Laffer on Incentives

Former Reagan economic adviser Arthur Laffer recently wrote in the Wall Street Journal that “incentives matter.” He was specifically referring to the incentive businesses and individuals have to shuffle their income earnings to this year instead of next when the Bush tax cuts are scheduled to expire.

As he notes, “People can change the volume, the location and the composition of their income, and they can do so in response to changes in government policies.” What this means, he argues, is that income for this year will be inflated making it look like the economy is improving. But, when taxes go up next year, economic productivity will go back down.

Businesses are incentivized to invest and produce when they keep more of their money thanks to lower tax rates. Increased tax rates decrease that incentive.

Similarly, something Laffer didn’t address in his piece is that increased regulation or uncertainty about what regulations government will soon implement also serve as disincentives for businesses to invest and produce. As such, the current climate in Washington doesn’t bode well for the prospects of a booming economy.