Unfortunately, I could not find the Klamer article in the library. “HB 172.5, yup. C66 nope. Guess I’ll have to go Google Scholar, hope the article isn’t crap…” No, it wasn’t bad at all, I just hope that I didn’t miss anything too fundamental. This weekend I’ll try to find the book and read it.

The Laffer Curve is the defining feature of Reagonomics; a simple bell shaped curve showing the quadratic relationship between tax rates and total government revenues, such that higher tax rates do not always result in higher tax revenues for the government. While the Keynesian approach considers only the absolute amount of income available, Reagonomics considers the opportunity cost of leisure.

There are a few effects that taxation causes, according to supply side economics.

1) Because taxes are imposed on work effort, the relative cost of leisure in terms of work hours declines, such that leisure is now less expensive, and working is less profitable. The person would now work less, and relax more.

2) Of course, there are also taxes on the future income and savings, so that under the US tax structure, people will decide to save less in the future. Knowing that the rate of return must at least equal the cost of investing, as the pre-tax rate of return must now rise “sufficiently such that after paying the tax, the net return will be that required to induce people to hold the same amount of capital.” Since this is not likely to happen, the amount of capital will decrease.

3) As the amount of capital decreases, from what we know about the inverse relationship between capital labor ratios and the marginal products, wages and rents paid to labor and capital, workers are now likely to get paid less because there is less equipment to work with.

So taxes are bad for the economy; a supply-shock that causes a downturn in savings and production function. Therefore, if we make a few basic assumptions about human behavior, it is possible to maximize government tax revenues while decreasing tax rates. “As the tax rate increases, the quantity of work demanded declines. At first, the higher tax rate applied to the fewer units results in greater total revenue. However, before too long, quantity falls in greater proportion than the rise in tax rate.” The tax rate has entered into the elastic region of the labor supply curve; or the argument assumes that income effect cannot dominate the substitution effect. Any decrease in wages per hour must result in an increase in leisure consumed.

Of course, this theory is a biased republican tool for world domination. Criticisms of the Laffer Curve are severe. 1) the curve is an “imaginary” aggregate of the individual choice between work vs. leisure. There is no honest way to measure or exploit the proposed benefits, because there is no way to locate ourselves on it. 2) It lacks any discussion of the economic processes that undergirds the macro-behavior. Sure, the individual is accounted for, but what about the macro economy? “It is simply assumed that the economy shifts from one point on the curve to another. There is no discussion of how the shift occurs, how long the shift takes, or what relative price effects are engendered by the shift.” We could just as easily be below the region of maximized revenues, so that we should raise taxes.

The author then elaborates a little on the distinction between risk and uncertainty, to show how time preference can give rise to government officials making bad policy decisions with respect to taxes and expenditure (although this connection is not clear). Risk and uncertainty can be related to class and case probability, respectively. Risk is a randomness that can be expressed in terms of a “specific numerical probability,” deriving the likelihood of an unknown even with class characteristics—hence this is class probability. Uncertainty however, cannot be neatly summarized in a numerical value, but must be decided upon following a case by case basis; in this, we know something about the event and the events surrounding it, but nothing about the class of events to which it belongs such that we have no context in which to find its probability.

Ludwig Van Den Hauwe. The Case for Supply-Side Economics Revisited: The Effect of Time Preference. European Journal of Law and Economics, 10, 139 160, 2000. http://64.233.179.104/scholar?hl=en&lr=&q=cache:3jveIKB56kJ:ftp://wueconb.wustl.edu/econ-wp/mic/papers/0508/0508007.pdf