Let’s give credit where it’s due, if it’s due.
If Barack Obama sends a $300 billion tax cut proposal to Congress as the meat of his stimulus package, he deserves high marks.
Tax Cuts Increase Tax Revenue
A large tax cut aimed at tax payers–individual and business alike–will not only stimulate the economy, it will increase federal revenue, defraying the irresponsible and dangerous spending of Paulson and Bernanke. As Kennedy, Reagan, and Bush 43 understood, tax cuts, to a point, increase federal revenue. Economist Arthur Laffer showed how in his famous, but seemingly forgotten, Laffer Curve:
- At 0 percent taxation and at 100 percent taxation, tax revenue is zero. The reason for no revenue at 0 percent is obvious. At 100 percent, people have no incentive to work–so they don’t.
- Somewhere between these poles lies maximum or optimal revenue.
- Laffer’s curve did not determine the exact location of this peak.
- There are actually two peaks: one for absolute tax levels, and one for marginal taxes.
The Curve Applies to Specific Activities
This curve applies both to aggregate taxes and specific economic activities. If we increase the tax on capital gains closer to 100 percent, then people will stop doing things that result in capital gains. If we tax dividends more heavily than capital gains, investors will favor growth stocks over steady stocks that pay dividends. It’s not very complicated.
Some economists have suggested eliminating business taxes altogether. These taxes are always passed through either in the form of prices to customers or salary cuts to employees. Either way, they reduce spending. And spending generates income.
Kudos to Obama
But enough economics. This story is really about Obama’s apparent willingness to step across the aisle into the Supply Side world. That would be a great thing for the economy and a liberating moment for Barack Obama. It’s so much easier to let the people decide how best to spend their own money.