Debunking One of the Worst Ideas in Economics (by Charles Wheelan, Ph.D.)

[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.

snip


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.

snip

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.


snip


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

[BOSSHOG]

1. And

add to your post the fact that republicans spend tax dollars like drunken Sailors and then convince their lemmings that they don't and you have a perfect storm for debt extravaganza.

Caveat: I was a Sailor so I can make that remark. In fact, Drunken Sailors spend their own money.

[Warpy]

3. A friend of mine had a better description of GOP spending

He likened it to a meth head with a stolen credit card.

That is so appropriate on so many levels it needs no embellishment.

[BOSSHOG]

4. Yeah, like reagan proved, debt doesn't matter

especially when you are spending someone else's money.

[Sammy Pepys]

2. Yup....

More debunking here:

Myth 9: An income tax cut helps everyone; not only the taxpayer but also the government will benefit, since tax revenues will rise when the rate is cut.

This is the so-called "Laffer curve," set forth by California economist Arthur Laffer. It was advanced as a means of allowing politicians to square the circle; to come out for tax cuts, keeping spending at the current level, and balance the budget all at the same time. In that way, the public would enjoy its tax cut, be happy at the balanced budget, and still receive the same level of subsidies from the government.

It is true that if tax rates are 99%, and they are cut to 95%, tax revenue will go up. But there is no reason to assume such simple connections at any other time. In fact, this relationship works much better for a local excise tax than for a national income tax. A few years ago, the government of the District of Columbia decided to procure some revenue by sharply raising the District's gasoline tax. But, then, drivers could simply nip over the border to Virginia or Maryland and fill up at a much cheaper price. D.C. gasoline tax revenues fell, and much to the chagrin and confusion of D.C. bureaucrats, they had to repeal the tax.

But this is not likely to happen with the income tax. People are not going to stop working or leave the country because of a relatively small tax hike, or do the reverse because of a tax cut.

There are some other problems with the Laffer curve. The amount of time it is supposed to take for the Laffer effect to work is never specified. But still more important: Laffer assumes that what all of us want is to maximize tax revenue to the government. If--a big if--we are really at the upper half of the Laffer Curve, we should then all want to set tax rates at that "optimum" point. But why? Why should it be the objective of every one of us to maximize government revenue? To push to the maximum, in short, the share of private product that gets siphoned off to the activities of government? I should think we would be more interested in minimizing government revenue by pushing tax rates far, far below whatever the Laffer Optimum might happen to be.

http://www.mises.org/Econsense/ch2.asp

[Inland]

5. It was incredibly bad science.

Yes, tax collection at zero rate is zero. Tax collection at one hundred percent rate is probably also zero. But NOBODY HAD ANY RESEARCH into where the rest of the curve was. Nobody knew if we were on one side of the bell or the other, or even if it WAS a bell curve. It was a perfect example of putting shit on stilts by calling it a curve and giving it a guy's name.

[oscar111]

6. Laffer ignored two things

ONE... even if fed revenue went up, that revenue would not be spent on helping the middle/lower classes. With thugs in control of government, the cash would go elsewhere.. Haliburton contracts for example.

TWO.. even if fed revenue went up, .. at the same time the wealth of the idle rich would rise , due to the taxcuts. That wealth would enable them to buy more elections. Making any help for the middle/poor classes, much less likely.

Toss taxcuts for the rich.

Wages lower than 1980. ... adjusted for inflation.

[Jim__]

7. Martin Gardner did some research into this.

IIRC, he wrote a column in Scientific American on it; and that article was in one of his books (I think The Night is Large). He found that not only was this not a Bell Curve, but, government revenue is not a function of tax tate (i.e. given the tax rate, you cannot compute government revenue - a surprise to no one, with the possible exception of Laffer). I believe he did some research on historical tax rates and government revenue, found proof that it wasn't a function, then did some extrapolation and "plotted" a curve of revenue versus tax rate - there is a brief description of his article here.

[Inland]

8. I think I remember...

the actual curve he drew did loop de loops?

Anyway, it was entirely bull. Stockman never DID believe it: but he thought that after the tax cuts, he could get spending cuts through. Strange, seems like people didn't want that bait and swtich at all, and eventually, Reagan had the two biggest tax increases EVER.

[ticktockman]

10. Additional research on the effect of tax cuts on revenues

IIRC, he wrote a column in Scientific American on it; and that article was in one of his books (I think The Night is Large). He found that not only was this not a Bell Curve, but, government revenue is not a function of tax tate (i.e. given the tax rate, you cannot compute government revenue - a surprise to no one, with the possible exception of Laffer). I believe he did some research on historical tax rates and government revenue, found proof that it wasn't a function, then did some extrapolation and "plotted" a curve of revenue versus tax rate - there is a brief description of his article here.

That's an interesting article by Martin Gardner. For another analysis of the Reagan tax cut, see the short and longer analysis at http://home.att.net/~rdavis2/taxcuts.html . Regarding the Bush tax cuts, the following graph shows how, as a percentage of GDP, individual income tax revenues plunged from 2000 to 2004:



You can likewise see how revenues declined from 1981 to 1984 following Reagan's tax cut. The actual numbers and sources are at http://home.att.net/~rdavis2/recsrc.html .

[Bamboo]

9. Unpaid Labor is Worthless.

On NPR when right wing think tanks have the chance to get their ideas out they jackknife and spill the toxic waste (Laffer Curve).They could romance the audience with some pickup lines,bring up a teenage minimum wage but instead they go directly to date rape.

One could just roll your eyes except for two words-death tax.Those words are now in the IRS literature which I do not credit a success by conservatives but a failure of public education.

NPR has Wall Street Journal and Hudson Institute commentary on their Marketplace show which gets my attention like a stall horn in an airplane,what the hell is going on and who let this guy steer the plane.

My greatest wish is for Amy Goodman to ask people who tell their tale of woe on her show to connect the dots between their choices in the voting booth and the policies that have them whimpering at the microphone.I would ask them to explain how think tanks use the media to spread their ideas.Then the oompa-loompas would then carry them away.

[alvarezadams]

11. Nice details

But where's the real debate on economics?

That's not just a rhetorical question, btw. I am seeking a discussion forum on economic ideologies and haven't found one yet.

In a world where the DNC and Blair have embraced neoliberal economics and globalization with nary a question raised or a debate heard, what's going on? Who died and let Von Misses and Hayek rule unopposed?

This little adaptation of Churchill's speech is only half tongue-in-cheek:

From San Diego in the Pacific to Brownsville in the Caribbean, an iron curtain has descended across the Continent. Behind that line lie all the capitals of the ancient states of Central and Southern America. Mexico DF, Guatemala City, Lima, Bogota, Quito, Panama City, Managua and Santiago, all these famous cities and the populations around them lie in what I must call the Capitalist sphere, and all are subject in one form or another, not only to American influence but to a very high and, in many cases, increasing measure of control from Washington. Caracas alone -- Venezuela with its immortal glories -- is free to decide its future at an election under International observation. The American-dominated Mexican government has been encouraged to make enormous and wrongful inroads upon America itself, and mass immigrations of millions of Mexicans on a scale grievous and undreamed of are now taking place. The capitalists, which were very small in all these L. American states, have been raised to pre-eminence and power far beyond their numbers and are seeking everywhere to obtain totalitarian control. Police governments are prevailing in nearly every case, and so far, except in Bolivia and Venezuela, there is no true democracy....