Mar­ket­place, a pub­lic radio pro­gram, has been cov­er­ing Wealth and Poverty issues on its pro­grams for sev­eral months. On July 26th, a seg­ment titled “Arthur Laf­fer on income inequal­ity, rais­ing taxes” was broad­cast. The audio can be down­loaded here. Fol­low­ing is an excerpt from the tran­script:

Hor­wich: Many econ­o­mists will say the data is extremely incon­clu­sive in prac­tice as to how mar­ginal tax changes actu­ally affect per­sonal and busi­ness activ­ity. What makes you so sure?

Laf­fer: Because basi­cally, these econ­o­mists you talk about never worked in the real world. They’re just look­ing at the econo­met­rics and the data there. If you ever go and look at what’s being rec­om­mended from the CPA firms, from finan­cial plan­ners. If you actu­ally look at how they go through, do their tax returns — believe me, they are more focused on their taxes than you and I are on their taxes.

Hor­wich: But am I right that I just heard you crit­i­cize econ­o­mists for actu­ally look­ing at the data and mak­ing their deci­sions based on that?

Laf­fer: No, no, not look­ing at the data. I think it’s won­der­ful to look at the data. But I think it’s really silly to look at this accu­rate data and not make any judg­ments beyond those aggre­gate data

I was espe­cially struck by this last state­ment about judg­ment ver­sus data. It sounded to me that Laf­fer has made the judg­ment to ignore the data! The whole point of care­fully mea­sur­ing the data is to test your judg­ments. I agree that taxes likely have an effect on indi­vid­ual behav­ior, prompt­ing less effort at work­ing and more effort at avoidance/​evasion. How­ever, who is to say how large these effects are and whether there are any counter effects? In this post, I quote page 115 of the book The Com­ing Gen­er­a­tional Storm, co-​​written by econ­o­mist Lau­rence Kot­likoff which states:

…For tax cuts to raise rev­enues, pre­tax labor earn­ings have to rise by a larger per­cent­age than the tax rate falls.

There are two com­pet­ing forces at play in deter­min­ing whether pre­tax earn­ing rise, stay the same, or fall. On the one hand, work­ers may say to them­selves, “Boy, now that taxes are lower, I can work less and still receive the same after tax pay. I’m going to cut back my work­week.” On the other hand, they may say, “Boy, now’s a good time to work more and earn more because taxes are lower on every extra dol­lar I earn”. Econ­o­mists call the first of these reac­tions the income effect. They call the sec­ond reac­tion, the sub­sti­tu­tion or incen­tive effect.

Some of the best labor econ­o­mists in the coun­try have spent their life­times mea­sur­ing the income and sub­sti­tu­tion effects. The broad con­sen­sus of these experts is that the two effects are roughly off­set­ting. This means that if wage tax rates are cut by, say 15 per­cent, tax rev­enues will fall by 15 percent.

Only by look­ing care­fully at all of the data can one test one’s judg­ments and make sure that one is not mis­judg­ing an effect or miss­ing counter effects. I did that to the best of my abil­ity in this analy­sis. For years, I’ve asked supply-​​siders to tell me any spe­cific num­bers or con­clu­sions in my analy­sis that they dis­agree with. Alter­nately, I’ve asked them to post a link to one seri­ous eco­nomic study that pur­ports to show evi­dence of any income tax cut that has ever paid for itself. None have. So, until some­one can pro­vide me with a study or argu­ments that counter this analy­sis, I’ll just have to stick with the data.

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