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Laffer Curve Pays Off Again
Tax cuts work because they increase the incentive to work, save and invest according to Dan Mitchell, the Heritage Foundation’s senior fellow in Political Economy. The cuts - meaning more earnings will remain in the pockets and bank accounts of the earners, if they choose not to spend it - also provide more income for taxpayers, part of which is taxed by the government, he says. This reality follows the economic theory created by economist Arthur Laffer, and known as the Laffer Curve, which suggests the relationship between tax rates and tax revenues collected by governments. The higher the tax rates beyond a certain point, the less incentive workers have to be productive, since they are not receiving the earnings anyway. "This is why pro-growth tax cuts (as opposed to rebates and credits) have what is known as a "supply-side" effect. If the supply-side effect is large, the revenue loss of lower tax rates is small ..."
Story Continues Below He cites the Wall Street Journal’s explanation that the 2003 supply-side tax rate reductions "had an unambiguously positive effect on state government finances. Governors and state legislators are getting a revenue windfall because supply-side federal tax cuts are generating faster growth around the nation.” This flies in the face of the claims of some liberal Republicans who demanded a $20 billion giveaway to the states to offset what they thought would be "lost" revenue in return for their votes for the Bush tax cuts. Despite their fears, the data now shows that the Bush tax cuts and the resultant economic expansion have been a windfall for state coffers. Mitchell reports that since the tax cuts were enacted in mid-2003, the growth of the Gross Domestic Product (GDP) has averaged close to 4%, the jobless rate is down to 4.9%, and federal tax receipts have climbed at the fastest pace in more than two decades. Moreover, he shows that more people in the work force with rising incomes translates into more taxable income for states. He concludes that "because most states tax investment income too, state budgets are also benefiting from an increase in corporate dividend payouts. If the states were smart, they'd offer to repay the $20 billion if Washington will make the tax cuts permanent.”
Editor's note:
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