Writing on the Limits of Policy Analysis yesterday, Megan McCardle said:
Consider the supply-siders. The thing is intuitively appealling; when we get more money from working, we ought to be willing to. And it is a mathematical truism that revenue must maximize at some point. Why couldn't we be on the right-hand side of the Laffer Curve?
It was entirely possible that we were; unfortunately, it wasn't true. And one of the reasons that supply-siders failed was that they were captivated by that one appealing intuition. In economics, it's known as the "substitution effect"--as your wages go up, leisure becomes relatively more expensive relative to work, so you tend to do less of the former, more of the latter.
Gee, I didn't know suppy-siders failed. It's nice to speculate where we might be on the Laffer curve at a given moment, and whether or not cutting taxes will induce a taxpayer to work longer or harder, but there's a little more to it than that. A discussion of supply side economics that is limited to the Laffer Curve is laughable. (I couldn't resist!)
The Laffer Curve says there are two income tax rates that will effectively yield no tax revenue – 0% and 100%. Somewhere in the middle there is an optimum rate that yields max revenue, and once beyond it tax revenues will theoretically decline. The Kennedy tax cuts may have demonstrated the Laffer effect, going from a 90% top marginal tax rate to 70%.
But supply-side in today's economy is about broadening the tax base. McCardle never speculates on possible secondary effects of supply-side tax cuts. What happens to the money not taxed? Under the mattress with it? Or maybe it gets invested in job creating ventures which put more people onto the tax rolls. More people on the tax roles and fewer on the dole means more revenue and less spending.
And there we find the real failure. It's the spend-side economics that will continue to drive the economy into the dirt, since it is directed by government toward political outcomes rather than economic growth.
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