My Economics 21 colleague Arpit Gupta has written an outstanding post on understanding where we are on the Laffer Curve:

A more rigorous treatment of this topic comes from a paper that Bruce Bartlett references, by University of Chicago economist Harald Uhlig (someone whose work we have previously featured here), and Mathias Trabandt. Though Bartlett takes Uhlig and Trabandt’s work to support the idea that we are far from the Laffer curve; in fact, their analysis shows that policymakers need to think hard before agreeing to future tax increases.

Arpit goes on to summarize their central findings:

1. America has crossed the Laffer “hill.” Uhlig and Trabandt do find that further increases in the tax rates on labor or capital income would raise revenue. Correspondingly, reducing tax rates on either of those taxes individually would result in lower tax revenue.
However, there are large differences between taxing labor and taxing capital. Taxing capital results in far worse effects on the broader economy in terms of foregone output than taxing labor. As a result, a tax reform that cut taxes on capital while raising taxes slightly on labor would actually increase overall tax revenues while also reducing the overall tax burden. This free lunch comes from changing the composition of taxes.
Unfortunately, many of the scheduled tax increases would result in hikes in the taxation of capital. Choosing to increase taxes on capital (while potentially maintaining lower marginal rates for many Americans) increases the likelihood that the nature of our tax system will start to choke off some economic growth.

This one reason why right-of-center, and some left-of-center, economists have long advocated shifting towards a consumption tax. Replacing the income tax with a progressive consumption tax was one of the ideas floated by President Bush’s tax reform panel [PDF], and it’s an idea that I’d very much like to see conservatives unite around.

Uhlig and Trabandt explore this issue further. In particular, they finds that 32% of a labor tax cut, and 51% of a capital tax cut are self-financing, in the sense that lowering those taxes raises economy activity, which itself generates additional taxes, and partially offsets lower tax revenue.
By the same token, higher taxes – particularly higher capital gains taxes – will reduce economic activity, especially in the long run. This will result in a substantial amount of foregone income, as a result of the “deadweight loss” incurred through taxation. As the tax rate approaches the top of the Laffer curve, this loss grows higher and higher.
In other words, future tax hikes, which are necessary to pay for the projected path of spending, will come at a high cost.

That is, the revenue-maximizing rate isn’t the target to keep in mind.

Arpit ends by reflecting on a tax-only approach to addressing U.S. fiscal imbalances, the implicit position of many champions of expanding entitlement programs:

3. There is not much room to raise revenue. Uhlig’s analysis finds that America has room to raise labor and capital tax rates by 30% before hitting the top of the Laffer curve, and 6% more by raising capital taxes. Put differently, this suggests that America can only raise 36% more revenue through conventional tools. Efforts to raise additional tax revenue beyond that point through tax hikes would fail, because at that point the costs of higher taxes would exceed the tax revenue they brought in.
Keep in mind that simply doing nothing would result in higher income taxes through real bracket creep, and higher capital taxes by statute. The scope of additional taxation in order to meet spending burdens before hitting the bend in the Laffer curve is therefore limited.

Arpit has written an impressively balanced, thoughtful guide to Uhlig and Trabandt’s work that merits close attention from policymakers and taxpayers.