Why Illinois voters should understand the Laffer Curve – WP Original
By: Mark Glennon*
“Please, don’t go to the top of the curve!” That was the warning from a Wharton School professor of finance, Robert Inman, in a recent presentation he made at the Federal Reserve Bank of Chicago, speaking in general about tax rates for states and cities. What did he mean? Are Chicago and Illinois at the top of the curve?
Those questions may seem obscure, but they’re key to our future. Voters don’t just need to asks whether more revenue should be raised, they need to ask whether that’s even achievable.
And hang in there on this. Even if you hate numbers, graphs and economics, this is actually pretty simple, and you can probably answer those questions better than most economists.
Suppose you lived in a town where property tax rates were trivial, say, a few hundred dollars a year. If your town increased property tax rates by, say, five percent, it would probably also collect about five percent more total revenue for the whole town. Nobody would leave town or abandon their property.
But suppose your taxes were exorbitant, and people were fleeing, abandoning their houses and nothing new was being built. If that town increased your rates five percent they’d just make those problems worse, resulting in something less than five percent new total revenue. If problems were really extreme, they could even end up with less revenue. Most state and local governments are somewhere in the middle. Raising taxes will generate more revenue, but not one-for-one with the percentage increase in rates.
Put this on a graph and you have what economists call the Laffer Curve. It applies to property, income and sales taxes, for all units of government. There’s no controversy about the basic idea behind the curve, but lots of controversy about where any particular cities or states are on the curve. You might not like Arthur Laffer himself, the author of the curve, because he seems to think pretty much every government has gone past the brink so that tax cuts will generate more revenue. But the principle of the curve itself is sound, and actually pretty obvious.
Where are Illinois, Chicago and other troubled Illinois cities on the curve? You could probably find an economist to produce a study to support either side, but most of you who live here and follow the news are just as qualified to answer. It’s a matter of sensing whether taxpayers are truly fed up — questions like whether people and employers are fleeing or on the verge of fleeing, and whether they’re hesitant to invest locally. Or, are they just griping about taxes like always, and will stay put and pay up with further tax increases?
You decide, but my sense is that Illinois and Chicago are just about to the top of the curve. Maybe some additional revenue could be squeezed out through things like expansion of the sales tax to services, and maybe a few fees could be jacked up, but any major tax increase probably would backfire. Big tax hikes might bring in more revenue for a few years because the negative effects take a while to kick in, but we are pretty close to being tapped out.
It might be different if we also fixed the big underlying problems — pensions, too many layers of government and bad leadership in Springfield. But as long as those problems go unsolved, taxpayers here will think any big increase in property or income taxes will go down a rat hole. They’ve had enough.
If that’s right, then the premise of the conventional narrative that treats more revenue as an option, or as an alternative to reform, is false.
Tax increases will be the biggest issue in the November election. Voters will be thinking about whether it’s necessary and fair for themselves or others to pay higher rates. Hopefully, they’ll also be considering whether a revenue solution is possible even if they want it.
*Mark Glennon is founder of WirePoints and Managing Director at Ninth Street Advisors.