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April 29, 2003

Tax and Taxability

Ever get tired of listening to lovable but misguided friends as they ramble on about how the Evil Republicans are going to drive up deficits by lowering tax rates? Yeah, me too. My advice is, just ask them this simple question: why not increase the income tax rate to one-hundred percent? With all of that tax revenue, we should be able to pay off the National Debt in a single year, right?

Heh.

Enter the famous Laffer Curve, named after Arthur Laffer, which demonstrates that government revenue becomes vanishingly small as tax rates near 0% and 100%. Conclusion: somewhere in between these two extremes is a tax rate which will maximize government revenue.

Of course, the Laffer Curve is more of a mental exercise than a definitive model for developing tax policy. Fortunately, Arthur has also contributed the following common sense questions, which we should all ask ourselves when we think about raising or lowering tax rates.

  • Is the existing rate very high? Can it be assumed that it has been holding back economic activity?

  • Are you are willing to wait for the incentive effects of lower rates to take effect?

  • Is there a way that people can actually change their behavior to take advantage of the tax-cut? Can they work harder, invest more, and so on?

  • Is there presently a lot of tax-evasion activity? Is the cost of that evasion high enough so that people will stop evading when the tax is cut?

  • Is there some other tax mechanism that could receive the additional revenues? For instance, if capital-gains taxes were cut would higher workers' wages cause income-tax revenues to go up?

    And finally, a thought of my own:

  • Is the current economy strong enough to withstand a raise in tax rates?

    Posted by crandal at April 29, 2003 10:52 PM