting" hedges (such as buying commodities) against the blanket governmental intrusion upon the economy for what they had been previously doing, namely real-world investment and consumpton. Underlying the curve was the notion that if tax rates were cut (and if the dollar regained soundness and the spending and regulation stepped back), people would substitute back into real-world economic activity. The increased tax revenue would be an effect of a much larger process of a return to the normal conditions of economic growth.
Keynesians had said that the chief effect of even a marginal tax cut was on the "income" side--it put more money in people's pockets. Laffer countered with an array of behavioral changes far beyond the income effect. The identification of the primacy of substitution effects became the foundation of the supply-side economics that at last bore fruit with the capital gains tax cut of 1978 and the Ronald Reagan reforms of the 1980s.
Laffer and his colleagues at his research and investment firm have published an enormous amount in this tradition. I have had the priviledge of bringing a sample of this work to print and public access: http://www.amazon.com/The-Pillars-Reaganomics-Supply-Side-Revolutionarie...
Please join us on Wednesday, Jan. 20 at 4pm in Old Main, for the public lecture by Arthur Laffer, and see this site for further announcements of lectures in the supply-side tradition.