The Economics of Tax Reform: Lessons from the Donut Shop

August 19, 2013

What can a donut shop teach us about tax reform? Maybe quite a bit. Would the federal government have all of the money it needed if Congress just kept raising taxes? Possibly, but after a while, higher tax rates would actually bring in less money for the government. The same is true of a business. If you were making a little bit of money selling donuts at $1 a piece, would you make 300 times as much money by changing your price to $300 per donut? Probably not.

When it comes to evaluating tax changes, the most common way is to assume that no matter how different the tax code is in the future, the economy will continue to behave as if nothing had happened -- Americans will keep working and investing in the exact same way. Using this "static," or unchanging, view of the economy, however, gives us a distorted idea of what the future is going to look like.

The Tax Foundation uses a sophisticated economic model to measure the dynamic effects of tax policy changes. We believe that this approach gives lawmakers a more realistic picture of the effects of tax changes on the economy and federal finances.