The Tilburg University
Survey of Top Schools in Economics has one noteworthy entry (or aberration depending on viewpoint): The University of Chicago, home of Milton Friedman and the Disaster School of Supply-Side Economics … ranked #2 worldwide:
Click on image to enlarge.
The University of Chicago is the birthplace of tax cuts for the wealthy, an economy theory that results in boom and bust cycles, and the stuff that makes Banana Republics possible. To illustrate my point, this graph shows the relationship between marginal income tax rates and the income gap between rich and poor for the past 90 years (
source):
Click on image to enlarge.
As the graph illustrates, the greater the gap between rich and poor, the more unstable economies will become. In 1928, the year before Black Monday triggered the Great Depression, the top 0.01 percent (the elite) averaged 892 times more income than the bottom 90 percent. From the post-war period until the Reagan era, higher marginal income tax rates for the rich meant more money in the pockets of the middle class … resulting in real economic growth. By 2006, however, middle class wages had shrunk, inflationary rises in cost of living had consumed all marginal income, and middle class savings rates turned negative. The top 0.01 percent averaged 976 times more income than the bottom 90 percent, thus reenacting the same conditions that triggered the Great Depression. Here is another view of the same data (
source):
Click on image to enlarge.
Arthur Laffer is a "supply-side" economist who served on Reagan's Economic Policy Advisory Board from 1981 to 1989. Laffer is best known for the
Laffer Curve, an illustration of tax elasticity, which claims that a decrease in tax rates will result in an increase in tax revenues. What began as a thought experiment on a paper napkin over lunch has turned into a mantra and marching orders for Banana Republicans ever since.
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According to theory, tax revenues would be zero if tax rates were either 0% or 100%. If the tax rate is zero, there is no tax revenue because there are no taxes. If the tax rate is 100%, there are no taxes because citizens would not want to work. Assuming everything is taken from them, citizens would resort to barter or an off-the-books economy. As taxes increase from zero percent, revenues will rise but once taxes get too high, revenues will fall because there is a disincentive to work.
One problem with Laffer’s thought experiment is that the equilibrium point (the lowest possible tax that yields the highest possible revenue) can never be clearly established. There are always concerns about the costs of wars, federal budget deficits, and the servicing of public debt. Since the equilibrium point varies with public opinion, what matters more is the
range of marginal taxation, not a fixed point to be taken literally.
In fact, historical data contradicts Laffer’s thought experiment. In the 8 years following Reagan’s tax cuts, personal income tax revenues rose from $353 million in 1982 to $516 million by 1989, an increase of 46%. During the same time interval, the federal deficit more than doubled.
In contrast, Clinton’s tax increases resulted in a personal income tax revenue increase from $586 million in 1993 to $1.137 billion by 2000, an increase of 94%. The Reagan era produced gigantic budget deficits. In contrast, the Clinton years yielded a federal budget surplus during a period of unprecedented economic growth (
source).
Bottom line: The middle class is the economic engine that drives the economy. Marginal income tax policies that favor the wealthy and punish the middle class set the stage for disastrous consequences, as we have recently experienced. Thus, the Republican mantra of lower taxes, lower taxes, lower taxes, do not always achieve a desired economic outcome. As we enter into yet another public debate on tax policy and federal deficits, it is useful to keep past economic policy failures in mind.
For another perspective, please refer to my post of February 10, 2009:
A Ghost of Depression Past.
H/T to
Brad Delong for posting the Tilburg Ranking.