Neoclassical Economics

Neoclassical economics is an approach to economics that focuses on the maximization of utility, with neoclassical theory operating under several assumptions that contribute to the maximization of utility. One such tenant of neoclassical thought is the presence of scarcity. Scarcity, as defined by economist Lionel Robbin, exists when an individual making a choice must forego alternatives that the individual would not wish to forego (Robbins 1932, p. 15). The presence of scarcity leads to the second tenant of neoclassical economics, which is the deliberate actions of individuals and firms to maximize their utility under scarce resource conditions. In maximizing utility, it is assumed that an individual or firm works in an axiomatic system, meaning

Primarily, taxes serve as a source of scarcity for the individual and for businesses, since their scarce resource, capital, is more constrained since less is available to them through taxation. Additionally, individuals and firms are aware of implications of taxation on their labor and consumption, and make decisions according to these restraints (Kotlikoff 1985. P 29). Under changed tax conditions the behavior of individuals begins to change, and this is believed to create economic stimulus. When tax rates are lowered a scarce resource, capital, suddenly becomes less scarce, and individuals change their consumption patterns because of this (Kotlikoff 1985. P. 29). Consumption patterns are altered because the relative price level of goods suddenly becomes lower. Additionally, the restraints that individuals place on their behavior suddenly become lessened. Due to their increased consumption, there is an incentive for firms to increase their output, since they could maximize their utility by increasing profits. Firms would then increase employment, which would not only increase their output, but it would also increase consumption due to the new labor that was hired to increase output. Although the rate of governmental receipts would be lower, gross governmental receipts would be expected to either remain steady or increase under this model due to the sheer

The Laffer curve contests that a change in tax rates will have two effects: an arithmetic effect and an economic effect (Laffer 2004. P. 1). The arithmetic effect states that tax revenues will respond to the respective increase or decrease in the tax rate. The economic effect, where neoclassicals argue that stimulus is created, are the incentives to increase employment and output, which would increase the tax bases, and thereafter increase gross governmental receipt (Laffer 2004. PG. 1). Furthermore, the opposite is believed to be true for a tax increase, with government receipts decreasing due to the disincentive. However, the effects on revenue depend entirely on where the tax system is placed on the bell curve shown above. If a tax system is to the right of the profit maximizing point, that tax system could achieve maximization by decreasing their tax rate. However, if a tax system is at the revenue maximizing point or to the left of this point, the revenue of the tax system will decrease. In the neoclassical perspective, our current tax system lies to the left of the revenue maximizing point, meaning that tax receipts could be increased by tax rate