11.3.06

The Mad Biologist has some fine thoughts...

... here, on the subject of crank economic 'theories.'

There is one or two things about the Laffer curve that bother me, which The Mad Biologist doesn't write about.

The first is that there is nothing in the model that justifies assuming that there is only one maximum.

Rather than being subdivided into two monotonous parts, it could be divided into any number of such, and still obey the boundry conditions.

This would (for example) be the result if more than one tax-rate-dependent effect (tax evasion) played into the equation.

One could easily imagine that shareholders (for example) would increase profit margins as taxes went up. There is a distinct possibility that this would slow down the economy, thus reducing revenue.

But if this effect essentially levels off at some point before tax evasion becomes a real problem, you'd get a seperate maximum due to this effect.

In fact, I can see no justification for assuming that it should even be single-valued (although it's probably safe to assume continuity). Common sense tells us that there is considerable hysteresis and a lot of transients in the tax system.

If you change a tax, it takes a while for society to react to the change (the transients).

For instance, if you make a government-induced price hike on gas, it will take time for people to begin consuming less gas (for one thing, much of the car fleet would have to be changed).

The car fleet could also provide an example of hysteresis. If car manufacturers had developed a gas-saving car as a result of demand provoked by a gas-price hike, there is no reason why the consumer should change back to high-consumption cars when the gas tax is abolished.

Thus, we see that the neat, smooth Laffer curve is complicated by a non-trivial evolution in time, the problem that you have no way of being sure that you're heading towards or away from the global maximum, the fact that the time to achieve equilibrium conditions might exceed the lifespan of any given taxation policy and the fact that society will not simply return to the status quo ante when you repeal a law...

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