Thursday, November 16, 2006

Carole Taylor's Laugher

Driving my kids to swimming lessons yesterday listening to CKNW radio in Vancouver. The host, I think it was Michael Smyth was interviewing Carole Taylor, the BC Minister of Finance. Most of the interview had to do with the efforts of Minister Taylor and the Premier to engage in dialogue with the province around budget priorities, particular in where to reduce spending to make education and healthcare more sustainable.

After brief interview, the host opened the phone lines for questions from listeners. One of the listeners made a statement more than a question for Ms. Taylor which I could expect from a listener, but the response blew me away. The statement went something like this:

We all know that when you cut taxes, that rather than decreasing government revenues, it actually increases revenues. Michael Campbell, the Premier's own brother has said this numerous times on this very station. Do you believe this? And if so, shouldn't BC be lowering taxes further?

As I said, the question was not so surprising, it was the response that blew me away.

Carole Taylor, the BC Minister of Finance responded by saying "Yes, absolutely! And provincial economy has responded robustly to the measures, including tax cuts we have implemented". Or something like that.

This idea that tax cuts increase revenues has become a part of the modern zeitgeist of popular economics ever since the Reagan era. But to anyone who has studied economics it is demonstrably false. The idea stems from the work of economist Arthur Laffer who described the Laffer Curve in a series of papers and books in the early 1980's including his seminal work, Foundations of Supply Side Economics - Theory and Evidence. in 1982. The Laffer Curve represents a theoretical relationship between tax rates and government revenues and is useful to a point. The two end points of the curve are well established. At 0% tax rate, government revenues are obviously 0. Also at 100% (or very high) tax rates, revenues are zero or close to zero as people have no incentive to work and will gravitate to the underground economy, or hide income. The important thing however is that there is little evidence to indicate what the shape of the curve is between these two end points. It is intuitive that at some point, increasing taxes yeilds dimishing returns as it decreases the incentive to work or declare income. But without knowing the shape of this curve or where on the curve the current tax regime lies, you simply can not say that incrasing taxes could yeild greater revenues. In fact, there is some evidence to suggest that this disincentive to work only kicks in at very high tax rates.

So this brings us back to Finance Minister Taylor. I can understand members of the general public repeating this little gem of folklore, but for a Provincial Finance Minister to endore this fairytale is scary indeed.

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