Regular readers know that I’m a big advocate of the Laffer Curve, which is the common-sense notion that higher tax rates will cause people to change their behavior in ways that reduce taxable income.
But that doesn’t mean “all tax cuts pay for themselves.” Yes, that happened when Reagan lowered tax rates on the “rich” in the 1980s, but there are also tax cuts that generate little or no revenue feedback.
The key thing to understand is that revenue feedback is driven by the degree to which a tax cut leads to more taxable income. And you tend to get bigger changes in taxable income when you lower rates on taxpayers who have considerable control over the timing, level, and composition of their income.
Who are those taxpayers?
Most of us don’t fall in that category. Cutting my tax rate, for instance, probably won’t have much impact on taxable income. My salary from Cato is already established, so there’s not much opportunity for a “supply-side” effect. Every so often I can earn some extra money by writing an article or giving a speech, but (unfortunately!) not enough for it to make a difference even if my incentives are altered.
But investors, entrepreneurs, corporate managers, and small business owners are among those who do have considerable flexibility to respond when incentives change.
Consider this new research from the Tax Foundation, which finds big “supply-side” responses from a lower corporate tax rate. Let’s start with their description of the problem.