How Well Do We Understand How Tax Rates Affect Revenues?

Some months ago we posted a video about how to think about tax policy using a conceptual tool called the Laffer Curve. We were challenged by a reader to do some research and understand how and where that curve might be seen in action in the United States. In light of the many protest signs calling for taxes to be raised or lowered, we wanted to get people thinking about how well they understand what would follow from raising or lowering taxes.

We found a simple study by Professor Davies at George Mason University that compared different ways of looking at tax rates vs. revenues. Below we see how the average marginal tax rate compares to tax revenue as a % of GDP.

rates-revenues

In the modern era, the average marginal tax rate has grown gradually, from about 25% to about 40%, an increase of 1.6x, but the revenue of the government (as a % of GDP) has only grown from about 16% to about 18% (pre-recession): less than 1.2x. Looking at the graph we can also see that as tax rates increase, there is a bump in revenues, often followed by a return to a mean of around 17% or so.

Does this mean that a proposed tax hike or tax cut would have no impact on government revenues? Maybe, but not necessarily. There could be many drivers behind why federal government revenues have been flat despite a higher average marginal rate. Let us know in a comment where you think we should go digging next!

1 Comment

Erik Fogg

We do politics, but we don't do the thinking for you.