Supply-Side Economics and Arthur Laffer

I always enjoy watch­ing news and com­men­tary from var­i­ous points along the polit­i­cal spec­trum — after all, no one is cor­rect one-hundred per­cent of the time. Every­one and nearly all the­o­ries are cor­rect at least part of the time, includ­ing those of supply-side eco­nom­ics and econ­o­mist Arthur Laf­fer.

So I find myself watch­ing Fox News once in a while to com­pli­ment CNN and the BBC. What I’ve noticed recently is that peo­ple on the right-wing wor­ship at the feet and take finan­cial help from from the Laf­fer Curve. Here is the the­ory in a nutshell:

Low­er­ing taxes on cor­po­ra­tions increases over­all tax rev­enue for the gov­ern­ment. Imag­ine that the cor­po­rate tax-rate is 33%. If a com­pany has $1 mil­lion in net profit, it will pay $330,000 in taxes. (Total profit after taxes: $670,000.)

Now, if the gov­ern­ment low­ers the tax, the cor­po­ra­tion will be able to invest more money in oper­a­tions and hir­ing employ­ees, allow­ing it to gen­er­ate more prof­its. If the tax is low­ered to 30% and the com­pany has $2 mil­lion in net profit, then it will pay $600,000 in taxes. (Total profit after taxes: $1.4 mil­lion.) In the sec­ond sce­nario, both the com­pany and the gov­ern­ment have larger profits.

Sounds good, right? After all, the right-wing’s solu­tion to the ongo­ing eco­nomic tur­moil is always to lower taxes. Well, just wait.

Look at the pic­tured graphic. There is an equilibrium-point that gen­er­ates max­i­mum profit for both the gov­ern­ment and cor­po­ra­tions. If taxes are too high or too low, both profit and taxes are less than opti­mal. But con­ser­v­a­tives always claim that the cur­rent tax-structure is always on the right-end of the curve — that it is always cor­rect to lower taxes. If you want to con­found a right-wing pun­dit on Fox News, ask him to define the opti­mal tax-rate that will gen­er­ate the great­est profit for busi­ness and taxes for the gov­ern­ment — they always assume that the cur­rent tax rate is some­where on the right-hand side of the curve.

But, no, you’ll never hear that.