Let’s say you buy a radio station. To increase your income, you increase the percentage of time for advertisements. But this repels your listeners, and they turn to other stations. Your income doesn’t rise after all, it falls. This reaction is called “negative feedback” – counter to what one would intuitively expect.
Negative feedback also applies when government raises tax rates. People avoid reporting taxable income by working less, engaging more in the underground economy, or otherwise changing their behavior. With less income subject to taxation, government revenues fall, despite the higher rates.
But when tax rates are reduced, the economy is strengthened, citizens earn more, and they choose to report more of their income. Government revenues rise, despite the lower rates.
Surprisingly enough, governments have no control over their revenues; they control only the tax rates. At a given rate, people change their behavior accordingly. If governments in the U.S. or Europe cut their tax rates, their economies would grow faster. The revenues would rise, and the deficits would fall.
With most big-government policies, in fact, the results are counter-intuitive.
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