The Electric Commentary

Tuesday, December 18, 2007

Why Not Reduce Taxes To Zero?

I often point out that many Conservatives support supply-side economics and the Laffer curve without actually understanding what they are. Case in point, Mark Belling:

Laffer is the father of "supply side economics," the theory that as income tax rates are lowered, actual tax revenues increase. Laffer famously demonstrated this by drawing a diagram on the back of a napkin that became legendarily known as the "Laffer Curve." Laffer’s theory was that as tax rates declined, economic activity (and therefore income) would increase resulting in more taxes paid to government.

This is not true. The Laffer curve shows that the actual cost of a tax cut will be smaller than the gross figure attached to the cut. This is due to distortionary effect that taxation has on the economy. When work is taxed, people do not work as hard. It does NOT say that tax cuts increase revenue. While it is possible for tax cuts to generate more revenue, the baseline tax rate for this is likely much higher than the current rate of taxation in the US. I say likely because the Laffer Curve is not some static thing; it changes with economic conditions.

Laffer and his eponymous curve have never asserted that tax cuts increase government revenue. Belling goes on to say that:

The real life experience in Wisconsin not only proves Laffer’s point in reverse but makes it clear that it applies to all taxes, not just income.

Well, not exactly. Taxes do have a distortionary effect on things, but certain activities are more inelastic than others. I'm not sure about property taxes off the top of my head, but I suspect that property ownership is quite inelastic, as someone tends to own any given piece of property. Perhaps people go around abandoning property when taxes are raised, but I doubt it.

Some politicians and economists favor a consumption tax instead of an income tax because in theory this would take away all of the bad incentives associated with an income tax and instead incentivize savings (while penalizing consumption, obviously).

Tax cuts are never as costly as they seem, and tax increases are often worse than they seem, but this is a far cry from what people like Belling claim. Poor Laffer. Almost no one believes him because almost no one actually knows what he said.


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