středa 7. prosince 2005

Laffer what?

I like liberal economics. Equally, I don't like bad economics. Unfortunately, often liberal economics overlaps with bad economics. A recent example is Petr Mach's leading article "Flat Corporate Tax and Laffer Curve" in CEP newsletter 11/2005. Mach estimates the impact of corporate tax rate on revenues from this tax, and identifies the top of Laffer's curve at about 20.75%. This sounds cool, but let's take a clooser look...

The estimate is based on OLS conducted over 5(!) observations over the last five years. Not many degrees of freedom, I suppose. Over the period, we observe steady decline in tax rate, and dramatic increase in taxable profits. The Mach's estimate assumes that the increase in profits is solely due to the change in tax rate, which is doubtful. In period of boom, with large foreign investments (excluding those exempt from taxation), changes in profits should be attributed to other causes than the tax rate. Three most evident causes may be general boom, competition for foreign investors, and tax competition.

Therefore, the estimates of Laffer curve and of predictions of revenues at 15% rate (as proposed by the Civic Democratic Party), are unfounded. The party should be cautious to propose a generous social system accompanied by a drop of corporate tax rate, since the only result can be growing deficits. So, I am in favour of lower corporate taxes, but not for wrong reasons.