Professor Bunyip coins a bon mot at my expense, saying in relation to a dispute between Sharon Beder and Leigh Cartwright over the effects of the Reagan tax cuts on revenue that
some of the itchier creatures in John Quiggin’s beard are the intellectual betters by an order of magnitude.
of one participant. Unfortunately, Prof B is not a professor of economics, and he applies the epithet to the wrong party in the dispute[1].
While there are plenty of open issues regarding the merits or otherwise of supply-side economics, the fact that the Reagan tax cuts reduced revenue is not of one them. This is an issue, like creationism for biologists, about which there is no disagreement among serious economists, although there are plenty of cranks and hacks willing to distort the data (for example by ignoring inflation and population growth) or ignore inconvenient facts (such as the fact that tax revenues only recovered when Reagan reversed course and raised taxes in 1986).
As an example of the distinction, here’s right-wing hatchetman Stephen Moore on Greg Mankiw, until recently Chairman of the Committee of Economic Advisors under Bush. Mankiw refers to Ronald Reagan’s supply-side advisers as “charlatans and cranks.”, specifically because of the claim that tax cuts increase revenue. Moore isn’t happy about this, since he is himself a prime example, but the “economists” he suggests as ideologically acceptable are so obscure as to be invisible.
fn1. I don’t mean to claim that Cartwright is the intellectual inferior of my beard fauna (not itchy at all, BTW), but his education has a long way to go on these matters.
John Quiggin 
“There is no reason to believe that tax cuts for the wealthy in Australia will benefit anyone but the rich. It is the latest bid to destroy progressive taxation and with it any lingering ideal of Australian egalitarianism, in order to line the pockets of those who already have large incomes.”
This quote, the last paragraph from Beders article is rubbish. The marginal tax system is regressive not progressive. See my post under Simplifying taxes.
https://johnquiggin.com/index.php/archives/2005/09/02/simplifying-taxes/#comments
Jude Wanniski who coined the term “supply-side economics” (although not the supply-side part) died this last month from a heart attack. So it is timely for a discussion of the whole topic.
In looking at tax cuts, the revenue impact and the whole issue of how the Laffer Curve works there are a couple of good points made by John Quiggin. There are also a few others that I would like to add.
Points made by Mr Quiggin.
1. We should adjust revenue figures for inflation to ensure we are looking at real numbers not nominal numbers.
2. We should adjust for population growth because we want to know the per capita impact.
Extra Points that Terje Petersen would like to make.
3. Ideally we should adjust for demographic changes also, although this would be messy in practice.
4. Ideally we should include tax revenue for all layers of government in any analysis because even if tax rate cuts are at one single layer all the other layers will reap the revenue benefit that flows from any economic expansion.
5. We should not expect an instant revenue response. The Laffer curve argument is predicated on the interaction of the arithmetic effect of any tax rate cuts and the incentive effect.
6. If tax cuts do lead to economic growth then revenue changes should not be the sole consideration. A stronger more vibrant private sector has social benefits in its own right.
7. Budget deficits do not mean tax revenues have fallen. They could simply mean government spending has increased.
We could probably add more points.
Reagan Tax Cuts
Having said all that, what is the actual record on tax rate cuts and in particular the Reagan tax rate cuts.
The relevant laws for most of the Reagan tax cuts were passed in August 1981. However the tax rate reductions were introduced in stages and did not come into full effect until the middle of 1983. The reduction in the top tax rate from 70% to 28% was not fully delivered until 1988. There never was an overnight slash to income tax rates, it was phased in.
This gives those on either side of the argument some room to fudge one way or the other to suit their agenda, so we need to take care in accepting a particular starting point. Those that defend the supply-side argument argue thus:-
Art Laffer:“Inflation-adjusted revenue growth dramatically improved. Over the four years prior to 1983, federal income tax revenue declined at an average rate of 2.8 percent per year, and total government income tax revenue declined at an annual rate of 2.6 percent. Between 1983 and 1986, federal income tax revenue increased by 2.7 percent annually, and total government income tax revenue increased by 3.5 percent annually.”
As John Quiggin points out there were tax increases in 1986. The capital gains tax rate was increased from 20% to 28%. However looking at this as a tax increase needs to be put into perspective. It was no more than a reversal of the reduction from 28% to 20% in 1981. And the reason for the reversal had more to do with political horse trading than any sudden change of heart by the Reagan administration.
The raw tax revenue data (US Federal Government only) without making the adjustments noted in all the points above can be found in the following PDF document.
Click to access HS-48.pdf
There are lots of acticles for and against the Reagan tax cuts that all choose their dates according to how they read the history and the theory being defended. They also choose the period of comparison and their rhetoric to suit. You can take sides and find a data set to suit your point of view.
Conclusion
My personal view (having poured over all this many times) is that the tax cuts were the right thing to do and that holisically the tax policy decisions made by Reagan delivered in spades. If you really want to know and understand for yourself you need to come to terms with the full story. Arguments from authority are all well and good but you don’t learn a lot from them. If you want insight go and do the ground work.
However if you just want an authority to tell you what to think then try what John Maynard Keynes had to say on the topic of tax cuts and tax revenue:-
John Maynard Keynes:“Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more–and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.”
Terje: “There never was an overnight slash to income tax rates, it was phased in.
This gives those on either side of the argument some room to fudge one way or the other to suit their agenda, so we need to take care in accepting a particular starting point.”
Indeed, however the numbers I presented show that (in real dollars) revenue did increase between 1983 and 1986. On a further note, I won’t profess to being an economist (I barely passed it as a high school subject), however the figures I saw on the Cato site contradicted the majority of claims in Beder’s article.
As it turned out, it’s going to provoke good discussion on a couple of blogs, which I’ll follow with interest.
Billions of blistering bashi-bunyips.
Besides how can you take seriously someone who operates under a net de plume?
I would say that beard fauna that do not itch are more likely to be worse than the sort that do, simply because they do not provide feedback of a proper pain signal sort. Anaesthetising the victim is in the interest of a mosquito or a bedbug, not of the victim.
I think that insight can properly be transferred to tax systems too, though which way to apply it depends whose side you’re on.
BTW, “bashi-bunyip” would – by analogy with bashi-bazouk – be Turkish for bunyip-head.
I’m not an economist, but (since Keynes was mentioned) isn’t massive government borrowing/military spending during the Reagan years also relevant here? Wouldn’t it make sense to offset in some manner the tax revenues (whether they grew or not) by the amount of debt accumulated during those years?
Otherwise it seems kinda pointless: sure, you can borrow a few trillion dollars, create a lot of useless economic activity and collect a portion of that money in taxes, but so what, who cares?
Aha! If there is no itch in JQ’s beard, it cannot be because there are no fauna. It must be fauna who do not itch!
No wonder we lefties are always bamboozled by these brilliant arguments!
BTW, the real story about Professor Mankiw, “Greg Mankiw, until recently Chairman of the Committee of Economic Advisors under Bush“. Didn’t some wag request a “Chairman Manque”, knowing any economic advisors to Bush would have to toe the American Enterprise Institute line anyway, and therefore would be something of a figurehead. Bush, of course, didn’t understand “Manque”, and went for something that sounded similar…
Abb1,
You could justify debt funded tax cuts if the revenue from growth was greater than the interest on the debt. The same is true of a debt funded infastructure program.
However your point seems to be that the economic growth was caused by deficit spending and that the US would be better off without the corresponding economic growth and without the interest liability on the debt.
The reason it is so difficult to argue convincingly to all people that most nations are over taxed and that tax rate cuts would be good for both the public and the private sector is precisely because there are so many variables in the mix. Any data set that proves the case can always be deconstructed by pointing to other factors.
Even so it will be interesting to watch public sector tax revenue in Australia as the Howard/Costello tax rate cuts are delivered.
It is quite important to make clear that the Keynesians and the Supply-Siders have a very different basis for analysing the effects of tax cuts.
For Keynesians a tax cut is a stimulous to demand. It puts money in peoples pockets.
For the Supply-Siders taxes are a tariff on inter-household trade. By cutting taxes you increase trade, specialisation and the division of labour. Hence productivity rises.
There is a distinct difference of paradigm. Trying to analyse a Supply-Side economic argument whilst retaining a Keynesian mindset is I imagine quite painful.
Before his death I conversed with Jude Wanniski online for half a decade. He was always at pains to make clear that Supply-Side economics was neither right wing nor left wing. He claimed with much logic that both Karl Marx and Adam Smith viewed economics prosperity as a supply issue rather than a demand issue. Keynes abandoned the classical deference to Says law and created quite a skewed (others would say inspired) model for economic analysis.
In Australia we had “Economics Rationalism” which is mostly about micro-economics and privatisation. Supply-Side economics is predominantly a study of macro-economics. You can have a Supply-Side revolution without privatisation.
In Russia following the end of the Soviet Union they had widespread privatisation that delivered minimal benefits, although it did work better in other ex-Soviet nations. Latter Russia had Supply-Side tax reforms that basically fixed their revenue problems.
What gets missed so much in discussions of Supply-Side economics is the whole monetary dimension of the theory that has never really been applied. Reagan considered it in 1987 but got distracted by other events.
This is not a trivial topic. Supply-Side economics is a comprehensive economic model. And in my view it is superior to the mainstream economic models used most widely today (even in tax cutting nations).
Regards,
Terje.
One of the overarching problems associated with discussion about the relative virtues of different models of economic growth and revenue maximisation is that awareness of the existence of the debate and adherence by important economic and political actors to one model over another must be built into the system.
Ants who live in an ant farm don’t know they live in an ant farm because they have no model for “ant” and no model for “farm”. Owners of ant farms can therefore monkey around with many different models of stimulation of ant egg production without needing to be concerned at all about what the ants might think about their role in the experiment.
Human beings are a bit smarter and a lot more aware of their cultural and political surroundings than ants. Entrepreneurs who barrack for supply side economics might have their animal spirits raised by the bracing existence of tax arrangements that may be interpreted (or misinterpreted!: the placebo effect) as “supply-side economics”.
From my admittedly casual reading on this topic, my impression is that “supply-side” economists tend to bring an a priori model of human economic behaviour as rational maximisers to the debate. Keynes, on the other hand, left himself an escape hatch. He tended to be more sceptical about what drives economic man. Sometimes “animal spirits” are up. Sometimes “animal spirits” are down. The animals spirits can be encouraged but they can never be driven into energetic action.
Given all of the qualifications and caveats that Terje injected into his very interesting discussion of the issue above, we are far from a clear answer to the question of the relative efficiency of the various models.
Now I propose another problem: culturally conditioned attitudes and mentalities that Keynes called “animal spirits” may inject so much noise into any economic system that it is nigh impossible to distinguish noise from efficient response to economic stimuli.
What gets missed so much in discussions of Supply-Side economics is the whole monetary dimension of the theory that has never really been applied.
Ah, the old “socialism (or christianity, or sacrifices to the gods, or whatever) works, it just has never been properly tried” move. Always the last resort of ideologues confronted by reality.
Look, lets stay on track here. You can argue that government should be smaller or larger, you can argue that funding it by debt is a good or bad idea, but the topic of this and the Bunyip’s post is a narrow and testable one: the effects on revenue of the 1981 Reagan tax cuts. And there, despite Cato’s contortions, the record is clear and accepted even by ‘respectable’ supply siders such as Feldstein – revenue fell well below what it would otherwise have been, and stayed down until the the cuts were reversed.
Further, when Bush 1 and Clinton raised taxes Cato and Feldstein, confidently predicted revenue would fall – and were dead wrong. To his credit this changed Feldstein’s views on the topic (while still leaving him a rabid small government person). You and Cato should do likewise.
If JQ has inhabitants in his beard, itchy or not, I suggest getting a bottle of brandy, thoroughly soaking the beard and then lighting.
Otherwise – shave it.
Onthe tax cuts debate – i know as a small business operator with a good sized mortgage that a tax cut would allow me to spend more employing staff, pay-off my debt quicker allowing more money for consumption and investment. All these things lead to economic growth and increased tax take in the long run.
Nabakov, 1:21am:
“Besides how can you take seriously someone who operates under a net de plume?”
Professor Bunyip’s real name is on his site if you bothered to look at the top of his blog.
“Professor Bunyip’s real name is on his site if you bothered to look at the top of his blog.”
The name on the top of he blog is Stanley Gudgeon.
Stanley Gudgeon was a character in Lennie Lower’s book, “Here’s Luck”.
Leigh, it looks like your education has a long way to go not just in economics, but English literature as well. Back to school for you.
Admit it, Dave. You ‘Googled’ the name Stanley Gudgeon, didn’t you?
No, I didn’t.
I read the book a long time ago. (And so I know it’s Australian literature – but something one might read in an English class.)
Anyway, Bunyip’s other pseudonym was the subject of a blog discussion some time ago.
Look on the bright side Leigh — you probably know more about economics than Donald Luskin.
Lenny Lower is one of Australia’s greatest ever humourists and Stanley one of his most loved creations. I’d have thought the folks always ready to defend our way of life against creeping commie PC multiculturalism would be aware of that.
And Leigh also seems to have missed the little dash of irony inherent in someone with a psuedonym criticising someone for using a psuedonym.
Not yer finest moment leigh-leigh.
‘Mankiw refers to Ronald Reagan’s supply-side advisers as “charlatans and cranks.â€?, specifically because of the claim that tax cuts increase revenue.’
At page 29 and 30 of the first edition of his famous textbook, Mankiw writes,
“Some fads come from charlatans who use crazy theories to gain the limelight and promote their own interests. Others come from cranks who believe that their theories are really true.
An example of fad economics occurred in 1980, when a small group of economists advised presidential candidate Ronald Reagan that an across-the-board cut in income tax would raise tax revenue. … It may be that some snake-oil salesman is trying to sell a miracle cure for what ails the economy.”
Few textbook writers have gone so far as to refer to Laffer et al. as ‘cranks’, charlatans’ and also a ‘snake-oil salesman’. What is particularly remarkable about this story is the sudden change that overcame Mankiw. Subsequent editions of his text do not contain these charges. Perhaps one of those ‘cranks’ (Robert Mundell) winning the 1999 Nobel Prize changed his views. In fact, in a 2000 Fortune article Mankiw praises then candidate Bush’s tax plan, and condemns candidate Gore’s plan. Mankiw was appointed chairman of the Council of Economic Advisors in 2003 (facing unsurprising hostility from many US Republicans – at the senate confirmation hearing, Senator Paul Sarbanes (D) said ‘I hate to see a highly competent professional turn himself inside out, twisting like a pretzel’) and resigned in February 2006. In his resignation letter, to president Bush, he wrote, ‘You understand that the free enterprise system works best under a policy of low taxes, fiscal discipline, and open markets.’ Yet, while chairman of the Council of Economic Advisors told a National Bureau of Economic Research Tax Policy and Economy conference ‘Let me be perfectly clear here. Tax reductions are generally not self-financing. In the vast majority of cases, the behavioral responses to changes in tax rates just are not high enough to yield that result’. Fundamentally, it is not clear what Mankiw’s views are. He refers to Laffer et al. as cranks, but latter removes that section from his book. He praises George Bush for cutting taxes, and the importance of cutting taxes, but does not believe lower taxes increase revenue.
The overall peformance of the US economy under Reagan was nothing special. Overall. US growth and productivity rates were lower than achieved under all previous post-war Presidents.
Allowance should be made for the fact that RR was handling the transition from an Old Economy characterised by cartelised goods production to a New Economy characterised by competitive service provision. The transition costs from these reforms would have made most economic administrations look a little shabby – fans of Paul Keating’s “recession we had to have” would know what I am talking about.
The Reagan’s economic growth record, such as it was, was more due to demand side stimulus than supply side growth. Tax cuts and Arms spending certainly pushed the US economy towards its production frontier, but did not expecially enlarge that frontier.
RR’s greatest success flowed from his determination to force US goods sellers and factor owners to face more national competitition, through tightening institutional constraints on the supply of money and loosening institutional constraints on the supply of goods and services. He backed up Volcker’s tight money policy, which constrained capitalists pricing power and he took on PATCO, which constrained trade unions labour supply power.
This short circuited the inflationary cost-price cycle and broke the barriers to reducing unemployment. It also paved the way for later increases in the quantity, and improvements in the quality, of productive factors.
It is also likely that Reagan’s reduction in the top marginal rates of taxation had alot to do with the encouraging the increase in hours worked amongst the owners, managers and professional users of the US’s capital stock. Thus the elite section of the US economy is characterised by a 24/7 working week. This has gone a long way in empowering US firms, which dominate other nations sales markets, and enriching US stocks which dwarf other nation’s stock markets.
Terje Petersen mentions the death this week of Jude Wanniski. This also got the following mention elsewhere:
“Jude Wanniski died last week, at 69, of a heart attack. He was best known to the public for his 1978 book, The Way the World Works, which helped build support for the election of Ronald Reagan in 1980. Among economic policy veterans, he was better remembered for his “Two Santa Claus” theory. So it is more than a little ironic that the Two Santa Theory should have been demolished by a storm called Katrina the same week that its creator died….” http://www.economicprincipals.com/issues/05.09.04.html
I’m obviously not an economist though: http://guambatstew.blogspot.com/2005/09/doodoo-economics.html
NET DE PLUMES: PROS and CONS
At the risk of getting slightly off the topic of the scratchworthiness of the infestants of Q’s facial hair, the issue about the credibility of net de plumes raised by Nabakov in this comments thread is worthy, I suggest, of a fuller debate.
I have some personal experience at this as I spend a fair bit of time creating havoc on the Libertarian forum under my CleverDick moniker. The benefits of anonymity and pseudonyms – names you use when you’re going to get sued – are fairly obvious. At the same time, a consistently used net de plume allows other forum dwellers to quickly identify the angle from which you are likely to come to an issue, and to build up a portfolio of evidence, over time, as to your character’s knowledge, rigour and readability.
For instance, the CleverDick brand seems to have built up a begrudging “can’t be ignored” respect from several Libertarians, including this forum’s own Terje Petersen and John Humphreys – although, perhaps partly as a result of the Dick’s jottings, some other “celebrity psuedonyms” on the Libertarian site – such as Strawman, 90210 and Another Bloody Libertarian – have seen their credibility diminish somewhat, although no doubt like The Black Knight, they would deny this.
Similarly, when one sees Dave Ricardo, derrida derider and the commentator formerly known as anon on this site, one knows immediately whether to get comfortable, to hit delete, or to reach for the dictionary.
Richard
Maybe an across-the-beard cut in tax? Peter the Great imposed a tax on beards, as part of his scheme to modernise Russia. How did that turn out?
Um Richard, I was just making a joke.
P.M. Lawrence’s one above is funnier though.
Glad you realised what you were doing too, Nab.
Rich
PS: Clarification for Nabakov – the above should not necessarily be interpreted literally.
Sinclair Davidson,
I have not read much of Mankiw, but perhaps the point he was making in his support for lower taxes generally, without the expectation that government revenue would increase in the long run as a result, was that the overall government tax take is too high.
The deficit can be reduced and tax take drop similtaneously if the overall expenditure reduces by more than the tax take drops. An obvious point, but one that seems to have been missed.
.
Ideally (IMHO), the government should work out what it needs to do in any given period and then work out the most efficient way to get it. Unfortunately, the budgetary process tends to work from the revenue side first – they work out how much they can get and then work out how to spend it.
Andrew, I agree with your points. I’m pointing out Mankiw is a low tax man. I’m not convinced his reference to Laffer being a “crank” etc. supports the argument people usually make when quoting him – that’s all.
I thought lighting up his beard was bloody funny! Shouldn’t laugh at your own jokes though.
Probably 99% of economists are “lower tax people” -some of us just think uncontrolled government spending is even worse than high taxes.
I hve no quarrle with the idea that in most western countries taxes could be lower – I have a quarrel with the free lunch perpetual-motion-machine snake oil pedalled by Bush et al.
However your point seems to be that the economic growth was caused by deficit spending and that the US would be better off without the corresponding economic growth and without the interest liability on the debt.
No, Terje, my point is that it seems disingenuous to do both tax cut and massive Keynesian intervention and then attribute whatever positive results there are to the tax cut alone.
Suppose I started eating more chocolate and running on a treadmill 16 hours a day. Now, suppose after a week of doing it I now feel much healthier and I lost 5 kilos. Is it fair to say that this is the result of my eating all that chocolate?
Terje Said: What gets missed so much in discussions of Supply-Side economics is the whole monetary dimension of the theory that has never really been applied.
derrida derider: Ah, the old “socialism (or christianity, or sacrifices to the gods, or whatever) works, it just has never been properly tried� move. Always the last resort of ideologues confronted by reality.
Terje responds: A fair point to make. So let me correct my original statement. The monetary component of supply-side economics has not been tested anywhere in the world during the last 30 years. However as far as monetary systems go it is the most tested in all of history. Its just that we need to go back more than 30 years. And when it was in use it was a resounding success.
sorry JQ but I just heard Ruddock say that beards are to be outlawed under the new terrorism laws.
good thing too!
… when one sees Dave Ricardo, derrida derider and the commentator formerly known as anon on this site, one knows immediately whether to get comfortable, to hit delete, or to reach for the dictionary.
I hope your list of responses in the last part of that sentence doesn’t correspond to the order of listing in the first!
Homer, its actually just the wearing of beards in publicly funded places of education that’s to be banned – as Dame Bronwyn says, such things are symbols of rebellion and seperatism rather than a part of true religion and so have no claim on taxpayers’ tolerance.
I’m sure the ASIO people will explain this point with adequate force to JQ during his first two week spell of incommunicado detention.
I hope your list of responses in the last part of that sentence doesn’t correspond to the order of listing in the first!
Don’t fret derrida, the list was in reverse order! 🙂
My Jewish friends alternate between saying that my own beard makes me look like a terrorist and that it makes me look like a rabbi. Of course, it is really an ancestral Scottish and Irish thing.
Well I’m Scots/Jewish so my facial growth was doubly inevitable.
DD, wearing a beard?
JQ is wearring a clip-on?
He must be a terrorist.
I am sending in the clipper police.
Mick Keely where are you?
Last budget the federal government introduced income tax rate cuts. Does anybody want to go on record here and say that it will cause lower tax revenues?
Terje, are they going to implement corresponding spending cuts, or will the government simply be borrowing the amount they would’ve been collecting as taxes otherwise? If it’s the later, why do you expect the tax revenues to grow? Seriously, why?
Thanks.
TJ,
I hope they will. Government at all levels in Oz is already pulling in too much revenue. The less the better.
Given the strength of the overall economy – which has much more to do with Chinese commodity demand than anything the Australian government does – the continuing growth in GST revenue and the fact they were primarily handing back part of the bracket creep of the last few years, I’d say its unlikely.
If they imitated Reagan and cut the top margin rate to 28% I’d say it probably would.
I’ll add that the Howard Government has, broadly speaking, cut taxes in what I’ve described elsewhere as a responsible way – they achieved a surplus first and then gave back part of the surplus while maintaining a significant surplus.
If they’d increased spending and borrowed heavily at the same time as they were cuttign taxes, the Australian dollar would have fallen significantly and interest rates would probably have risen significantly. The US has managed ot avoid this outcome (so far, this time around) but there’d no such thing as a free lunch. Government can’t continue indefinitely to fund ever increasing spending levels by additional borrowing.
If nothing else, you reach a point were you’re borrowing to pay the interest on the money you borrowed to the interest on the money you borrowed…
Surely the Scots/Jewish thing predestines you to an interest in economics? It’s noteworthy that the early economists were predominantly Scottish or Jewish, possibly from having the issues thrust upon them in their times and places.
Yeah I’m a bearded economist – and since my Jewish ancestors ended up in Scotland when the British kicked all the jews out of England ca. 1600 i’m also predisposed to hate the english.
You have indulged in the hateful conflation of the English with the British.
Furthermore, the Jews were kicked out in the Middle Ages (apart from some special exemptions), being allowed back in by Cromwell (for commercial reasons) in the very century you thought they were ejected.
It has been thought by some that this comparatively early ejection and non-establishment sponsored re-entry prevented the rise of anti-semitism in the UK later. Many countries with an anti-semitic history experienced a history of the Jews getting on side with oppressors; by seeking to avoid oppression themselves, they were associated with oppression by the other oppressees. This happened most recently in Algeria.
ABB1: If it’s the later, why do you expect the tax revenues to grow?
TERJE: I expect pretty much all tax cuts to deliver a growth dividen. In revenue terms the question as to whether that growth dividen is big enough to compensate for the arithmetic effect of a tax rate cut is a speculaitive one. The reason why I expect all tax cuts to deliver growth is because all tariffs lower productivity. They give us an insentives to choose less productive ways of satisfying our needs and wants.
IG: I’d say its unlikely.
TERJE: So no complaint about tax cuts from you then.
AR: I hope they will.
TERJE: Thats a bit like some anti-war people who long for a full blown civil war in Iraq. Although I understand your sentiment.
What’s the mechanism of tax cuts delivering growth, could you be more specific? I’m particularly interested in an example of a high-income person (such as a high-level manager or rich investor) becoming more productive due to a tax cut.
Thanks.
In early agrarian societies every household lived largely by subsistence. Each household produce its own clothes, its own food, its own entertainment. When the option arose people would naturally find ways to trade with their neighbours because it allowed for an increased level of specialisation. The key to modern efficiency is specialisation, trade, the division of labour and the application of capital.
At the moment my household needs some new fencing built. This activities include a materials component and labour component. Lets use this as an example.
Lets say that the labour rate for a carpenter is $50 per hour. Now lets assume that my professional charge out rate is also $50. Lets say that the carpenter is 1.5 times faster at fence building than me.
a) Carpenter takes 5 hours to build fence. Cost is $250.
b) Terje takes 7.5 hours to build fence. Opportunity cost is $375.
So it looks like it is much more efficient for me to work an extra 5 hours at my specialty and to get a carpenter to build the fence rather than work 7.5 hours building a fence.
Now with a marginal tax rate of 50% we can do the maths again:-
a) Carpenter costs is still $250. But with a 50% tax it will take me 10 hours to earn this much cash.
b) Terje still takes 7.5 hours to build his own fence.
So now it makes more sence for me to build my own fence, the carpenter can spend his day looking for work.
In practice few people do the maths like this. Most people gain a feel for money and good value following a few iteration attempts. They know how hard (or easy) it is to earn money and they spend accordingly.
Taxes are a tariff on inter-household trade. They lower productivity in exactly the same was as tariffs on international trade.
It is true that an increase in productivity may not deliver growth. We may instead choose to spend the time saved by sleeping in more often. However human ambition being what it is most people extend themselves when opportunity permits.
Fair enough. But what about the guy who makes $5,000/hour – is he going to start building his yachts and golf clubs himself? And what’s the difference for the economy if instead of paying $2 mil/year in taxes he is now buying $2 mil/year worth treasury notes?