Laffer Curve

(From a letter to Jerry Pournelle)

For the most part, I accept the Laffer curve as fact.  The 0% and 100% tax rate boundary conditions are obvious, and some sort of curve must connect the two points.  We can also offer a hand-waving argument to the effect that the revenue is nonzero at all points in between.

While I haven't read any of the technical literature on the Laffer curve, the popular discussions seem to assume there is one true shape of the Laffer curve, rather like Mark Twain's one true shape of the Mississippi River.  I'm not sure I buy that.  Indeed, I think it's a mistake to treat the subject as if the tax rate is the only relevant variable.

For example, I imagine there are different Laffer curves for different income levels, as the poor have fewer options than the rich for sheltering income. 

It's probably an error to treat the tax rate as if it's a single variable.  The tax rate is a function of the income level in many cases.  The exact shape of this function probably has considerable effect on the shape of the Laffer curve.  The shape of the curve is not given by R = L(tax rate), but R = L(tax rate(income level)).

And to make matters worse, discussions of the Laffer curve all seem to assume the economic system is in equilibrium. Economic activity will have one pattern if tax rates are assumed to be fixed over time, and a different pattern if rates are expected to change.  A tax holiday of 18 months will encourage a lot of activity, but it will be biased toward the sort of activity expected to pay off in a year and a half or less.

Just as non-equilibrium thermodynamics becomes very complicated very quickly, so I suspect does non-equilibrium economics.   (FWIW, Google finds 10,300,000 results for "non-equilibrium economics", and Wikipedia has a stub on the subject.  "non-equilibrium thermodynamics" yields 322,000 results, but Wikipedia has a much meatier page on it.)

I think the tax holiday would be good because it selectively rewards the people who produce, as opposed to extending unemployment benefits which rewards people who are not producing.  But that's another area where equilibria can be perturbed.  If you print money to pay unemployment benefits, eventually the money illusion takes hold, and each unit of money is depreciated in proportion.  But the unemployed benefit because they represent a local increase in the concentration of money.  Inflation is called a "hidden tax"; printing money to pay unemployment checks is "hidden redistribution" due to temporary variations from the equilibrium. 

Just a few thoughts, and some work is now calling for attention.