I wanted to write a response to bonddad's post yesterday about the Laffer Curve, Supply-side economics and the like. The immediate issue I have is that the arguments are sloppy. If the Laffer Curve is not supported anywhere, then we should stop using it in our arguments as if it were real. For example, bonddad makes the point that the theoretical pont t* at which the tax rate maximizes tax revenue could well be higher than the current tax rate.
bonddad sez:
The Laffer Curve can't be derived from existing data.
If this is true, then it diminishes the impact of the argument to keep coming back to it, as if it were valid. More below the fold...
But let's assume for the moment that the Laffer curve is theoretically plausible. What it claims is that, beyond a certain tax rate, revenues fall off because people will choose not to work. At 100% tax rate, no one will work, because theoretically no one would work when the government took it all. So here's the curve (from Wikipedia):
This image begs all sorts of questions:
- at what rate is t*? Can t* be derived in any real world scenario?
- is maximizing government tax revenue desirable?
- since the basis involves incentives to "work" does this apply to individuals or corporations who derive income passively?
- is the shape of the curve correct? should it be a bell curve? drop off sharply after t*?
- does the curve change depending on the perceived return on taxes, e.g. service provided by the government?
- how does the curve change relative to income level?
I'll leave these as open questions because I haven't had the opportunity yet to research them. But I want to separate out some arguments that seem to be getting confused.
One well-worn supply-sider talking point says that "reducing taxes spurs the economy." Cheney (who should skip the quail and stick to canard) was apparently there when the curve was sketched on the proverbial napkin, and was recently quoted propounding, yet again, this talking point. That's one argument. The expanded TP goes something like this:
tax cut -> increases discretionary income -> increases consumption or savings ->grows the economy -> leads to higher wages / GDP -> increases tax revenue
The RWNM will try to use tax revenue stats to justify, and bonddad will use them to deny, this equation. The problem is that this equation is not the only equation. The expanding economy is the thing that appears to have the most effect on tax revenues, and that expansion is spurred by other things than tax cuts, namely money supply as regulated by the Fed by means of the short term lending rate. Increasing worker productivity is also a key factor, since it is the only thing that allows the economy to grow without exerting upward pressure on wages leading to inflation.
The point I want to make here is that the economy is a complex system of interrelating parts, functions, players and measures. Reduce it's complexity to simple linear equations at your peril. The discipline of regression analysis is designed to untangle the various weighting of factors in systems. Another tool is modeling which the RWNM's Royal Scientist Fictioner Michael Crichton has publicly derided as non-scientific. But that's another diary. Suffice to say that the Laffer curve, supply-side arguments, Keynes, Hayek, Schumpeter, Friedman et. al. can not easily, or summarily be debunked, and we should be cautious about claiming such.
Another argument favored by supply-siders is that supply, overall, creates its own demand. This appears to be the central argument in the supply-side theory, and is related to Say's Law which states that products can only be exchanged for other products, therefore supply precedes demand and supply inherently creates incentives for the producer to exchange the goods supplied (cost of holding inventory, declining value of investment). This only works on a macro level across the whole economy and is not meant to apply to certain products, markets or even industries. Keynes said it was wrong, but that's another diary too.
Note that the supply-side always wants to increase capital, savings and investment. The part of the equation [increases consumption or savings] should tend toward savings for supply-siders. Again we can generate a lot of wind about the negative savings rate, and what's causing it, but I'll again urge caution.
Now it may be that the Repug framing of these issues is wrong, without merit, way off, unsupportable by the facts. They've been very successful at framing these issues though. You almost never hear anyone talk about "demand side" economics, theory or policy. And who wants to argue with tax cuts? We need to reframe economics in order to take back our government. And the reframing cannot be based on the data, or on refuting / reacting to the current framing. It has to be re-framed, taken in a whole other direction. Then we can use the data and refutations to back up our new frame. I'll pick this up in future posts.