The Tax Curve Sketched on a Napkin

The dinner happened at the Two Continents restaurant in Washington, D.C., in late 1974. Arthur Laffer, then a 34-year-old economist, was arguing tax rates with Donald Rumsfeld and Dick Cheney over drinks. To make his point he sketched a simple curve on a napkin: tax revenue plotted against the tax rate. At a rate of zero, the government collects nothing. At a rate of 100%, it also collects nothing, because no one bothers to work or report income. Somewhere in between sits a peak.

The shape itself was not original. Ibn Khaldun made the same argument in the 14th century, and Keynes alluded to it. What Laffer added was a vivid image at exactly the moment American policymakers were looking for an alternative to high marginal rates.

The sketch became the intellectual scaffolding for the Reagan tax cuts of 1981, which dropped the top marginal rate from 70% to 50% and later to 28%. Whether the cuts paid for themselves through extra growth is a question economists are still arguing about — most studies say no, with the partial exception of the very top brackets in some periods.

The useful piece of the curve is unsexy: there exists some rate above which raising taxes lowers revenue. Estimates of where that peak sits range wildly, from around 30% to over 70% depending on the country, the tax base, and how mobile the income is. The hump is real. Its location is the whole fight.