Snake-Oil Tax Cuts

Two theoretical propositions have played important roles in the thinking of U.S. presidents enacting large tax cuts since 1981. The first, often known as the Laffer Hypothesis, claims that reductions in marginal tax rates stimulate economic activity so much as to raise overall tax revenue. The second, often known as the Starve the Beast Hypothesis, claims that tax reductions, by depriving the government of revenue, lead to reductions in government spending. This paper reviews the conceptual arguments and available empirical evidence on these two propositions. The two contradict each other. Despite this, both run counter to most of the evidence, at least for the case of the United States.