The use of Laffer Curve to justify the unjustifiable

Claudio Fernandes*

Beginning in the early 1980s, the second-degree parable of the American economist Arthur Laffer was used to justify tax cuts in the United States and England, in an episode that history now sees as a return of liberalism in the economy.

To put it in context, Laffer answered a macroeconomics question, thinking about added value. In short, it said that society bears the tax burden to a certain extent, after which tax revenues begin to decline, as people and businesses find ways to eliminate tax payments through market alternatives, or by increasing the use of cash, in order to get off the radar of surveillance.

But once confronted with reality, Laffer’s theory proves itself wrong, even in the macroeconomics field. Its main logic contributed to the evolution of the monetarist thesis known as the “supply economy” of money, which calls for a reduction in income and profit taxes, arguing that with more money people would buy more and companies would invest more. It sounds plausible, but it depends on other dynamic factors, as showed by the policy of tax relief given to companies in the Dilma administration. They did not invest the extra resources in production.

In Brazil, the Laffer Curve has become part of the arsenal of economic theory with the advent of selective health taxation policies, especially with the signing of the World Health Organization’s Framework Convention on Tobacco Control. It has been mentioned by entities that defend the economy of the cigarette, barring the increase of taxes on the product.

The recent decision made by the Minister of Justice to gather together a working group to analyze the possibility of reducing cigarette taxes in order to fight smuggling in the country is yet another distortion of economics theses based on ignorance about the supply chain of smoking, both in Brazil and South America. In a presentation to the WG, the economist Perry Shikida argued that cigarette taxation in Brazil would have reached its collection inflection point. His 2017 study covers data on consumption, revenue and illicit market estimation only from 2010 to January 2016, leaving aside important information for reliable analysis, such as consumer income segmentation, as illegal smoking is consumed by low-income people. Nor does his paper consider the oligopoly theory of pricing, or Murphy-Becker’s model of addictive rationality. That is, its study may be mathematically rigorous, but it is inaccurate and of little scientific validity.

Data from 1999 through 2018 show that the reduction in cigarette demand predates the 2011 minimum price policy, and illegal market behavior is volatile rather than linear. As cigarettes in Brazil are still very cheap, the drop in revenue is still far from being a problem. Moreover, what we must take into consideration is that the purpose of tax policy is not to feed the state with increasing resources or to benefit producing companies, but to reduce the demand for cigarettes, whether legal or illegal, but also to reduce health costs with diseases caused by smoking. Therefore, security policy cannot be based on the destruction of tax policies that work, even more so based on false assumptions.

* Claudio Fernandes is an economist, consultant for ACT Health Promotion and WG 2030 Agenda.

 ** Published in the newspaper Gazeta do Povo in July 8th 2019.

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