Thursday, December 12, 2002

Supply-side theory and the Law of Diminishing Returns

I'm a supply-sider. I believe that cutting taxes actually leads to greater tax revenue down the road, and this belief is bolstered by a quick examination of the U.S. budget when Reagan took office and when he left office: although tax rates were drastically cut, revenue by the end of the decade was up (in real dollars).

However, it also seems to me that this principle must have a limit, in the mathematical sense. There must be some tax rate at which this principle ceases to apply. After all, taking it to is logical extreme -- a 1% tax rate -- would surely not yield greater tax revenue in the near future, would it?

So what is the "perfect" tax rate? How do we know we aren't there now? I'm not saying we are, but I think we who call for tax cuts need to remember that there is a "basement" tax rate, below which the supply-side principle fails to work.

Anyone have any insight?

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