From the NYTimes Economic Scene column (A bit of doodling ...):
One motivation for Mr. Reagan's tax cuts was a guess that the United States was on the right side of the curve - that is, that lowering rates would actually yield more tax revenue over all. Some recent statements by Joshua B. Bolten, President Bush's current budget director, seem to indicate that he still believes this to be true, though rates are much lower now than when Mr. Reagan took office in 1981.
The highest marginal tax rate in 1980 as 70+ percent. Mr. Reagan probably made a good guess. The highest rate in 2000 was about 40%. Maybe not so good a guess?
In July 2003, Mr. Bolten said this at a press conference: "All economists, I think, will agree very strongly that when you reduce taxes, put more money back into the economy, that has a feedback effect in the economy that causes growth" and in turn "increases receipts." He added that he wanted "to see how much better the government's fiscal situation is as a result of the tax cuts."
The problem with this statement is that it depends on the current rate of taxation. Consider the extremes. If the tax rate is 100%, no one will work and revenue will be zero. Reducing the tax rate will encourage some people to work and increase revenue. This is the impact that Mr. Bolten expects from tax cuts. At the other extreme, a 0% tax rate, no revenue is earned. Raising the tax rate will increase revenue. Both of these effects work themselves to the point where there is a tax rate that maximizes revenue. Increasing or decreasing the tax rate from this level will reduce tax revenue.
I think that only when the tax rate is 100% will ALL economists very strongly agree with Mr. Bolten. But, then, who am I to say what ALL economists think? In a paper published in the Journal of Economic Education in Fall 2003, 31% of surveyed AEA members disagreed with the following statement:
Lower marginal income tax rates reduce leisure and increase work effort.
In other words, tax cuts won't increase labor hours and won't increase revenue. Again, not ALL economists agree with Mr. Bolten.
Back to the NYT article:
The recent analysis by Mr. Page at the Congressional Budget Office dismisses the idea that tax cuts may actually improve the government's fiscal situation. Even in his most generous scenario, only 28 percent of lost tax revenue is recouped over a 10-year period. The United States, it seems, is firmly planted on the left side of the Laffer Curve.
Ooops!
The article goes on to describe the benefits and costs of reductions in government revenues. The benefits are the increased disposable household income and the inevitable shrinking government. The costs are the reductions in government services if government reduces spending and, if the government does not reduce spending, budget deficits. Budget deficits require borrowing and governments that increasingly borrow increasing amounts forever ultimately face some sort of crisis (higher interest rates and/or higher inflation and maybe some gremlins and goblins). These costs are nice because we don't suffer them until a long time from now. We can discount the future pain away.
Nice article, and I need to read the CBO paper.
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