Economic Theories Behind the Benefits of Lower Taxes

Part 2

"Inflation is taxation without legislation," Milton Friedman

Lower taxes are not merely a political slogan but a cornerstone of sound economic theory, promoting growth by enhancing individual incentives and resource allocation. Classical economists like Adam Smith laid the groundwork in "The Wealth of Nations," arguing that minimal government interference, including low taxes, allows markets to flourish.

But modern theorists like Milton Friedman and Friedrich Hayek refined this, emphasizing how taxes distort behavior. Friedman, in his advocacy for free markets, highlighted that high taxes penalize success. He noted, "Inflation is taxation without legislation," but extended this to direct taxes, arguing they reduce savings and investment.

Lower rates, he posited, stimulate entrepreneurship by leaving more capital in private hands, leading to job creation and innovation. Empirical data supports this: tax cuts in the 1980s under Reagan increased real GDP growth from 2.5% to over 4% annually.

The Laffer Curve, popularized by economist Arthur Laffer, provides a mathematical rationale. It illustrates that beyond a certain point, higher tax rates reduce revenue as people work less, evade taxes, or relocate. Laffer stated, "When the tax rate is zero percent, government will collect nothing... When the tax rate is 100 percent, government will also collect nothing."

Optimal rates maximize revenue while minimizing disincentives. Reagan's cuts validated this, with federal revenues rising 28% from 1983 to 1989 despite lower rates.

Hayek, another Nobel winner, linked low taxes to freedom, warning that progressive taxation erodes liberty. He wrote, "The system of private property is the most important guaranty of freedom," implying taxes undermine property rights and voluntary cooperation.

High taxes force inefficient allocations, as government spending lacks market signals, leading to waste. Murray Rothbard took a radical libertarian stance, viewing taxes as immoral and economically destructive. He argued, "The best way to help the poor is to slash taxes and allow savings, investment, and creation of jobs to proceed unhampered."

Rothbard contended that taxes transfer wealth from productive sectors to bureaucracy, stifling innovation. Studies show that a 1% GDP tax increase can lower growth by 2-3%.

Supply-side economics integrates these ideas, positing that lower taxes boost supply through increased labor participation and capital formation. Corporate tax cuts, for instance, encourage investment; post-2017, U.S. business investment rose 9%.

Critics argue cuts favor the rich, but evidence shows broader benefits: wage growth accelerates as firms compete for workers.

Lower taxes also reduce evasion and black markets, broadening the tax base.In essence, these theories demonstrate that lower taxes foster a virtuous cycle of growth, where individuals retain earnings, invest wisely, and drive prosperity. High taxes, by contrast, create deadweight losses, discouraging the very activities that build wealth.