This 40-year-old economic theory shows raising taxes isn’t going to solve Joe Hockey’s budget problem

Dr Arthur Laffer. Image: Screenshot.

The economist who famously scribbled a chart on a napkin while dining with Donald Rumsfeld and Dick Cheney more than 40 years ago, subsequently influenced Ronald Regan’s tax cuts in the 80s and has now hit out at Australia’s tax policy.

Using his famous “Laffer Curve” which shows the relationship between taxation rates and government revenue, Dr Arthur Laffer said Joe Hockey’s taxation strategy isn’t going to plug the budget deficit.

A key adviser to Regan who famously cut the top US tax rate from 70 to 28%, leaving two tax brackets (15% and 28%), Laffer argues a low, broad-based tax on business revenues and personal incomes is the best way to stimulate economic growth and raise government revenues.

“What you want to do is have a low rate, broad-based flat tax so everyone pays his or her fair share, there are no loopholes,” Laffer told the ABC.

Using Laffer’s theory, which starts 0% tax which delivers 0% revenue to government, the Laffer Curve rises to a maximum rate of revenue at a certain rate of taxation before falling to zero revenue again at a 100% tax rate, because why would you bother working if the the government takes all that you earn?

Laffer Curve. Image: screenshot.

Simply, higher taxes eventually result in lower tax revenues flowing through to government.

“If you tax people that work, and you pay people that don’t, don’t be surprised to see a lot of people not working,” he said.

In an interview on ABC News 24 on Tuesday Laffer said Treasurer Joe Hockey’s budget repair levy, which lifted the marginal tax rate for incomes over $180,000 from 45% to 47%, will fail to plug the budget black hole.

The government expects lifting the rate will raise $3.1 billion over three years.

But Laffer said hiking up taxes on the rich hurts the economy.

“Rich people are different from us. They can hire lawyers, accountants, deferred income specialists, senators. They can change the location of their income, the timing of their income, the composition of their income, the volume of the income. We can’t. The one thing we know about US taxes is that whenever you raise tax rates on the rich you collect less money from them and whenever you lower tax rates on the rich, you collect more money from them,” Laffer said in an interview with the ABC.

“I’m not Australian. I don’t know enough about the country but if that was done in my country, the people that recommended those surcharges would be hypocritical political hacks.”

Add to all these things Australia’s high income earners have access to, including the tax shelter of negative gearing for property investment and discounted tax rate superannuation.

You can watch the full interview here.

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