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Sunday, November 18, 2007

A laugher of a curve offers a lesson on leverage

A former colleague of mine, Jim Mork, sent me the ‘heads up’ to this blog by Mark Chu-Carroll, a PhD computer scientist who works for Google. He and others* mocked the Wall Street Journal (WSJ) for a poorly fitted curve of tax revenues versus percentage of gross domestic product (GDP) by country. They claim that it confirms the Laffer curve, which quantifies the diminishing returns that a government gains by going beyond a certain level of taxation.

"It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments."
-- Ibn Khaldun (14th century)

The WSJ curve starts from the origin at 0 percent corporate taxes for United Arab Emirates (UAE), which obviously contributes 0 to their treasury (presumably their money comes from a general sheikh down). The WSJ graphic designer then took the curve all the way up to Norway at 10 percent on the y (upper) axis, ignoring the dozen countries below this in the mid-range of rate of taxation on corporations. This is a case or providing one point (Norway) an extreme leverage in curve-fitting.

I searched out comparable Organisation for Economic Co-operation and Development (OECD) figures from a few years earlier (2002) than those upon which WSJ based their analysis. My curve-fit, done in with Design-Expert® software, does show a characteristic Laffer peak at 29 percent corporate rate, thus supporting the argument for reducing our USA rate of 35 percent. However, as one can see from the very broad 95 percent confidence band, this finding is not one that government officials ought bank on.

*Kevin Drum of the Washington Monthly


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