Saturday, August 04, 2007

The Laffer Curve: Where'd It Go?

Three weeks ago, I highlighted this fanciful drawing of the Laffer curve found in the editorial pages of the Wall Street Journal. Having somehow survived graduate level statistics, I expressed my skepticism:
Imposing the Laffer curve on the data isn't as delusional as pointing to an apparition of the Blessed Virgin in a grilled cheese sandwich, but it is intellectually dishonest.
Brendan Nyhan, a Ph.D. candidate at Duke, summed up the reaction to the miraculous appearance of the curve:
But as numerous bloggers pointed out at the time, the alleged "Laffer curve" drawn in the graph is absurd. It's fitted directly through the data point for Norway, an obvious outlier with significant oil revenue (and an omitted excise tax), and then plunges straight down toward zero (who knew that increasing your corporate tax rate from 28% to 32% was so destructive?).
Nyhan reconstructed the data presented in the offending graph and ran linear and quadratic regressions on the data. The results weren't even close to the WSJ fantasy. So is this a case of intellectual dishonesty or just editorial hyperbole? An educated reader who looks at such a graph has a right to assume that the curve is actually related to the data presented. This was clearly not the case with the WSJ graph.
Reasonable people can disagree about macroeconomics and tax policy. But you can't claim that data support a particular position, without doing the math. The WSJ didn't do its homework and instead presented a curve that was clearly not based on the data, and thus intellectually dishonest.


Anonymous Anonymous said...

It is strange and unnerving to be living in a time in which we must "prove" that increasing corporate tax rates has the effect of increasing corporate taxes as a percent of GDP.

It is like having to prove that the earth revolves around the sun or proving that lightning is electricity.

12:50 AM, August 05, 2007  
Blogger Tom Noyes said...

Those who "know" that tax cuts work (whatever that means), or that cutting taxes increases revenues, seem incapable of embarrassment at the lack of evidence to support their assertions.

7:10 AM, August 05, 2007  
Anonymous Anonymous said...

OK, the WSJ graph was incompetent, but isn't the "quadratic regression" line laffer-like? Doesn't it show the US on the wrong side of the maximum?

Now, ignoring the lines altogether, the data points show the US with comparatively high corporate tax rates and comparatively low tax collections relative to GDP. It appears the US should cut its corporate tax rate!

So Norway is an outlier in part because of its energy production? Maybe that's why Iceland looks so good in this data too. It appears the US should start drilling ANWR and offshore where oil production is now banned.

Isn't it true that corporate tax collections went up dramatically after the recent tax rate cut in the US?

-Jerry B.

9:37 AM, August 05, 2007  
Blogger Tom Noyes said...

Good questions, Jerry.

First, exploiting the oil reserves in ANWR would not bring the U.S. close to matching Norway's oil production when compared to relative GDP.

The curve is not pronounced, and becomes even flatter as outliers like Norway and the U.A.E. are removed from the data.

It is true that U.S. corporate tax revenues have increased over the last three years. However, U.S. corporate tax rates were last cut in 1994.

By the way, the data in the graph are from 2004, before the recent increase in corporate tax revenue.

1:14 PM, August 05, 2007  

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