About a year ago Bruce Bartlett wrote a very good paper on supply-side economics entitled Supply-Side Economics: "Voodoo Economics or Lasting Contibution? It can be found along with other discussions of taxes and growth on this page at NCPA.org. The link above points to the paper in PDF format. Here it is in HTML.
Although it is only one aspect of supply-side economics, the Laffer Curve has come to represent what it was all about, in the minds of most people. It simply makes the indisputably true point that neither a zero percent tax rate nor a 100 percent tax rate collect any revenue; the former because there is no tax and the latter because no one will earn taxable income, knowing that the government will confiscate all of it.
The Laffer Curve implies that there is some point between zero and 100 percent that will maximize revenue. If rates are above this point - in the prohibitive range - then a tax rate reduction could theoretically raise revenue. A more important lesson of the Laffer Curve is that there are always two tax rates that will collect the same revenue - a high rate on a small base and a low rate on a large base.
Bartlett's paper is quite an explanation of the history and philosophy behind supply-side economics.
It will come as a surprise to many people that the intellectual origins of supply-side economics can be traced to a 14th century Muslim philosopher named Ibn Khaldun. In his masterwork, The Muqaddimah, he wrote about the rise and fall of empires. He argued that high taxes were often a factor in causing empires to collapse, with the result that lower revenue was collected from high rates. As Khaldun wrote:
It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments.At the end of the dynasty, taxation yields a small revenue from large assessments (Khaldun 1958: 2: 89).
Some belated commentary: I think when the JFK tax cuts went into effect, tax rates were on the north side of Laffer's point of maximum revenue. That resulted in the tax cuts actually increasing revenue as the tax rates moved closer to the optimum. When the Reagan tax cuts took effect this was not the case, and revenue initially went down. But the Reagan tax cuts had the effect of growing the tax base, and the deficit was eventually eliminated. I suspect the Bush tax cuts will be much like the Reagan cuts. There has been an initial reduction in revenue, but the tax base is growing and will more than make up for it in the longer term.
I don't want to start a long debate here, so let me simply say this about the Laffer Curve and Ibn Khaldun: a 5% increase in the marginal tax rate of any particular group won't "cause an empire to fall." As an argument for tax reduction, false gloom and doom scenarios don't make the case. There are numerous other arguments to present but I'm really not interested this time around.
No serious economist doubts the importance of the Laffer Curve, but darnit, it doesn't justify every tax cut. Right, let's get taxes down to 0% and have private foundations and charities fund the national defense. Please.
Posted by: Scott | December 31, 2004 at 09:07 AM