Sunday, March 11, 2007

More Laffer Curve Laughers

Via Greg Mankiw, we find this National Review interview of Senator McCain by Ramesh Ponnuru. Greg refers us to this part of the Q&A (by far the worst on economic issues):

Ponnuru: If you could get the Democrats to agree, or at least to come to the table on entitlements or on tax simplification, are those circumstances under which you’d be willing to accept a tax increase?

Sen. McCain: No; no.

PONNURU: No circumstances?

Sen. McCain: No. None. None. Tax cuts, starting with Kennedy, as we all know, increase revenues. So what’s the argument for increasing taxes? If you get the opposite effect out of tax cuts?

Greg suggests two appropriate follow-up questions for McCain:
1. If you think the 2001 and 2003 tax cuts increased revenue, why did you vote against them?

2. If you think tax cuts increase revenue, why advocate spending restraint? Can't we pay for new spending programs with more tax cuts?

As Greg has announced that he's an economic advisor to Governor Romney, I'll be very curious to hear Romney's response to a direct question about the circumstances under which he would be willing to increase taxes if he's elected President.

The question that I would like to have answered by any policy maker who voted for the tax cuts and believes that they have increased revenues is:

Why did you make them so small?


paul a'barge said...

Why did you make them so small

Maybe he was working under the Goldilocks theory that neither too big nor too small would be just right.

Maybe a professor of economics would understand such a concept.

Then again, maybe not.

Christopher Taylor said...

I guess I'm just not as economically savvy as you Mr. a'barge, but what about the size of the tax cuts makes you believe they were "just right?" I mean obviously, by definition "too small" and "too big" are extremes, but is there any reason to believe that the work that was done was "just right?"

Could they not have been any bigger? Would that have, in your opinion, been bad? Based on what?

Attila said...

"I'll take Tax Policy for $200, Alex."

"The answer is 'Static revenue analysis.'"


"Why did you make them so small?"

Anonymous said...

This explains how reducing tax rates increases tax revenues, reduces wealth concentration, improves family life, improves the entrepreneurial climate and lowers demand for government social services. This makes the case for tax rate reductions that I have never seen elsewhere. This my own work.

If the tax rate on Monday was 100% and the tax rate on Tuesday was 10% would you report for work on Monday? Would you work harder on Tuesday? What tax rate would make you show up for work on Wednesday, Thursday and Friday? Will your tax rate at which you are willing to work be the same as everyone else's? If you would stay home Monday and would go to work on Tuesday you understand Voodoo economics.
Voodoo economics says tax revenues increase when tax rates go down. How does this happen? It happens because high tax rates cause a decrease in economic activity. Rewards for taking business risks are lower under high tax rates. Lower tax rates stimulate economic activity. Rewards for taking business risks are higher when tax rates are lower.
This concept can be demonstrated graphically. The basic concept is taken from the Laffer curve. The horizontal axis is tax rate, zero to one hundred percent and the vertical axis is tax revenues. Tax revenues are derived from the tax rate times the tax base. At zero tax rate tax revenues are zero. At 100 percent tax rate tax revenues are again zero. No one can afford to go to work if all their compensation is forfeited to taxes. There is no economic activity to tax, so no tax receipts.
However we do have a point where we have tax revenue and a tax rate greater than zero and less than 100%. So the question is what is the shape of the curve that connects the three points? For the sake of the illustration assume the current tax rate is about 30% and the revenues are about 1/4 the height of the vertical axis. There are three possible basic revenue curve shapes, depending on the slope of the line through this non zero revenue point. The slope can be positive, negative or zero. Proponents of raising tax rates to increase tax revenues say the slope is positive, proponents of Voodoo economics say the slope is negative. No one makes a case the slope is at zero.
What does real world experience reveal of the true shape of the revenue curve? Empirically tax rate reductions have yielded growing economies, In the 1920's low tax rates stimulated the economy. In the depths of the 1930’s depression tax rate increases to 99% on incomes greater than $60,000 increased the unemployment rate from 25% to 35%. In the early 1960’s John Kennedy stimulated economic growth with tax rate cuts. Gerald Ford lowered tax rates and the stock market boomed. In the 1980’s Ronald Reagan lowered tax rates from previous levels and the economy again boomed. George H. W. Bush raised tax rates and was rewarded with a recession that cost him his reelection. In the 1990’s Republicans forced Bill Clinton to reduce tax rates on capital gains and the economy boomed again. (note that income will be taken at the lowest tax rate possible) George W. Bush pushed for tax rate decreases that have pulled a 9-11 shocked economy back into growth. Tax receipts have recently reached record levels, and in some recent months even exceeded expenditures. These examples suggest that the correct shape of the curve is negative slope at our current tax rate.
Examples can be seen in other countries, low flat tax rate Estonia is booming after suffering decades under Soviet communism. Ireland has gone from being the poorest country in Western Europe (with a high tax rate) to one of the richest (with a low tax rate) Why? low tax rates have attracted investment. Russia itself has seen tax revenues jump after implementing a low rate flat tax after high tax rates failed to provide revenues. Many other countries from the former Eastern block have implemented low flat taxes and these countries economies are showing far better growth than the Western Europe high tax rate economies that are mired in low growth and high unemployment. Recently it has been pointed out the US has created over 50 million new jobs since the 1980's (when tax rates were lowered) where high tax rate (and larger population) Western Europe has created only 4 million new jobs, and most of these are government jobs.
The following graphs show the three slope possibilities at a tax rate of 30%, with the added reciprocal curve above the revenue curve being the size of the tax base, ie the size of the economy. Note that with all slope scenarios the slope of the economy is negative, that is, the higher the tax rate the less economic activity there is to tax.


What does this decreasing size of economy with increased tax rates mean to you? It means little or no job creation, and certainly lower overall employment. There must be economic activity to have jobs and the level of economic activity can be a good proxy for the number of jobs in the economy. The following graph uses the size of the economy as a proxy for the number of jobs.
Compare the number of jobs in the economy with the size of the available workforce. The size of the available workforce remains basically constant independent of the number of jobs available. Where there are more available workers than available jobs, as under high tax rates, there is downward pressure on wages paid to workers. Where there are more jobs available than workers in the workforce employers must pay more to attract workers, wages are bid upwards. So would you rather look for work under high tax rates or low tax rates?
Another overlooked effect of high tax rates is wealth concentration. High tax rates are said to be needed to tax from the rich and give to the poor to redistribute incomes. But high tax rates actually concentrate wealth. How? Under high tax rates jobs are few, workers plentiful, and compensation is low. The employer can pay far less than the value of the workers contributions and pocket the difference between the compensation paid and the value the worker generates for the employer. With large numbers of employees getting paid far less than the value of their contributions the employer can still profit greatly even if the tax rate is high, the net after taxes is still large.
Under low tax rates jobs are plentiful and employers must pay more to retain valuable employees. Because employers are forced to pay a higher percentage of the value of the employees’ contributions to the employee there is less wealth concentration. Wealth created by the business enterprise will be more evenly spread among the creators of the wealth. Employers will earn less from each employee, but will pay a lower tax rate and may not suffer as much damage to their net as one might expect.

There are a variety of other effects of higher wages stimulated by low tax rates.
1. Capital investments will be made to increase productivity. Productivity increases correlate strongly with increased living standards. Productivity growth also moderates inflation.
2. Low paying jobs often lead to two income earner families which expands the active workforce. With each worker earning more, fewer families will need two income earners. More families will have a single income earner with a stay at home parent. This could have a cascade effect on the job market in that this will reduce the active labor force, potentially forcing wages even higher. And a stay at home parent usually means good things for children.
3. More jobs = less government assistance needed. With more jobs available, the whole of the work force that wants to work should be able to find a job, the chronically poor and last hired minorities could find a job. This should reduce the demands on a variety of governmental assistance programs, including unemployment programs, welfare, medicaid, social security.
4. Workers with more disposable income can accumulate wealth and join the investor class or start their own businesses.

So the big question is where are we on the tax curve now? Most certainly we are on a point on the negative slope and decreasing tax rates will increase revenues and increase the size of the economy. How far should tax rates be reduced? Should they be reduced to the zero slope point (the highest point on the revenue curve) on the curve? This would maximize revenue to the government, but this is not the point where standards of living would be the highest, or where the fewest people would require governmental assistance. The goal should not be to maximize government, but to maximize the standards of living for the population of the country. This would indicate lower tax rates, to the left of the zero slope point, where economic activity is highest are desired.
Dirk Schulbach

Fritz said...

Why not ask about hidden taxes? Too many federal programs cost shift costs on the private sector, like Medicare & Medicaid.

Edward Charles Ponzi Jr. said...

I suppose you could make the case that less actual government could have real economic benefits -- but less taxes and the same amount of gov. spending?

I think the debt numbers speak for themselves.

But many of the people who advocate this nonsense know damned well that THEY are benefiting now and EVERYONE pays later.