After the Laffer curve: taxing the rich, at last

It’s time finally to jettison the convenient claim that taxing the rich more would only reduce tax revenue.

Fifty years ago, a highly influential economics theorem was born—the ‘Laffer curve’. An apparently simple illustration of how excessive taxation damaged the economy, it served in all policy arenas as an encouragement to reduce taxes, especially on the richest.

The five decades since have however provided many examples of tax cuts at the top damaging society, without improving economic performance. The time has come to retire the Laffer curve.

‘Trickle down’ economics

On September 13th 1974, the Chicago economist Arthur Laffer sketched his famous curve on a restaurant napkin in Washington DC. He claimed that, beyond a certain point, any further increase in tax rates would result in lower tax revenue and falling economic output.

Laffer’s audience consisted of Donald Rumsfeld and Dick Cheney, who were shortly afterwards to be appointed chief of staff and deputy chief of staff respectively by the incoming Republican president, Gerard Ford. They would become much more infamous in the presidential administrations of George Bush Snr and Jnr.

Laffer meantime served in 1981-89 as a member of Ronald Reagan’s Economic Policy Advisory Board. He later advised Donald Trump’s 2016 presidential campaign and in 2019 Trump awarded him the Presidential Medal of Freedom for his contributions to economics.

It was however the journalist Jude Wanniski who rendered the curve eponymous and popularised it from 1978. References to the Laffer curve have since been very frequent in the discourse on public finance.

Yet the policies it inspired did not succeed. Reagan’s claim in his 1980 campaign that tax cuts would spur the economy and the benefits ‘trickle down’ was dismissed as ‘voodoo economics’ by his Republican primary opponent George HW Bush. Reagan presided over record federal deficits and financial instability, while income inequality and a slew of social problems spiralled out of control during his two presidential terms.

Zombie idea

The Laffer curve however became one of the zombie ideas of economics: it kept coming back and finding new audiences. In the 1990s, the neoliberal paradigm was sold to the transition countries in central and eastern Europe, with flat-tax regimes part and parcel of it. This resulted in major economic and social dislocation, with autocratic political consequences too.

Since the 1990s, globalisation has brought more worldwide competition. Many interpreted that as meaning high top taxes were no longer an option. Nevertheless, in western Europe even the more neoliberal countries saved themselves from flat income-tax regimes. Some of the high-tax countries—such as Sweden, the Netherlands and France—maintained robust economic performance, linked to high-quality public spending and state capacity to guide public investment. The benefits of retreating from flat taxation in central and eastern Europe have also now been demonstrated.

In recent years, the tide has been turning, with innovation in international tax co-ordination as well. The minimum corporate tax, introduced at the initiative of the United States, will play an important role in protection of the tax base of advanced countries. What was considered impossible for long has become possible today. And, earlier this year, G20 finance ministers declared that they wanted to go further on taxing wealth.

Chronic income inequality

In recent decades, income inequality has become chronic and, in some cases, grotesque. Contrary to neoliberal ideology, this is not a price of growth but a consequence of stagnation which keeps generating further economic weakness. And during the years of disruption resulting from the pandemic, the war in Ukraine and the unfolding global economic warfare, inequalities have grown even further.

Today the rich get richer and the poor get poorer, which Oxfam calls an ‘inequality explosion’. Since 2020, the five richest billionaires in the European Union have increased their wealth by 76 per cent; the richest 1 per cent have captured nearly half of all new wealth created during this period of crises. The super-rich exercise increasing influence over resource allocation, without sharing the concerns of the majority of society. Fair taxation is not the only tool to fight inequality but it is essential.

Restoring social solidarity in Europe and north America would entail a proper audit of tax systems to expose their anomalies and dysfunctions. Regimes that might have been adequate 30-40 years ago may not perform well in current circumstances. To provide the financial meansto fight poverty, end global hunger and advance the digital, ecological and demographic transitions, we need to think differently about taxation and implement the necessary changes—sooner rather than later.

Taxing the richest

Other instruments, such as competition policy, minimum-wage schemes and regulation of market power, can help brake the growth of inequality, but taxation must play a central role in this paradigm shift. In situations such as that in which the new British government has found itself, the Gordian knot cannot be cut without increasing the tax on the richest.

Inspiration for reform can be gained from such pioneers as the state of Massachusetts, which introduced the Fair Share Amendment in late 2022 to support education and transport. Using funds from the Fair Share tax on incomes of over $1 million, the 2025 budget will provide universal free meals in schools, free community college for all and a free and expanded bus service at regional transit authorities.

An increasingly important argument in favour of fair taxation is climate change. The protection of our climate requires a mobilisation of resources. To tackle social inequality and climate change at the same time, higher taxes at the top end would be fair—not least because the consumption patterns and investment decisions of the 1 per cent are disproportionately responsible for unsustainable emissions of greenhouse gases, biodiversity loss and waste of natural resources.

Investment policy

The EU has responded to the ecological emergency with robust policies, particularly the European Green Deal announced in 2019. While a backlash against the EU sustainability agenda is looming, progressive policy must keep the Green Deal on track, even if an update and fine-tuning is necessary.

This is first of all an investment policy. Of course, the green transition is also a matter of regulation (such as by lowering daytime speed limits) and requires adaptation of habits and customs (such as by eating less meat), but the main point is investment. New types of infrastructure, new models of housing and new jobs must be created soon, to achieve Europe’s ‘net zero’ objective in 25-30 years.

Supporting the sustainability agenda, key tools have already been launched at the European level, including the Just Transition Fund and the Carbon Border Adjustment Mechanism. To support green investment, some even wanted to establish a ‘green bank for Europe’. But eventually it was not needed, since the European Investment Bank rose to the challenge and became a kind of green bank for the continent—this capacity can be boosted further.

Citizens’ initiative

Without however addressing the distributional issues within countries, a just transition cannot be implemented. To ensure the transition to a sustainable economic model is just, taxation will have to play a key role. The EU has no explicit competence on matters of taxation, but its policies have indirectly affected taxation practices and we need to see the paradigm shift here too.

Just transition is simply an imperative. This is why a European citizens’ initative has  been launched to connect the dual struggles against income inequality and climate change. The initiative calls on the European Commission to establish a European tax on great wealth. The goal is to collect one million signatures before October 9th, so the commission will have to propose legislation on the issue.

Five years ago the European Parliament elections gave a boost to climate policy, which became a centrepiece of the EU agenda. Today the risk is that the 2024 swing to the right buries key points of the progressive programme. Campaigns such as that for taxing the richest can help turn the tide. They can amplify the voice of the most vulnerable social groups but also the ‘squeezed middle’.

A just transition is in the interest of the older as well as the newer member states of the EU. Maritime and landlocked countries are in the same boat. The success of the citizens’ initiative is also in the interest of all. Promoting greater fairness and intergenerational solidarity, it can become a unifying policy for the EU.