Laffer on the blackboard

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The IMF has published a paper on the Laffer curve that concludes:

The paper shows how tax rate cuts can increase revenues by improving tax compliance. The intuition is that tax evasion has externalities: tax evaders protect each other, because they tie down limited enforcement capacity. Thus, relatively small tax rate cuts, which decrease incentives to evade taxes, can lead to increased revenues through spillovers - creating Laffer effects.

The supply siders will be over the moon with joy. There's just one problem. The assumptions that make this work are:

We investigate an economy populated by a unit volume of taxpayers. There is a single tax authority with limited resources, which audits taxpayers. The model is set up in three steps. First, we describe how tax enforcement works. Second, we introduce the maximization problem of the taxpayer, in particular the decisions on compliance and labor supply. Third, we introduce taxpayer heterogeneity and solve the model.

In other words, this is a blackboard based model. Well, we all already know that Laffer works on a napkin. Adding a formula or forty makes no difference: there is no evidence for it in reality.

This economics is a bit like Nintendo's Wii. Right around the world now there are millions of people believing they can play championship tennis or beat Tiger Woods at golf. That's because the assumptions have been changed in the virtual reality model of their world to achieve the illusion they desire. So too with mathematical modelling that creates the assumptions that deliver the result you first thought of. In reality these people can hardly play tennis or golf. And they're not doing either: they're playing make believe. This economics is also playing make believe.

So don't get too excited guys: we won't be buying the argument. It's wrong, as almost all evidence based research shows.