Blog author: jcarter
by on Thursday, February 6, 2014

Napkin003During a meeting in a restaurant with two officials from the Ford Administration — Dick Cheney and Donald Rumsfeld — a young economist sketched a curve on a napkin to illustrate an argument he was making. Arthur Laffer was explaining to the policymakers the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation.

By 1974, the idea was already ancient. Ibn Khaldun, a 14th century Muslim philosopher, wrote in his work The Muqaddimah: “It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.” John Maynard Keynes had made the same point in 1933. But for American politicians the idea that people change their behavior based on rates of taxation seemed revolutionary, so the concept became popularized as “The Laffer Curve.”

The crucial point, as Laffer has explained, is that,

People do not work, consume, or invest to pay taxes. They work and invest to earn after-tax income, and they consume to get the best buys after tax. Therefore, people are not concerned per se with taxes, but with after-tax results. Taxes and after-tax results are very similar, but have crucial differences.

The Laffer Curve explains why higher taxes provide an incentive to work less. When tax rates are too high, people work less since they are working mainly to pay for the marginal tax increase. The result is that higher tax rates can cause revenue to the government to decrease below what it would have been without the increased rate.

But there is another way to create the same effect as a prohibitive tax increase: provide subsidies that reduce incentives to work.

Consider, for instance, how the subsidies for Obamacare are affecting economic growth:

The CBO, the government’s nonpartisan number-cruncher, included the figures in its projection of economic growth over the next decade. The CBO estimates that Obamacare will lower full-time employment by 2.3m in 2021, compared with what might have been without reform. That 2.3m drop is nearly three times larger than the CBO’s earlier projection.

The CBO does not give credence to Republicans’ common claim that Obamacare is already reducing employment. Rather, the CBO expects Obamacare to have its biggest impact from 2017. Furthermore, the main reason for the decline is not that employers will slash jobs, but that Americans will choose to work less. Nevertheless, the CBO provides the best case yet that Obamacare will depress work, rather than boost it.

Many factors account for the drop. Top among them is the affect of subsidies for health insurance. To help Americans buy coverage on new health “exchanges”, Obamacare offers tax credits to those earning between 100% and 400% of the federal poverty line (about $11,500 to $46,000 for a single adult). Those tax credits are offered on a sliding scale, by income, so workers effectively pay a higher tax rate as their wages rise. This may dissuade workers from trying to earn more. It also allows a higher standard of living (that is, with health coverage) at a lower income, which may further discourage work.

[. . .]

The CBO analyses other provisions, too. For example the higher payroll tax for couples earning $250,000 or more may lower their desire to earn higher wages. Obamacare’s requirement that insurers cover the sick, without raising their rates, may prompt some to retire earlier than they would have otherwise.

The unintended affect of Obamacare is that it provides incentives to work less — or to not work at all. And with fewer people in the workforce, the government will be bringing in zero revenue from the income those people would have otherwise generated.

This outcome was not exactly unexpected — it was what Republicans had predicted all along — but it seems to come as a surprise to President Obama. Perhaps he should invite Laffer to bring his napkin to the White House to show him exactly where he went wrong.

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