A central tenet of U.S. “conservative” and Republican economic policy since at least the election of Reagan in 1980 is that tax cuts cause people to work more and longer hours. This is part of the so-called “supply side economics”. The implication is that the longer hours and more labor supply will then raise the dollars of taxes collected despite the rates being lower, the so-called Laffer Curve effect.
The argument is overly simplistic and fallacious on it’s face. The theoretical support is the one-liner theory idea that “people respond to incentives, take-home money is an incentive to work, and therefore increased take-home pay causes people to work more”. It’s just a version of the retailer’s “cut the price and make it up on volume” logic. And as such it is dependent on the elasticity of the responses – remember when the response is inelastic, as in “I have to work to live”, the volume won’t be made up. Despite their being no strong empirical evidence of tax cuts helping raise more tax dollars or motivate widespread increased labor supply at least in the range of real-world tax rates, the concept persists – another Zombie Economics idea.
Dillow adds more to the evidence pile:
Do tax cuts boost labour supply and hence tax revenues? Here’s some evidence that they don’t. Pierre Cahuc and Stephane Carcillo report on an experiment* in France:
The detaxation of overtime hours introduced in October 2007 was intended to allow individuals in France to work more so as to earn more. The evaluation conducted in this article indicates that the detaxation of overtime hours has not, in fact, had any significant impact on hours worked…
Detaxation is a measure costly for the public purse, without any ascertained impact on hours worked.
We can put this alongside the evidence we have for footballers and New York cabbies, which suggests that we are on the positive side of the Laffer curve, where tax cuts do not increase revenues. It’s also consistent with the – very tentative – evidence we have from UK tax receipts this year, which suggests that the introduction of the 50p tax rate has not (yet) reduced revenues.
Now, this is not to deny that Laffer curves exist. No doubt, there is a point at which higher taxes would be counter-productive and tax cuts would pay for themselves. And I’ll concede that it’s possible that the 50p tax rate will, eventually, have adverse effects.
But where is the hard evidence that, at tax rates around current levels, there are such effects? Do the glibertarians have anything more than prejudice, half a theory, and the post hoc ergo propter hoc fallacy?
Readers and students should note: There is no conflict between these claims and the Keynesian macro-economic policy assertion that tax cuts can stimulate the economy. The Keynesian policy mechanism works differently. It asserts that tax cuts work to widen the budget deficit. The households spend part of the tax cut while the government continues to maintain it’s other spending. Therefore Aggregate Demand, total spending, in the economy increases. As the spending is received by firms who then pay for labor & resources in the circular flow, the increased spending has a multiplied effect. The Laffer curve concept is different. It asserts a direct greater willingess-to-work labor supply response.