15 July 2007

Let's Talk about Taxes

President Bush's former Chief Economic Adviser, Mitt Romney's current Campaign Adviser, and - most importantly - my Economics Professor N. Gregory Mankiw has a great piece on taxes in today's New York Times.

(Note: Party Faithful, the Times is okay to read - this time at least!)

I need some rejuvenation after liberal bloggers attacked my favorite newspaper, The Wall Street Journal, for its editorial declaring the U.S. on the wrong side of the Laffer Curve.

Liberal bloggers slammed the editorial for supposedly drawing a line through an outlier instead of finding the "best fit line" which, according to them, would show that tax revenue increases with higher corporate tax rates. In their rage, liberals demanded that the editorial board dust off the high school math books...

But it's our liberal friends who need some reeducation. You find the best fit line only when you think the data suggest a linear relationship. The Laffer curve suggests a parabolic relationship: when tax rates are low, raising them slightly does indeed raise tax revenue. The government gets a larger slice of the economic pie, but not large enough to discourage people from working. If Uncle Sam continues raising tax rates, however, the incentive to expand a business decreases since people keep less of each additional dollar they make. Eventually, tax rates are so high that people lose their incentive to work longer and harder than they already are: why work more to keep only a few cents of every additional dollar you make?

So the Laffer Curve rises, flattens out, and declines. No "best fit line" does that.

Professor Mankiw, who leans right, thinks we're not on the wrong side of the Laffer Curve; but at least he does not lecture his colleagues on geometry.