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Thursday, August 13, 2009

Something to think about

There are plenty of people who pan the Laffer Curve, but the general idea is probably fairly sound. The real issue is determining at any given point in time where society is on the Laffer curve - if on one side then raising tax rates will increase revenues, if on the other side then raising taxes will reduce revenues.

To complicate matters the Laffer curve most of us teach in a principles of economics class assumes a static world when, in reality, the world is dynamic and thus trying to determine on which side of the Laffer curve we are at is difficult.

I found this paper on the Laffer curve at CF&P - will read later tonight:
The Laffer Curve shows the relationship between tax rates, taxable income and tax revenues: at a certain point, higher tax rates fail to produce more revenue. This paper uses real world evidence to demonstrate that certain tax cuts can have a positive impact on economic performance and that "supply-side" tax cuts do not "cost" the government much in terms of foregone tax revenue. This paper further explains how the Joint Committee on Taxation's revenue-estimating process is based on the untenable theory that changes in tax policy - even dramatic reforms such as a flat tax - do not effect economic growth. In other words, the current system assumes the tax rates have no impact on taxable income.

Here is a three-part video series on the concept:

Video #1
Video #2
Video #3

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It would be hard to dispute the theoretical plausibility of the Laffer Curve. In fact, in the trade literature, the concept has long been used to demonstrate the existence of a revenue maximizing tariff before Art came up with it. That does not make it empirically relevant for the case of general income taxes. One thing that's important to remember is that the tax rate would have to be high enough to not only stifle productivity, but to stifle it by a proportion greater than 1:1 to the tax hike. I've heard casual calculations ballparking such a rate at 80-90 percent.
I think you (or maybe your colleagues at DoL) have made the point that, just because something is plausible, doesn't mean it's probable (arguing against market failures). Is this a case where what's good for the goose is good for the gander?
One other thing: it probably not only depends on the rate itself, but also on the public's perceptions about how the tax revenues are being allocated. It's been hypothesized that many Europeans are more "OK" with high taxes than Americans because the middle class gets something back for what they put in. In the US the poor gets some transfers, the rich get some subsidies, and the middle class gets...
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