Voodoo Economics = Liberal Fantasies (or What Supply-Side Economists Really Said)

McArdle, as she recounts things, leaves herself open to little sympathy because either the Laffer curve is a useful model or it isn't. American levels of taxation may be on the short side or the long side of the hump, but to say "it doesn't apply" is to say "it is not a valid model" -- ostensibly at ANY level of taxation.

Perhaps McArdle meant to say that American levels of taxation are currently at a level of taxation lower than the [short-term] revenue-maximizing rate. But she didn't say that -- she said, astonishingly, it didn't apply, and before anyone could say ah . . . wait a sec., Liberal Values ran all over the field dismissing the modern conservative movement as ideologically driven (maybe they are -- but this hardly supports the claim).

Because over-generalization are like fragile over-inflated balloons, I thought it would be easy to deflate this Laffer Curve doesn't apply claim with some obvious real-world examples. Wrong! (however, it was a great writing exercise, which is really why I did it).

Well, actually, that's not quite right -- it did have some effect because pro-tax Liberal Values followed up with an accurate qualification of the Laffer Curve by factcheck.org,

The supply-side theory that tax-cut proponents often espouse was demonstrated by the Laffer curve, named for economist Arthur B. Laffer. The curve suggests that a higher tax rate can generate just as much revenue as a lower rate. But most economists are not Laffer-curve purists. Instead, while they may believe in the power of tax cuts to create an economic boost, they don’t say that growth is enough to completely make up for lost revenue. For example, N. Gregory Mankiw, former chair of the current President Bush’s Council of Economic Advisers, calculated that the growth spurred by capital gains tax cuts pays for about half of lost revenue over a number of years and that payroll tax cuts generate enough growth to pay for about 17 percent of what is lost.

Corporate income taxes, however, may be an exception. There is some evidence that cutting the corporate tax rate can produce more revenue than was projected under the higher rate in the special case of multinational corporations, which can move their money and operations around to take advantage of lower taxes in certain countries. Economists with the pro-business American Enterprise Institute came to that conclusion in a study released in July 2007. They found that lower corporate rates attract enough growth in corporate income to produce higher government revenues. However, one of the authors, Kevin A. Hassett, told FactCheck.org that small countries, such as Ireland, had the most success and that “it may or may not be correct” to apply the study’s results to the United States.

So, pro-tax Liberal Values, thank you -- this is an important qualification, but it misses the main point of the debate.

Alan Reynolds penned a clear reasoned explanation of the state of thinking about the Laffer Curve and Supply-Side economics in Humaneventsonline.com, and he convincingly argues they are far, far, from the state of "Voodoo:"

I grow weary of people telling me what supply-siders supposedly said, thought or wrote without bothering to actually quote anyone. No economist ever claimed that all taxes are so distortionary that increasing any tax rate would reduce revenue. Art Laffer never said that. Bob Mundell never said that. Larry Lindsey, Larry Kudlow, Craig Roberts, Steve Entin and Bruce Bartlett never said that. I never said that.

[However] supply-siders are right about one thing: Because higher tax rates reduce the size of the tax base, raising taxes generates less revenue that the 'static' revenue estimates assumed in Washington would suggest."

[Greg Mankiw, the distinguished former head of the President's Council of Economic Advisers on the occasion of Hank Paulson's appointment as treasury secretary had this to say to The Wall Street Journal]: "One of Mr. Paulson's first briefings from the Treasury staff should be about what high taxes have done to the economies of Europe. According to research by Nobel laureate Edward Prescott and by economists Steven Davis and Magnus Henrekson, the high tax rates in Europe have reduced work effort and distorted the industrial mix."

Mankiw simply restated what real supply-siders really did claim. He emphasized that higher (marginal) tax rates reduce work effort and cause other inefficient distortions. He added that higher tax rates also reduce the size of the tax base -- people respond to higher tax rates by taking it easy or figuring out ways to report less taxable income. This used to be called "the Laffer Curve," but it now goes by the more respectable name of "taxable income elasticity."

Reynolds continues by re-stating what supply-siders have been saying for 30 years, which anyone on the left would know -- if they cared enough to pay attention:

. . . .reductions in marginal tax rates may induce people to alter their taxable income in many ways: Entrepreneurs may start more businesses, spouses of high-bracket taxpayers may rejoin the labor force, those previously working in the underground cash economy may take jobs that require taxes to be paid, skilled professionals and managers may work harder and retire later, executives may negotiate for cash rather than perks, high-income investors may hold fewer tax-exempt bonds and trade stocks more frequently, taxpayers may not try so hard to maximize tax deductions and adjustments.

[This] is not significantly different from what supply-siders were saying 30 years ago. It is also what Mankiw and other mainstreamers are saying today.

Reynolds goes to cite several papers by Harvard's Martin Feldstein, head of National Bureau of Economic Research, and two Treasury Department economists, Robert Carroll and Warren Hrung, all of which comes down to this:

What all this means is that cutting the top tax rate in half has resulted in much more income being reported and taxed in every country that tried it -- the United States, United Kingdom, New Zealand and India, for example. Some mistakenly imagined that proved the rich suddenly became richer when U.S. tax rates fell from 1986 to 1988. What it actually proved was that the rich reported more taxable income when tax rates on an extra dollar became more reasonable. These facts are not seriously in dispute regardless what portion of this widely observed "Laffer Curve" phenomenon was due to a change in actual income (a supply-side effect) or to a change in the proportion reported to tax collectors.

Reynolds concludes:

In other words, supply-side economists were right all along. Their critics were wrong. Several Nobel Laureates in economics have now said as much. Get over it.

Postscript. Pro-tax Liberal Values states:

Some people who both want tax cuts and don’t want to make the hard decisions on spending cuts defend the Laffer curve despite all evidence to the contrary.

Liberal Values is exactly right on this point -- cutting taxes while raising spending (i.e., borrowing) is clearly insane, but this is a politician's dream, not any serious supply-sider's hypothesis or theory.