A Laffer Curve for physical climate risk

Louie’s article on Friday really got me thinking about the financial system and the likely effect that physical risk might have on bank profitability.  His article – which you should go and read, of course – is focused on the Network for Greening the Financial System (NGFS) and their newfound recognition of the legitimacy of adaptation as a response to physical climate risk.

His thesis was based on the assumption, almost universally held across the industry, that physical risk is a downside proposition for the economy and thus, presumably, also for the fortunes of banks.  

As a card-carrying contrarian, I like to challenge even the most basic assumptions.  Could increased property destruction ever be a positive for the financial system?  While musing on this I started thinking about Arthur Laffer and his famous curve.

This curve illustrates a belief that government revenue must, at some point, decrease following a rise in marginal tax rates.  On the flipside, there’s an assumption that government revenues can increase if rates are cut, something that right-wing politicians like to trot out whenever tax policy is debated.

The problem for such policymakers is that the facts have a well-known liberal bias.  The data clearly shows this particular right-wing fantasy only becomes reality when rates are extremely high.  The cut-taxes-to-boost-revenue argument held a lot of water in 1944, for example, when the top marginal tax rate in the US was a mere 94%.  With rates in the 30-60% range, however, there’s plenty of tax raising to go before the Laffer Curve kicks in.