According to the wedge doctrine propounded by Professor Arthur Laffer, government taxation introduces disincentives to supply while government spending, particularly transfer payments, introduces incentives to demand. Underinvestment and low productivity suppress output and employment even while consumption is burgeoning; stagflation is the inevitable result. Laffer’s conclusion: The economy would produce more and consume less if government’s role were reduced.
High taxes may indeed have something to do with low rates of investment, profitability and productivity improvement. On the other hand, the assumption that only government stands in the way of inflation-free economic growth is at odds with a long history of economic instability under capitalism. High rates of profitability and investment are destined by their very nature to self-destruct; the wedge theory is dangerously optimistic in implying that high levels of employment and output are, in the absence of government intervention, indefinitely sustainable.
On the other hand, the wedge hypothesis is dangerously pessimistic in arguing that we have no way out of our troubles short of a major withdrawal of government from the economy. Just as the euphoria of the 1970s led directly to the unhappy economic performance of the past decade, so the disappointment, distress and modest investment levels of recent years are destined to lead to something much better in the years ahead.