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Laffer Curve/Supply Side

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Beefheart posted on Thu, Mar 10 2011 12:12 AM

I just sent this to my teacher regarding my skepticism of the Laffer Curve and supply-side (which he is also skeptical of, though he is not an Austrian so it may be different reasons, especially since my chief complaint is that it assumes that we should see increased government revenue as positive, which I focused on a little less here because a) he is largely Keynesian, and b) I figured I'd like to discuss some related details first, etc.

I was hoping some of the experts here could help me out with anything I missed. I also ignored methodological problems for the time being, but feel free to comment on that too.

Excuse me if the thoughts are messy, I'm almost thinking aloud here

I figured I'd mail this to you, since it isn't on the wiki anywhere, and no one on it would care but...this thing always gave me the heebie-jeebies; like a square circle conjured up by politicians. I've largely ignored it mostly because outside of purely scientific purposes I had little interest in it, seeing as a Libertarian I'm not really interested in an idea that has its initial focus on cutting taxes to increase government revenue; one possible objection to the use of the Laffer Curve is that it seems to assume an economy benefits from the government having more funds, which is debatable-- and I would staunchly argue that it is not a happy picture-- but I think its best to assume that there is no such moral presupposition, and that the Laffer Curve simply purports to illustrate a relationship, and at most a hypothetical imperative, i.e. if you want to raise government revenue, then you may want to cut taxes-- indeed, it is possible that an economic advisor may not desire full possible revenue. If, for instance, a person is a small-government libertarian/classical liberal or conservative then it is probably theoretically popular that, assuming the Laffer Curve is correct, he or she would want the marginal tax rate to be set at that level to the “left” of the estimated apex that would fund the costs of government at the lowest marginal tax rate possible to fund the limited functions such figures endorse (the "night watchman state" I think Robert Nozick called it)... and an anarchist, accepting the Laffer curve, would want to be at the very bottom left of the curve.
Allow me to put that aside for a moment, there are some other curiosities here, in my mind. One, the relationship is simplistic to a worrying degree-- there seems to be little justification that there is a simple functional relationship between tax rates and tax revenue. You could purpose the same relationship exists if you replace "tax rate" with "average weight of a person's body." At very low weights (0lbs) the person doesn't have enough muscle mass to make any money for the government to tax, or on the other hand (I dunno, 1000 pounds) the person is too monstrously gigantic to move in order to make money for the government to tax. Ergo, there is an optimal weight level for government revenue. Perhaps this a simplification of supply-side positions, but I haven't really been able to find a legitimate, logical proof of this simple relationship. Sure, there is reason to believe cutting tax rates from 99% to 95% would likely raise revenue, but theres little reason to accept this on a grand, universal scale-- nor is there any reason to believe that the increase in tax revenue would be enough to balance the State's budget (if it rises at all), or counteract against inflation. It seems much more likely to me that there would be no Laffer effect whatsoever, because the tax cuts probably cut the amount of revenue to a lesser degree. In fact, it seems pretty much absurd to apply it to national income taxes. It would make more sense to apply it to a local excise tax. I remember reading about this time the District of Colombia imposed a tax increase on gasoline... so drivers would simply move on over a bit to get gas in Virginia or Maryland at a cheaper price-- causing DC tax revenue to fall. This seems to suggest that it has little application to larger, macro problems and the national income tax-- it feels unrealistic to suggest that slight changes in tax rates will cause any economic actors to move to different countries or stop working (and I'm going to just pretend that the IRS (as well as other countries) doesn't continue to demand taxes from you if you move out of the country or even outright denounce citizenship). Part of this again feels like a political failure that this economic model won't account for-- the size of a particular nation makes it hard to "vote with your feet" and thus show economic policy makers where they are on the Laffer Curve, not to mention the State's monopolistic tendencies that make such competition difficult and/or impossible (but if we subject the State to competition, the Laffer Curve, as perhaps primarily a policy instrument, becomes pretty pointless, so we have to retain the State in this hypothetical). Then again, it could manifest itself in the form of firms leaving the country to set up shop in more business-friendly countries as well as the inability of existing firms to hire workers to earn wages in which to tax.
But that leads me to another concern-- how in the hell do you figure out the optimal tax point? What is the shape of the curve and how do we figure out if we are on it? The variables that would have to be involved are out of this world it would have to be the cumulative subjective estimations of a multitude of all individuals about the relative advantages of work vs. leisure, consumption vs. savings, etc. I don't even fully trust GDP figures and other general methods of Keynesian aggregation (thats for another time)-- to be able to actually envision the Laffer Curve would require the production of something so erratic-- as erratic as the individual preferences and expectations of any person-- it would make for a model that would be useless probably about a day after its creation. The amount of time we should expect to see results from the curve are never specified either-- in fact, many supply siders seem to hint that large tax cuts will instantly increase revenue-- production cannot increase overnight, and any supposed Laffer effect would take years. 
To the extent that supply-side economists endorse tax cuts on the grounds that they give incentives for productivity (progressively rising marginal tax rates that take a greater proportion of one's income will tend to dissuade work, create incentives to move into barter or cash transactions that can avoid taxation, diminish the incentive for saving/investment, etc. and so that lowering the tax rate lessens the opportunity cost of performing an economic action) is simple recognition of old classical and Austrian ideas. But their biggest flaw is the fact they ALWAYS advocate keeping up the current level of government expenditures, and beyond, so that the burden of shifting resources from productive private to wasteful government spending will still continue. It does appear to be voodoo economics on the grounds that it purports to be able to keep government services going at current (and always expanding levels), lower taxes, and create a balanced budget all at the same time. Its a Free Lunch if there ever was one-- thanks Dr. Laffer!
And thats all supply-side has seemed to be, in its final legacy. Its ultimate failure seems to stem from the fact that it failed to incorporate its economic theory into other social sciences, which I believe are almost all interconnected in some fashion-- most notably that of political science. It ignores the existence of political entrepreneurs and rent-seekers (which, though coined and delightfully (though timidly in my opinion) by Tullock and Buchanan is a concept going as far back as the moment Adam Smith wrote "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.") and the work within the tradition of Establishment Studies/Libertarian Class Analysis (which is the concept of rent-seeking taken to a larger scale, really). It either ignores this point or fully endorses the fact that only the elites will be involved in it-- which isn't surprising, as supply-side still largely rests on Keynesian fundamentals, and the Keynesian economic model-- as any centralized organization, especially the State-- is inherently a top-down anti-democratic system (lots of group think-- thats why people who say whats unpopular get fired) seeing as many decisions on balancing budgets, running a surplus, increasing taxes during a boom, and borrowing during a recession, can simply not be made in a democratic spirit (as Hayek pointed out often, and as Keynes admitted in his introduction to the German edition of his General Theory). As a correlative, it also neglects the political application of time preference. A problem with these temporary leaders is that they have little binding them to the long-term interests of the country, and so are perfectly capable of benefiting themselves in the short-run politically (just as in the Frontline documentary: eliminating pay-as-you-go, making huge tax cuts and then increasing spending to a diabolical degree) while foisting the costs on the next leader-- and the country. A theory that cannot account for practice is ultimately a bad theory.

I know I'm forgetting some objections I had, but its 1am now, so I'm tired. Hope you read it, thanks!

My personal Anarcho-Capitalist flag. The symbol in the center stands for "harmony" and "protection"-- I'm hoping to illustrate the bond between order/justice and anarchy.

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