"There is always a philosophy for lack of courage."—Albert Camus

Wednesday, June 22, 2005

Laffer Curve and Seven Nobel Prizes

In his June 20 post on “The Laffer Curve” below, Hunter asks me to weigh in on Steve Moore’s piece noting that recent tax receipts have been much larger than expected, in the wake of substantial reductions in marginal tax rates in 2003.

No op-ed can do justice to the distinction between a cyclical revenue rebound and longer-term incentives. Budgeteers at the CBO and OMB always underestimate cyclical revenue rebound in the early years of recovery (1985, 1995 or 2005), just as they overestimate future revenues at cyclical peaks (2000). Unfortunately, it is not self-evident whether decent economic growth over the past two years was mostly the result of lower tax rates or lowering the fed funds rate from 6.5 percent to 1 percent.

On the other hand, some serious statistical estimates showing that sensible reductions in marginal (not average) tax rates typically lose little or no revenue over time come from Greg Mankiw, a self-described neo-Keynesian.

When I borrowed the phrase “supply side fiscalism” from Herb Stein in March 1976, and gave it to Jude Wanniski at The Wall Street Journal, we had in mind a number of incentives that have since become associated with several Nobel laureates in economics -- including the unique “policy mix” solution to stagflation from Jude’s mentor Bob Mundell (who won the 1999 Nobel).

Ed Prescott (2004)now emphasizes the impact of labor taxes on work incentives. Bob Lucas (1995) emphasizes tax incentives to invest in physical capital. James Heckman (2000) and Gary Becker (1992) emphasize the way progressive tax rates weaken incentives to invest in formal education and on-the-job training. James Mirrlees (1996) and Joe Stiglitz (2001) emphasize the welfare and tax-revenue (Laffer Curve) gains from low marginal tax rates on highly-skilled individuals ("optimal tax theory").

One who has not yet received a Nobel Prize, Glenn Hubbard, emphasizes the effect of marginal tax rates on entrepreneurship. Another possible Nobel Laureate, Marty Feldstein, proved that income reported to the IRS by high-income taxpayers is extremely sensitive to changes in marginal tax rates -- which was always a key part of the Laffer Curve argument.

The original supply-siders combined all those effects, not just one or two. Much of what the actual and potential Nobel Laureates later discovered can even be found in Jack Kemp’s popularized 1979 book An American Renaissance, which I helped write. What Mr. Kemp's book said about the Laffer Curve and marginal tax rates has stood the test of time so well that bits and pieces of that message can now result in Nobel prizes being won without anyone remembering who started it all.


Hunter Baker said...

Thanks for the erudite remarks, Alan. My sense is that the world of academic economics has moved significantly in the direction you've described. Is that the case or simply an illusion perceived by a spectator?

Hunter Baker said...

By the way, Alan, I think you can take the lack of commentary to indicate an inability to argue with an authoritative statement.

Anonymous said...

We've hashed through all this before.

Alan Reynolds said...

There are only two schools of economics -- the right wing and the wrong.

To win a Nobel Prize, an economist must get at least some of these incentive issues right.

Other economists take refuge in fading credentials and they take comfort from quaint theories. What they're lacking is facts.