Thursday, June 14, 2007

Laffer et al

Reading Fred Thompson's Tax Op-Ed Today led me to these thoughts:

Progressives and even many Republicans often mention that tax-cuts do not pay for themselves, and indeed broad-based tax-cuts do not. This applies to all of the major tax-cuts starting with Kemp-Roth in 1981 thru Bush II. What does this mean? It means that the stimulus of the tax-cut does not expand the economy to at least the extent necessary for the tax policy to be revenue neutral.

This idea of revenue neutral tax-cuts comes to us from Art Laffer. The, so called Laffer curve, describes that above some tax-rate further revenues cannot be had because taxes retard productivity and growth and because of evasion. Under such a situation cutting taxes leads to tax-revenue increases.

Several tax-reduction programs have been sold on the basis of their stimulating effects, but it is plainly obvious that they never seem to pay for themselves. Ergo, we must be below the Laffer point. Or not?

The trouble with aggregate analysis is that it obscures our tiered tax structure. As it happens all tax-cuts have effected all of the tax brackets. This ends-up impeding revenue neutrality. Tax-cuts against the lower brackets tend to be very costly to revenue (because the middle-income bracket is very broad) and because there seems to be very little growth stimulus from cutting mid-range taxes.

The picture changes dramatically though if we only look at the top-brackets. Top-bracket cuts pay for themselves. This is the Laffer effect, only it applies to only the Top Brackets not the middle-brackets.

1 comment:

sbchurl said...

I guess I've heard different things than you have. Here's a study by Mr. Laffer himself:

The data he cites on the Kennedy tax cuts seems to make a strong case for the economic benefits of correctly timed and targeted tax cuts. You state that "it is plainly obvious that [tax reduction programs] never seem to pay for themselves." Could you please point to a study that supports that claim?