Supply Side Public Choice Synthesis

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    Developing A Supply-Side/

    Public-Choice Synthesis

    Supply-Side Fundamentals for Tax Reform

    By

    Lawrence A. Hunter

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    CHART 1

    Original Laffer Curve

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    Revenues

    TaxRate

    A

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    E

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    CHART 2

    0%

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    Tax ate

    Output

    B

    Ym

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    Y+

    rmr

    +r-

    C

    Y-

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    CHART 3

    Rahn Curve

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    Tax Rate

    IndexofOutput

    Output

    T1

    YMAX

    Output is maximized at Ymax with a tax rate of T1

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    EXAMPLE 1Output Maximized @ 13% Tax Rate Tax

    Revenues Maximized @ 26% Tax Rate

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    RevenueAsPercentOutput

    Output Revenues

    Maximizing Revenues Reduces Economic Output by 27%

    CHART 4

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    EXAMPLE 2Output Maximized @ 18% Tax Rate

    Revenue Maximized @ 39 % Tax Rate

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    Output

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    RevenueAsPercen

    tOutput

    Output Revenues

    Output-Maximizing Tax Rate Equals 18%

    Revenue-Maximizing Tax Rate Equals 39%

    Pure Rent Seeking

    between Tax Rates of

    18% and 39%

    Up to 25% Lost Economic Output Due to Excessive Tax Rates

    CHART 5

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    CHART 6

    Demand For Taxable Output

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    TaxRate

    Tax RevenueExcess

    Burden

    T1

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    CHART 7

    EXAMPLE 3Output Maximized @ 33 Percent Tax Rate

    Tax Revenues Maximized @ 60 Percent

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    CHART 8

    Derived Laffer CurveOutput Maximized @ 33% Tax Rate

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    Revenues As Percent Output

    TaxRate

    E = Revenue Maximizing Rate of 60%

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    CHART 9

    Revenue-Maximizing Tax Rate

    Exceeds Output-Maximizing Tax Rate

    Even With Output Extremely Sensitive To Tax Rate

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    CHART 10

    Revenue-Maximizing Tax Rate Exceeds

    Output-Maximizing Tax Rate Even With Output-Maximizing Rate Skewed Unrealistically to Right

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    DIAGRAM 1

    OUTPUT CURVE

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    Out

    ut

    A

    Y+

    rr

    +r-

    CY

    -

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    (1) By Conjecture: Rm > R' R' { Rm

    (2) For all r-, the Conjecture clearly is true since by definition (rm) > (r

    -) and

    (Ym) > (Y-), which implies (rm)(Ym) > (r

    -)(Y

    -), proving that Rm > R

    -, r-. This fact is

    easily seen in Diagram 1. As r-increases above 0, Y

    -also increases but still remains

    smaller than Ym,, and the rectangle representing revenues, Y-Cr

    -0, remains contained

    within YmA rm0, the rectangle representing revenues at rm,

    (3) For all r +, it is not readily discernable from Diagram 1 whether the Conjecture is

    true since it is not obvious whether the increase in revenues due to an increase in the taxraterepresented by the area of XBr

    +rmexceeds the loss of revenues due to the

    decrease in output (tax base)represented by the area ofYmA XY+. Therefore, it is

    necessary to derive the conditions, if any, under which the conjecture holds. To explorewhether such conditions exist, and if so what they are, rewrite expression (1) for R

    +as:

    (4) (rm)(Ym) "(r+)(Y

    +)

    (5) Rearranging terms

    " YY

    m

    r

    rm

    (6) Recalling that Ym = 1

    " Y

    rrm which establishes the condition for

    the Conjecture to hold:

    Condition: Y+