Say "tax rate cuts," not "tax cuts"

For years we have argued that the real issue with respect to taxes is not "cutting taxes" but rather cutting the tax rates! In other words, the goal is not to necessarily take in less money overall (which is the way many politicians as well as their echo, the media, frame the issue when they say things like "how will we pay for this tax cut?").

That's why you should insist on the more precise phrase "tax rate cuts" rather than "tax cuts," because cutting tax rates -- especially in the highest income tax brackets -- has an immediate and powerful effect on productive behavior, leading to higher tax revenue.

In our opinion, nobody can explain this as well as economist Art Laffer, whose name is synonymous with this concept and with the "Laffer Curve" which illustrates its effect. He explains in a piece published in today's Wall Street Journal (and available to all, subscriber or not, in the new no-subscription-required Wall Street Journal Editorial Page) that tells the story better than we can.

For readers who may not be completely familiar with the concept of "marginal" tax rates, you can refer to the diagram at the top of this post. Think of your taxable income as water that is poured into a giant barrel that looks something like the diagram at the top of this blog post.

Your taxable income is taxed at a different rate as it fills up the barrel -- from the bottom rate for the first $8,000 or so of your taxable income (for a single filing status, and the bottom $16,000 or so if you are married filing jointly), which will be taxed at the lowest rate of 10%, all the way up to the very top of your income stream. That last part -- the part that is at the top of your particular income tax barrel -- is called your marginal income. That is the part that Art Laffer is talking about in his article. He states, "It's the marginal tax rate that elicits the supply-side response."

People whose income streams go all the way up to the highest bracket (which goes on forever, as indicated by the arrows in the diagram) are the ones who (logically) make the most changes to their behavior when their marginal tax rates are raised or lowered by the government.

As indicated in Art's article, history demonstrates that lowering the rate on the highest bracket has a tremendous positive effect on job creation and economic production, which in turn helps everyone else including those in lower marginal brackets (those whose marginal or top rate is in a lower bracket than the top bracket).

This assertion is very closely related to one that we posted here last week, in the fourth paragraph from the bottom of the entry.

Tax rates may seem like a political issue, but they are immediately and profoundly important in their economic impact.

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For later posts on this same subject, see also:

• "The 'wealthiest' rates matter to everyone" 12/03/2010.