Saturday, October 08, 2005

Curves along the Economic Road

When supply side economics became the vogue in the eighties, Arthur Laffer came up with the Laffer Curve to show that there was an overall tax rate which maximized tax revenue. There would be no tax collected if the rate was zero and if the rate was 100% no one would be interested in working so the revenue collected would again be zero. Somewhere in between a rate would exist which would result in the maximum tax revenue.

An analysis of government intervention in the free market would yield a similar curve, which we will call the Laugher Curve, since we would all be laughing instead of fighting if we could find the optimum point. Growth is increased by some government regulation of markets because it makes the markets more stable and prevents monopolies from developing. Some government regulation also promotes growth when it helps workers by promoting safe working conditions and stable employment. So growth increases as the degree of government intervention increases, up to a point, beyond which growth drops when the tax burden necessary to improve the lot of workers and regulate competition swamps its beneficial effects.

These trends are indicated in the following graphs, which are not meant to represent the actual data, because we don’t know at what percentage the peaks in the curves occur.

Supply siders always seem to assume that any tax rate cut is a good tax cut because it stimulates growth. But, this is only true if the current rate is beyond the peak of the Laffer Curve. Similarly, conservatives always seem to assume that any government intervention in the free market is too much, and liberals appear to assume the opposite, when in fact there is some degree of intervention that produces the maximum growth rate.

To further complicate the issue, even if we could determine the optimum percentage in each case we still might not have the best overall situation for the good of the country. Growth due to increases in productivity usually increases our overall standard of living, but not necessarily the standard of living of everyone. It is possible to have an increasing standard of living for a few people, while the majority tread water or backslide. To ensure an increasing standard of living for everyone, further government intervention is usually necessary to level the playing field by transferring benefits to those lower on the economic scale. This may result in lowering overall economic growth, while at the same time enhancing overall well being. A measure of this effect might be represented by the median per capita domestic product (MPCDP), rather than the gross domestic product (GDP). Comparing the solid and dashed Laugher Curves shows the trends. The peak of the MPCDP curve occurs at a higher rate of government intervention.

Unemployment can be addressed in a similar fashion. Low wages and no government assistance may result in the least unemployment and greatest GDP, but it won’t result in the greatest MPCDP, or overall well being of the population.

We need to get away from addressing prosperity only in terms of maximum GDP growth and lowest tax rates and try to determine what these curves actually look like if we want to minimize class warfare and promote the well being of the whole country.

No comments: