The 100th Anniversary of Hebei University: HBU Moments

Reviewing Laffer Curve

In 1989, He Yuxing graduated from the Institute of History of Hebei University (now the Song History Research Center) with a master’s degree. Later, he received a doctorate in journalism and communication from the Chinese Academy of Social Sciences. Now he works in the Development Research Center of the State Council and is the executive associate editor of the magazineEconomic Reference.

There is an article circulating on the Internet, “A company earned 2 million, leaving only 21,400 after tax”. It may be an individual case. However, it is an indisputable fact that the tax burden of enterprises is generally too heavy; it is an indisputable fact that the government tax revenue has been increasing at a double-digit rate for decades; it is an indisputable fact that enterprises have closed down.

In the first half of 2018, the scale of domestic value-added tax, consumption tax, enterprise income tax and personal income tax was 2392.8 billion yuan, 3360 billion yuan, 686.9 billion yuan and 812.7 billion yuan respectively, with a year-on-year growth of 16.6%, 17.4%, 12.8% and 20.3%. In the same period, GDP increased by 6.8%. According to the simultaneous calculation of tax revenue growth rate and GDP growth, in the first half of 2018, instead of tax reduction, it was overcharged by 632.2 billion yuan. With such a heavy tax burden, can investment increase and enterprises not close down? Can employment be stable? Can consumption be expanded? Can the financial system be stable? Can the downward pressure on economic growth decrease?

This reminds me of the “Laffer curve”. Laffer Curve Theory was put forward by Arthur Laffer, a representative of the supply-side economics and a professor at the Graduate School of Business of University of Southern California. At a banquet, in order to persuade Cheney, the White House assistant of President Ford, understand that only through tax cuts can the United States get rid of the dilemma of “stagflation”, Laffer drew a parabola on a napkin at the dinner table, depicting the disadvantages of high tax rates.

The basic meaning of Laffer curve is that tax revenue does not increase with tax rate. When the tax rate is higher than a certain point, the total amount of tax revenue will not increase, but decrease. If the tax rate is too high, the enterprise will be disheartened, and then reduce production, reduce the tax base, shrink the tax source, and finally the total tax revenue reduced. When the tax revenue reaches 100%, no one is willing to invest and work, and the government tax revenue will be reduced to zero.

When Reagan was an actor, he stopped working and went on vacation after finishing four films a year. Because most of the income from continuing to work will be used to pay taxes. After entering the White House, he implemented the largest tax reduction in American history. Laffer Curve Theory became an important theoretical basis for Reagan’s Economic Recovery Plan. Economic growth also showed a rare boom at that time.

Trump, an entrepreneur, knows best what taxation means to an enterprise. Since he came into power, he has been practicing substantial tax reduction, attracting investment through tax incentives, expanding the tax base, which makes the cake bigger. Let alone a 10-point drop, even if a two or three-point drop will help many companies turn losses into profits, which will affect investment expectations. The current tax rate in the United States is close to tax havens. A large number of companies will return to and flood into the United States. Coupled with the scale effect brought about by the huge size of the U.S. economy itself, a virtuous circle will be formed and the multiplier effect will erupt, which will increase GDP by 6.9 to 8.2 percentage points and create 2 million new jobs.

Before the principle of “Laffer Curve” was put forward, Keynes said inPersuasion Collectionpublished in 1931: “If the tax is too high, it will deviate from its original goal. If there is enough time to harvest the fruits, tax reduction is more likely to achieve a balanced budget than tax increase.”

David Ricardo, a classical economist, discussed the harmfulness of excessive tax burden inPolitical Economy and Tax Principles: “A country’s production will inevitably decrease proportionally with the decrease of capital. Therefore, if the unproductive expenditure on the people’s side and the government side continues to remain unchanged, and the annual reproduction volume continues to decrease, the resources of the people and the country will increasingly and rapidly dry up, and poverty and disaster will follow.”

Regarding the cultivation of tax sources, Wei Yuan, a thinker in the late Qing Dynasty, has a metaphor inThe Collection of Governance in the Ancient Weitang: “Those who are good at giving people are like planting willows! They pay attention to cultivating its roots. Those who are not good at giving people are like cutting leeks, cutting all the time, and there will be a moment when nothing will be left.” Wei Yuan’s second metaphor is inappropriate. The tax source is not leeks. If you cut one crop, you can grow another. Excessive tax burden means cutting down the trunk and digging the roots.

Marx said: “Taxation is the nurse who feeds the government.” Quesnay said inTax Theory: “It is not the tax itself that causes great harm to the country, but the way of tax collection.” Yan Fu put forward the principle of “paying taxes on surplus money”. We can’t take “money for raising”, “money for teaching” and “money for elderly seeing doctors” as the tax objects, “appropriate tax is appreciated”, and we should “Open up a source of earning money for the people instead of collecting heavy taxes”. Cao Dewang called for that the value-added tax should be abolished and changed to income tax, just like the United States. At the same time, the income tax should be raised to pay taxes if money is made. If there is no money, there is no need to pay taxes.

Professor Wei Sen of Fudan University said: “Chinese governments at all levels and around the world have such a large balance of fiscal deposits and it is constantly rising, which shows that we still have room for tax reduction. At present, the only effective macro policy is fiscal policy, and the effective fiscal policy is not the government spending money, but tax reduction, not structural tax reduction, but the total tax reduction.”

Laffer not only drew a curve, but also wrote a book:The End of Prosperity: How High Taxes Destroy the Economy-If We Let It Go. In fact, the principle of “Laffer Curve” is neither new nor profound. The key is whether it can be done or not. The key is what position you hold and whether the vision is in the present or in the long run.