Debunking One of the Worst Ideas in Economics

[norml]

The Naked Economist
by Charles Wheelan, Ph.D.



Debunking One of the Worst Ideas in Economics
by Charles Wheelan
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Wednesday, May 3, 2006

In this column, I'm focusing on bad economics. In fact, I'm going to write about what I consider to be the two worst economic ideas -- or at least ideas that pass as economics, though both have been thoroughly repudiated by nearly all credible thinkers.


The Laffer Curve

Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves. (In one of life's great coincidences, he first sketched a graph of this idea on Dick Cheney's cocktail napkin.) If the government cuts taxes, then Uncle Sam gets a smaller cut of all economic activity -- but reducing taxes also generates new economic activity. Laffer reasoned that, under some circumstances, a tax cut would stimulate so much new economic activity that the government would end up with more in its coffers -- by taking a smaller slice of a much larger pie.

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No Big Jolt for the U.S.

But here's the problem when we take Laffer's theory and try to apply it in the U.S.: We don't have a 99 percent marginal tax rate. Or 70 percent. Or even 50 percent. We start with low marginal tax rates relative to the rest of the developed world. (Yes, I understand that it may not feel that way after the check you wrote last month.)

So cutting the tax rate from 36 percent to 33 percent is not going to give you the same kind of economic jolt as slashing a tax rate from 90 percent to 50 percent. There's no huge black market to be shut down, no big supply of skilled workers to be lured back into the labor market, and so on.

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That's basically what happened with the large Reagan and George W. Bush tax cuts, both of which were followed by large budget deficits. Yes, spending has a lot to do with that, but the bottom line is unequivocal: In both cases, government revenue was lower than it would have been without the tax cuts.


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http://finance.yahoo.com/columnist/article/economist/4065?p=1

[Jack Rabbit]

1. There are cases where cutting taxes works like that

For example, cutting taxes did increase overall revenue when President Kennedy proposed one in 1961. However, to say it works just like that in all cases is a gross oversimplification. Ergo, the best term for this theory is the Laughter Curve.

The Republicans are under the delusion that it works in any and all cases. If that were the case, why not just abolish taxes?

Well, the reason is that if the government isn't taking in revenue, then it has to borrow money to fix roads or (listen carefully, neocons; this part applies to you) build nukes for national defense. And if the government is borrowing money to cover deficits, then there less money for consumers to borrow and if there is less money to borrow, borrowing it becomes more expensive; that is to say interest rates go up. It seems to me the law of supply and demand works that way. That is one economic theory that isn't bunk.

The mantra of the supply siders who promote the Laughter Curve (the oversimplified version the Laffer Curve) is that deficits don't matter. Horesepucky. When government spending is up and the government needs revenue, we the people will be providing it one way or the other. We either pay higher taxes, which goes directly to the government, or we pay higher interest rates to subsidize government borrowing, which is an indirect form of taxation. And the thing about the latter is that sooner or later we need to pay higher taxes to cover yesterday's tax cuts. We lose wither way.

[4dsc]

2. Revenue alway goes up!!

If I am not mistaken, governmemt revenues have risen every year since 1946, making most of the conservatives arguements about tax cuts moot.

[yurbud]

3. isn't that because of inflation and population growth? that is like the

GOP saying they didn't cut programs, they just stopped increasing the amount given to it, which given inflation and population growth, is the same as a cut.