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I have never understood why the basic notion of the Laffer Curve is so controversial. Every day, businesses everywhere mark down prices in hopes that higher sales will yield a greater total profit. Obviously, it works or they wouldn't continue doing it year after year. The same principle applies to tax rates, which alter important relative prices. Among these are the decision to work overtime or not, invest one's earnings or consume them, buy tax-free municipal bonds or taxable corporate securities, start a business or continue working for someone else, and pay all the taxes one owes or take the risk of evasion. When tax rates rise, people shift their work, saving, and investment choices in ways that lower the government's revenue. Hence, lower tax rates can cause people to shift back, thereby raising revenue. For these reasons, economists have long recognized that at some point high tax rates become counterproductive in terms of raising revenue. More than 200 years ago, Adam Smith had this to say: "High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes." In recent years,
Russia, of all places, has been a virtual laboratory for the Laffer Curve.
When Communism collapsed there a decade ago, the country really had only
a rudimentary tax system. Although the old Soviet Union had taxes, they
didn't serve the same purpose that taxes do in market economies. Since
the government owned everything, it could get all the revenue it The tax system Russia
adopted after the fall of Communism was very inappropriate for its stage
of economic development. It thought it was more developed than it really
was. Consequently, The International Monetary Fund correctly recognized that tax revenue needed to rise in Russia to control inflation. But it erred in encouraging it to enact new taxes and crack down on evaders, which only exacerbated the flaws of the existing tax system. The result was that Russian tax revenue fell from 11.1% of GDP in 1995 to 8.6% in 1998. Finally, the Russians
figured out for themselves that their tax system needed to be overhauled.
Against the IMF's advice, taxes were cut, leading to increased revenue
as evasion became In recent days, Russian President Vladimir Putin has announced further plans to cut tax rates on small businesses precisely in order to reduce evasion and raise revenue. As the Wall Street Journal reported on April 4, "Russia's small business community could finally come out of hiding if sweeping reforms to the corporate tax system make it onto the statute book." Even the New York Times, normally hostile to anything that smacks of supply-side economics, has noticed. A March 23 news story said that Russia has had "stellar first results from a bold experiment, a 13% flat-rate income tax." And two years ago, the Times even editorialized in favor of Russia's flat tax, noting that the previous system was "the worst of all tax worlds: high rates and little revenue." George W. Bush has
also taken note of Russia's flat tax. In a meeting at his Texas ranch
with President Putin last November, he specifically praised Russia's flat
tax. All he needs to do
— Mr.
Bartlett is senior fellow at the National Center for Policy Analysis |
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or years, supply-side
economists have been arguing that lower tax rates often bring in more
revenue than higher rates. Immortalized in the Laffer Curve, the idea
is that tax rate reductions can sometimes expand the tax base by more
than rates are cut, causing net revenue to rise.
