Supply Side Economics Guru Laffer: Tax Ideas Not Partisan But Common Sense
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Laffer Curve economic theory was sketched on cocktail napkin in Washington hotel in 1978.
Economist Arthur Laffer won fame for his "Laffer Curve," so-called supply-side economics policy drawn on a cocktail napkin at a Washington hotel in 1978.
(Please see explanation of Laffer Curve Theory at end of this column.)
Mr. Laffer has been embraced by conservatives as their guru who can do no wrong. They have interpreted his "curve" and his statement "all taxes are bad save sin taxes" as a broad brush mandate to slash government.
Forgotten is his idea that taxes "should do the least damage to society."
Also cast aside in the rush to slash all taxes, and government programs, is Laffer's caution that common sense should be the first consideration.
"The worst thing government can do is enact policies that destroy production base from which all beneficence flows," Mr. Laffer told the American Legislative Exchange Council on Friday.
It just so happens that the "production base" is not just equipment sitting in a factory or other work site, but is people.
No production base can function without productive, innovative people who are adequately compensated for their work and who can support a family structure that complements their productivity.
Mr. Laffer's strongest points were that tax policy should not be partisan. Good tax and economic policies and good government are not Democrat vs. Republican, conservative vs. liberal, right vs. left.
In our opinion, that is where we got lost in recent years. We have linked tax and economic policies with partisanship. One side contends it is always right and the other side is always wrong. That just doesn't follow Mr. Laffer's experience, or his advice.
Jerry Brown, Democratic (some would say far left) governor of California was credited by Mr. Laffer with being very good for the economy, while he bashed Republican Pete Wilson, and even his mentor, Ronald Reagan as "not a very good governor."
Democratic governor of New Mexico, Bill Richardson, got thumbs up from Mr. Laffer while Bob Taft, conservative icon of Ohio politics, got another finger.
There is little argument that tax cuts stimulate the economy.
John F. Kennedy is perhaps more famous for sparking economic growth by cutting taxes than for social programs he promoted.
JFK cut the highest corporate tax rate from 91 percent to 70 percent and the lowest rate from 20 percent to 14 percent, Mr. Laffer reminded the group, noting that he was a Democrat.
Mr. Laffer added: "Bob Dole voted against the Kennedy tax cuts because 'we couldn't afford the revenue loss.'" Dole, of course was a Republican senator from Kansas who served as vice president under George H.W. Bush and was candidate for President.
The problem in our society is not whether or not to cut taxes, but how to make sure that taxes are fair to all.
The main underlying complaint about tax cuts is they unfairly enrich the rich, further impoverish those already in poverty, and pinch those in the middle class.
The emergence of Rep. Charles Rangel, New York Democrat, as the chairman of the House Ways and Means Committee, has stirred immediate, knee jerk opposition.
Some policy wonks automatically assume "this guy is a Democrat so he will try to raise taxes and push big spending measures."
Not necessarily true, responds the button-down Heritage Foundation, leading conservative think tank.
A recent article in the Heritage Web Memo by William W. Beach and Guinevere Neil says the bill proposed by Rep. Rangel "contains some good points."
The article continues: "Almost everyone supports protecting taxpayers from the AMT (alternative minimum tax); the one-year patch and subsequent full repeal is a step in the right direction. So, too, is the reduction in the corporate tax rate from 35 percent to 30.5 percent beginning in 2009.
"Not only does the lower rate make doing business in the United States more attractive, but it frees businesses to spend more on expanding their operations, creating new jobs and developing new products."
Heritage, however, cautions: "Had the Ways and Means Committee stopped with AMT repeal and corporate tax relief, workers and taxpayers would be better off than they likely will be under the 'mother of all tax bills.'
"However, to make up for the foregone revenues that corporate tax relief and the AMT repeal are supposed to 'cost' the government, the committee chose to raise new taxes."
The Heritage report inflames the debate, we think unfairly, by the stated assumption that if the Bush tax cuts are allowed to expire "the U.S. economy would severely weaken."
Calling the Rangel proposal "the end of pro-growth tax policy," the foundation paints a dismal scenario if the Rangel plan should pass:
gross domestic product would fall,
millions of jobs would be lost,
disposable income of households would fall and
"household savings would shrink, investment would decline and the general pace of economic life would subside."
It seems that some of the outcomes on that list are exactly what we have been facing in the past seven years. American families, especially the middle class and poor, are suffering as a result of misguided tax and economic policies.
American jobs have been taken by illegal immigrant aliens, millions of jobs have been outsourced or taken by foreign competition, disposable income of households is at low ebb, savings have shrunk, etc., etc.
Laffer's common sense has been abandoned in the midst of hysteria to blindly follow Laffer's supply side economics.
Heritage whines that if the 2001 and 2003 tax cuts are allowed to expire:
Dividend tax rates would go from 15 percent to the tax rate imposed on ordinary income, 35 percent; (whoop-de-doo!)
Long term capital gains tax would rise from 15 to 20 percent; (la de da)
Tax rates on ordinary income return to levels of 2000, with the highest rate going from 35 percent to 39.6 percent; (yikes!)
Death taxes return in 2010, after being totally repealed. (Oh migosh!)
Re the so-called "death tax." Newt Gingrich calls it "unfair" and "discriminatory." To who? Most wealthy people establish trust funds for their offspring or make outright gifts long before their death. If there are funds still subject to the death tax in most cases it would be only because the deceased did not have adequate legal or accounting advice. That's our humble opinion.
That kind of thinking has brought us ideas like:
all guns are good, even assault weapons,
all immigration, even illegal, helps the economy because these are "jobs Americans don't want,"
tax breaks to companies that outsource jobs overseas is good economic policy because it helps those companies, and
any war is better than no war.
I find it hard to gin up much sympathy for investment managers above certain income levels who, under the Rangel plan, "would see a cap on itemized deductions and a phase out of their personal exemptions." The fact that "their partnership income would be taxed as ordinary income, which increases their personal income taxes significantly," seems to me an attempt to reach fairness in tax policy.
Perhaps we should follow Mr. Laffer's advice and back away from judging, and legislating, tax policy based on partisanship.
Perhaps condemning the Rangel tax plan just because it comes from a Democrat is not the wisest way to analyze it.
Let's think about how tax policy affects people, and realize good government is not made by partisan egomaniacs.
It's not made to further enrich the ultra rich at the expense of everyone else.
It's made through people of good will collaborating for the common good. It's called, as Mr. Laffer says, common sense.
LAFFER CURVE THEORY
The Laffer Curve theory says changes in tax rates have two effects on tax revenues: the arithmetic effect and the economic effect. The arithmetic effect is simply that if tax rates are lowered, tax revenues (per dollar of tax base) will be lowered by the amount of the decrease in the rate. The reverse is true for an increase in tax rates. The economic effect, however, recognizes the positive impact that lower tax rates have on work, output, and employment--and thereby the tax base--by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities. The arithmetic effect always works in the opposite direction from the economic effect. Therefore, when the economic and the arithmetic effects of tax-rate changes are combined, the consequences of the change in tax rates on total tax revenues are no longer quite so obvious.
At a tax rate of 0 percent, the government would collect no tax revenues, no matter how large the tax base. Likewise, at a tax rate of 100 percent, the government would also collect no tax revenues because no one would be willing to work for an after-tax wage of zero (i.e., there would be no tax base). Between these two extremes there are two tax rates that will collect the same amount of revenue: a high tax rate on a small tax base and a low tax rate on a large tax base.
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