[Song Seungseop's Financial Light] Doodles Scribbled on a Napkin Spark a Tax Cut Craze

An American Economist Who Passionately Advocated Tax Cuts to a White House Insider
Introducing the 'Laffer Curve' Named After Himself to the World
Designed and Led President Ronald Reagan's Tax Cut Policy
"Deceptive Words of a Fraud"...Strong Criticism from the Economics Community
From Trump to Yoon Seok-yeol...Tax Cut Theories Continuing to the Present

A napkin on which American economist Arthur Betts Laffer is known to have drawn the Laffer Curve named after him. Photo by National Museum of American History

In 1974, an unknown American economist in his 30s was eating at a restaurant in Washington D.C. The people dining with him were Dick Cheney and Donald Rumsfeld, key figures in the White House at the time. The topic of conversation was the tax increase policy of then U.S. President Gerald Ford. The economist argued that if tax rates were set too high, total tax revenue would decrease, so instead, tax cuts would actually increase tax revenue. He even drew a graph illustrating his theory on a napkin at the restaurant.

The protagonist of this anecdote was Arthur Betz Laffer. The curve he scribbled on the napkin came to be known as the "Laffer Curve." Their story first appeared in a book published in 1978 by Wall Street Journal reporter Jude Wanniski. After Wanniski's death in 2005, his wife discovered the napkin with the Laffer Curve while organizing his belongings and donated it. It is now reportedly housed in the National Museum of American History. Laffer himself denied the story, saying, "That restaurant only used cloth napkins."

Whether true or false, the story of the Laffer Curve and the napkin spread widely across the United States. It was adapted into a tale of patriotic politicians who listened attentively to an unknown economist. Later, Ronald Reagan, elected in 1981, appointed Laffer to the White House Council of Economic Advisers. President Reagan embraced Laffer's theory and implemented sweeping tax cuts. The Laffer Curve became the foundation of the Reagan administration's economic policy known as "Reaganomics."

"If you want to collect more taxes, lower the tax rate"

Raphael curve. R represents tax revenue, and t represents the tax rate. When the tax rate exceeds a certain level (t*), tax revenue begins to decrease. Photo by Korea Development Institute (KDI)

The Laffer Curve is a simple shape resembling an upside-down letter U. It shows tax revenue depending on the tax rate. What would tax revenue be if the tax rate were 0%? Since no one pays taxes, it would naturally be zero. What if the tax rate were 100%? All income would have to be given to the government as soon as it was earned. Individuals and businesses would cease all economic activity. Why bother earning money? Therefore, tax revenue would also be zero at a 100% tax rate.

So how can the government collect the most tax revenue? The core of the Laffer Curve lies in this question. It is clear that tax revenue increases as the tax rate rises from 0%. It is also clear that tax revenue decreases as the tax rate approaches 100%. Therefore, Laffer argued that when tax rates are too high, cutting taxes would actually increase tax revenue.

Laffer believed his theory applied in reality as well. He focused on the reduction of the top U.S. income tax rate from 91% to 70% in 1965. In the four years before the tax cut, income tax revenue grew at an average annual rate of 2.1%. In the four years after the tax cut, tax revenue grew at an average annual rate of 8.6%. As his curve predicted, lowering tax rates led to increased tax revenue.

President Ronald Reagan explaining his tax cut plan in a television address from the White House Oval Office in July 1981. Photo by U.S. National Archives and Records Administration

The tax cuts during President Reagan's administration were also judged to have positive results. President Reagan lowered the top individual income tax rate from 70% to 28% and the corporate tax rate from 48% to 34%. As a result, the unemployment rate, which was 7.6% at the start of his term, fell to 5.5% by the end. The average annual growth rate of real Gross Domestic Product (GDP) during his term was a much higher 3.2% compared to before.

The Laffer Curve Continues Despite Criticism as a 'Con Man's Sweet Talk'

However, criticism of the Laffer Curve is not insignificant. The biggest problem with the Laffer Curve is that it is difficult to find the optimal tax rate. There is no way to know whether the current tax rate is excessively high or not. It is also difficult to determine how much to lower the tax rate. If the judgment is wrong, only side effects occur. If taxes are cut further when rates are already low, tax revenue will not increase but rather decrease. This leads to budget deficits. During Reagan's presidency, the national debt as a percentage of GDP surged from 26% to 41% by the year before he left office.

There is also much criticism from academia. Gregory Mankiw, author of "Mankiw's Economics," called the Laffer Curve "a con man's sweet talk." Mankiw questioned whether the expected effects such as increased investment, consumption, and productivity improvements actually occur due to tax cuts. Harvard professor Jeff Frankel also published a paper titled "Tax Cuts Are a Fake Panacea," stating that the Laffer theory is merely a hypothesis.

Arthur Laffer receiving the 'Medal of Freedom' from then U.S. President Donald Trump on June 19, 2019.
[Image source=Yonhap News]

Despite the controversies surrounding the Laffer Curve, his theory has persisted to this day. Laffer was an economic advisor to former President Donald Trump's 2016 presidential campaign. He directly proposed various tax reductions to President Trump. In fact, President Trump lowered the top individual income tax rate from 39.6% to 37.0%, and the top corporate tax rate from 35.0% to 21.0%. He also abolished the corporate minimum tax rate (20%). In 2019, President Trump awarded Laffer the Presidential Medal of Freedom, the highest civilian honor in the United States, in recognition of his contributions.

The current tax revenue policy of President Yoon Suk-yeol's administration also aligns with Laffer's ideas. Last year, President Yoon announced the new government's economic policy direction, emphasizing "private sector-led growth" and mentioning reductions in corporate tax and comprehensive real estate tax. Regarding this policy, President Yoon said, "By enabling companies to perform properly, the market mechanism can operate dynamically, which greatly helps the middle class and ordinary people." Subsequently, the top corporate tax rate was lowered from 25% to 22%, and the number of tax brackets was reduced from four to three. However, due to opposition from the opposition party, the tax rates for each bracket were lowered by 1 percentage point instead.

This content was produced with the assistance of AI translation services.