Center for Business and Economic Research - Ball State University


CBER Data Center
Projects and PublicationsEconomic IndicatorsWeekly CommentaryCommunity Asset InventoryManufacturing Scorecard

About

Commentaries are published weekly and distributed through the Indianapolis Business Journal and many other print and online publications. Disclaimer

RSS Feed

Disclaimer

The views expressed in these commentaries do not reflect those of Ball State University or the Center for Business and Economic Research.

Recent

The 246th Anniversary of ‘The Great Experiment’Our nation may be at its most divided, but I have great hope.

Inflation Affects Each Family DifferentlyWe understand earthquakes and hurricanes better than we do inflation.

Yes, State Stimulus Checks Boost InflationTax reductions and rebates can only increase inflation.

Time to Dump the Rich States, Poor States RankingsTax policy is the wrong incentive to spur economic growth.

View archives

Top Tags

jobs and employment 217
economics 169
education 134
economic development 133
taxes 121
finance 105
state and local government 99
recession 96
budget and spending 88
unemployment and the labor market 84
Browse all tags
Reporter / Admin Login

December 2, 2012

Demagoguery and Truth About Taxes

The popular media has lately been full of astonishing piffle with regards to taxation—so much so that a reasonably smart listener might suppose that there was some magnificent disagreement among economists, like there is among lawyers in a court case. Of course, there is not; we economists are in broad agreement about the facts of taxation. This does not mean we agree about policy, for there is more to any policy decision than the truths of taxation. Still, we should be a bit mindful of demagoguery about taxes. This column will focus on known truths of taxation.

First, higher taxes on a good or service will lead to less of it being consumed and produced than would otherwise have been the case. So, a higher tax rate must lead to less economic activity, all things being equal. Of course, all things are never equal. Oftentimes taxes are cut at a time the economy is stalling or increased as it rebounds. Unsurprisingly it is common to have coincident periods of increased tax rates alongside a booming economy. It actually requires statistical modeling to tease out the effect, so when you hear someone comparing tax rates and growth using one historical example you may be certain they are either lying or have no idea what they are talking about (or both).

Second, the effects of tax rate changes are nonlinear in the sense that a small tax increase causes less of a decline in economic activity than a big tax increase. Moreover, the rate of tax that matters most in dampening economic activity is that levied in the last dollar, not the first dollar earned. This is the higher marginal tax rate economists warn about.

These truths combine to explain many things including the Laffer Curve, a hypothesized relationship between marginal tax rates and tax revenues. A staple of supply-side economics this theory roughly suggests that too high a tax rate will dampen economic growth so much that overall tax revenues will decline. The converse is also true that at some point lowering tax rates will boost the economy so much that tax revenues will actually increase. This is because there is both a mathematical relationship (higher rates lead to more revenue) and an economic relationship (higher tax rates leads to less economic activity). While the existence of a Laffer Curve is largely accepted, the best evidence suggests that we are a long, long way from having tax rates that are high enough to feel the effect of the Laffer Curve. So, a tax cut will almost certainly not increase tax revenues, while a tax rate increase will not grow revenues proportionately.

Debates about tax rates are appropriately political. Taxes influence decisions about how much we save, where we live, how many children to have, and how big a home to buy and what type of government we have. We should all understand though, what is true and not true in the debate over the appropriate level of taxes.

Link to this commentary: https://commentaries.cberdata.org/652/demagoguery-and-truth-about-taxes

Tags: economy, taxes, economics, politics


About the Author

Michael Hicks cberdirector@bsu.edu

Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University. Hicks earned doctoral and master’s degrees in economics from the University of Tennessee and a bachelor’s degree in economics from Virginia Military Institute. He has authored two books and more than 60 scholarly works focusing on state and local public policy, including tax and expenditure policy and the impact of Wal-Mart on local economies.

© Center for Business and Economic Research, Ball State University

About Ball State CBER Data Center

Ball State CBER Data Center is one-stop shop for economic data including demographics, education, health, and social capital. Our easy-to-use, visual web tools offer data collection and analysis for grant writers, economic developers, policy makers, and the general public.

Ball State CBER Data Center (cberdata.org) is a product of the Center for Business and Economic Research at Ball State University. CBER's mission is to conduct relevant and timely public policy research on a wide range of economic issues affecting the state and nation. Learn more.

Terms of Service

Center for Business and Economic Research

Ball State University • Whitinger Business Building, room 149
2000 W. University Ave.
Muncie, IN 47306-0360
Phone:
765-285-5926
Email:
cber@bsu.edu
Website:
www.bsu.edu/cber
Facebook:
www.facebook.com/BallStateCBER
Twitter:
www.twitter.com/BallStateCBER
Close