Have you ever heard of an economist named Arthur Laffer? Back in the 1970s he created a story about the effect of income tax rates on high income people. Because the rates were allegedly too high, incentives had been damaged and the wealthy were refraining from saving and investing. This caused the economy to grow slower. Laffer convinced Congressman Jack Kemp that permanent dramatic income tax cuts would create such a big improvement in incentives that the resulting increase in economic activity would raise the tax base so much that even with lower rates, revenues would actually rise. (The principle is the same as with a sale – the discounted price is more than made up with an increased volume of purchase. In the case of a tax cut stimulating activity, say a 10% cut in tax rates produces income increases of 20% (raising the amount subject to the tax) --- revenues actually go up.)
The theory came to be represented by something called the “Laffer Curve” which has sometimes actually made its way into Principles of Economics textbooks. The idea behind the Laffer curve was based on a piece of logic. If the income tax rate is 100%, people will hide their income and the government will get ZERO revenue. If the tax rate is zero percent, people will keep all their income and government revenue will be zero also. So Laffer reasoned that as you raise rates from 0% to 10% to 20% the government revenue will increase. BUT, if at 100% the revenue falls to zero, there must (by LOGIC) be a rate that if you raise taxes above that rate, revenue will start to decline. Laffer argued that rates in 1980 were so high that by cutting the rates you would actually increase revenue. The problem was, there was NO WAY to tell whether the relationship between tax rates and revenue followed a smooth curve and even if it did, what was the rate at which revenue turned down? Was it 50%, 70%, 90% --- there was no empirical evidence to make a judgement. Laffer and his political supporters argued that 70% (the top rate in 1980) was definitely too high. On the day Trump introduced the outlines of his plan to cut taxes, the New York Times profiled Arthur Laffer.
[For details on the Laffer Curve, see Meeropol, Surrender, How the Clinton Adminisration Completed the Reagan Revolution (U. Michigan Press, 2000): 46-48, 79-81. For a textbook treatment see Meeropol and Howard Sherman, Principles of Macroeconomics: Activist vs. Austerity Policies (M.E.Sharpe, 2013): 333-336. The Laffer curve was first introduced in a 1975 article by Jude Wanniski, “The Mundell-Laffer Hypothesis,” in the journal The Public Interest vol. 39 (spring, 1975): 31-52. Supposedly, Laffer drew his curve on a napkin in a Washington, DC restaurant for Representative Kemp who then introduced a three year 30% income tax cut (co-sponsored by Senator William Roth of Delaware) in 1978. That Kemp-Roth tax bill was later rewritten as the Economic Recovery Tax Act in 1981, the centerpiece of what came to be known as Reaganomics. The profile of Laffer in the New York Times is on page A19 on April 26, 2017. The article includes a drawing of the famous Laffer curve. Note that there is no number for the tax rate at which the curve begins to show declining revenue though Laffer drew it as if the rate were 50%.]
After Laffer convinced Kemp to introduce the three years of tax cuts, the love affair of Republican politicians with tax cutting began. First capital gains taxes were cut in 1978. Then, in 1981, Ronald Reagan convinced Congress to pass a modified version of Kemp’s three years of tax cuts. On April 19, in the NY Times, Laffer and three other like-minded economists asserted that the Reagan tax cuts ushered in one of the longest periods of prosperity in American history. They also stated that President Kennedy’s 1964 tax cut did the same.
[See Arthur Laffer, Steve Forbes, Lawrence Kudlow, and Stephen Moore “Why Are Republicans Making Tax Reform So Hard?” https://www.nytimes.com/2017/04/19/opinion/why-are-republicans-making-tax-reform-so-hard.html?_r=0]
The article urged Trump to work with Congress to do something similar – cut the corporate tax rate from 35% to 15%, permit businesses to deduct the full cost of every investment rather than spreading out the deduction over a few years, and a few other steps that (they claim) will reduce the burden of taxation and regulation on American business, thereby creating jobs. As a sop to ordinary folks, they recommend an infrastructure program. The fine print shows that program actually to be an effort to privatize our roads and subsidize more drilling for fossil fuels. Between the date I recorded this and date the commentary was broadcast, Trump himself released a one-page outline of some of his tax proposals – with virtually no details. The one-page summary did include a cut in the corporate and small business tax rate to 15%. (Currently, small businesses including partnerships and closely held companies like Trump’s own business pay at the individual top rate of 39.6%.) As a sop to middle class taxpayers, the proposal involved doubling the standard deduction so that the first $24,000 of income for a married couple would be tax free. There was no sop to Democrats with even a hint at an infrastructure proposal, so even the giveaway version supported by the four economists in the NY Times on April 19 was not included. With a nod to tax reformers, most special deductions would be abolished except for the two biggest --- the interest on real estate and charitable contributions. The abolition of the deduction for state income taxes has a political goal --- sticking it to states which raise lots of money from an income tax --- states like California and New York. Billionaires got major tax relief because the estate tax would be completely abolished (right now only estates of $11 million or more pay anything) as would the alternative minimum tax (AMT).
[In the one example of the recently released pages from Trump’s 2005 tax return, the AMT made the difference between him paying only $5.3 million instead of $36.3 million because the AMT caused him to pay an additional $31. See Ian Salisbury, “This Controversial Tax on High Earners Is Key to Understanding Trump's Leaked 2005 Returns”http://time.com/money/4701799/trump-tax-returns-alternative-minimum-tax/ (March 14, 2017) So abolishing the AMT would put lots of money directly into Trump’s pocket.]
For details on the non-plan, see the article in the April 26, 2017, New York Times https://www.nytimes.com/2017/04/26/us/politics/trump-tax-cut-plan.html.
There is an old saying that history repeats itself, one time as tragedy, two times as farce. We have seen this story that tax cuts will magically produce a glorious economics future before. I spent the decades of the 80s and 90s teaching and writing about Reaganomics and I can tell you that the assertion by these four economists and Trump’s cabinet members as well as Paul Ryan and other members of Congress is utter nonsense.
Yes, Reagan’s tax cuts helped end a deep recession in 1983 and there was a long period of economic growth from that year till 1990. But that was not because the supply side tax cuts magically increased incentives. Instead, there was good old fashioned Keynesian economic stimulus --- lower taxes increased disposable personal income and the result was a rise in consumption. The rise in consumption spending (coupled with cuts in interest rates by the Federal Reserve in December of 1982) led to a recovery in 1983 and growth from then till the next recession in 1990. But in fact, those years saw lower rates of investment and slower growth in productivity and higher unemployment than in previous years – including the “bad old days “ of the Jimmy Carter Administration. More significant, there was slow growth in the median income of year-round full time male workers. For details see Meeropol, Surrender, pp. 150-168.
[The reason I am referencing the income of year-round full time MALE workers is because the 1980s saw the end of the great transformation of the American middle class family from a single-male breadwinner (the standard through the 1960s) to a two earner family (with massive increases in the labor force participation of women). During that period, the median incomes of year round full-time female workers grew dramatically, not because wages in general grew but because women began to move into more skilled and highly paid jobs than they had previously occupied. This was in large part due to the decline (but not elimination) of the discriminatory barriers to women entering well-paying professions and job categories. Thus, the increase in women’s wages reflected the movement of women from lower paying jobs to higher paying jobs --- not a decent increase in the wages of people already in those higher paying jobs. The wages of year-round full time male workers more appropriately tracks the trends for those jobs.]
What the four economists writing for the New York Times do not state is that despite tax increases in 1990 and in 1993 (the latter increase saw right-wing economists and all Republicans in Congress claiming that this tax bill would destroy the economy), the years from 1992 to 2000 saw the income of year round full time male workers increase at a faster rate than during the Reagan years. Unemployment was much lower as well.
The first repeat of Reagan’s policies --- the tragedy part --- occurred under George W. Bush. These writers, having told us how wonderfully successful Reagan’s tax cuts had been, fail to tell us that Bush II’s Reagan-style tax cuts in 2001 and 2003, led to the stagnation of the incomes of year-round full time male workers, and that this group never regaining the level they had reached in 2000 for the entire period of economic recovery under Bush II. [For more details about the economy under President George W. Bush, see Meeropol and Joao De Souza, “Looking for Causation in the Wrong Place: Why Decrying Government Deficits During the Bush Presidency is a Serious Error,” in Bose, Meena and Richard Himelfarb, edd. The George W. Bush Presidency: Domestic and Economic Policy Vol. 2 (NY: Nova Publishers, 2016): 19-30.)]
The most significant thing that happened as a result of what I’ve called THE REAGAN REVOLUTION – which in my opinion basically continued through both the Clinton and the Bush II Administrations --- was the beginning of the massive increase in inequality that raised the percentage of total income received by the top 1% from below 10% in 1977 to over 20% before the financial meltdown of 2008 (it is now back above 20%).
[For details check out the website of Emanuel Saez: http://eml.berkeley.edu/~saez/ The key article is entitled “Striking it Richer” and it has been updated many times since its initial publication. See also Piketty, Thomas and Emanuel Saez, “Top Incomes and the Great Recession and Policy Implications” IMF Economic Review (Vol 61 No 3) which is available on the Saez website as well.]
Nothing in the proposal by the four economists or Trump will do anything to reverse the trend in increased inequality.
There is one aspect of the argument by the four economists that is tangentially useful, and that is when they mention federal budget deficits. Traditional Republican talking points are that deficits are always bad. The four economists argue that the tax changes they are advocating do not have to be revenue neutral – that those tax cuts should be allowed to at least temporarily increase the federal budget deficit. Though I personally think that any argument that counters the knee-jerk demonization of deficit spending is important, even when making their case, they utilize faulty arguments. Tax cutters like these folks continue to insist against all evidence that the RIGHT KIND of tax cuts will pay for themselves while continuing to assert that deficits resulting from increased spending are always unacceptable.
The New York Times of Friday, April 28 didn’t help much. The lead article by James Stewart in the Business section of the paper was entitled “Tax Cuts for Everybody and Responsibility for Nobody.” (p. B1) All the quotes were from people who oppose deficit spending. All numbers are in absolute figures ($4 trillion to $6 trillion added to the federal deficit over 10 years). These numbers mean nothing --- as the economist Dean Baker argues, you might as well just say “really big number” and convey as much information. The reason is because without context (what will happen to the debt to GDP ratio as a result of that borrowing?) we know nothing about the impact of this projected increased borrowing. In 2016, GDP was about $18.5 trillion. Taking the larger number of $6 trillion and dividing it by 10 gives us 600 billion per year which is less than 4 percent of GDP. The ratio of the debt to GDP in 2016 was 104%. Adding another 4% is not going to make much of a difference. However, the worst assertion in the article was the following: “…. Most [economists] argue it [higher deficits] would drive up interest rates, curbing the very growth the cuts were intended to foster.” It is totally untrue that MOST ECONOMISTS believe higher deficits always drive up interest rates, curbing economic growth.
The era when government debt rose dramatically during peacetime was, of course, the 1980s under Ronald Reagan. The most dramatic reduction in federal borrowing occurred during the second term of President Bill Clinton. I have researched both periods and have discovered that there is absolutely no relationship between rises or falls in federal borrowing and interest rates. [Check out Meeropol Surrender: pp. 162-165, 170-176. See also Carlos F. Liard-Muriente and Michael Meeropol "The myth of Rubinomics", Humanomics, Vol. 25 Issue: 3, (2009) pp.204-216, doi: 10.1108/08288660910986937] There was a detailed analysis of 42 separate studies of the relationship between federal deficits and interest rates published in 1991 (Rudolph Penner, ed. The Great Fiscal Experiment, Washington, DC: Urban Institute Press). ; In one chapter, the researchers found that seventeen studies concluded that rising deficits lead to rising interest rates, nineteen showed either no impact or a fall in interest rates and six had what were called “mixed” results. (Barth, Iden, Russek and Wohar, pp. 71-141 in the Penner book)
In fact, it has long been clear that when the political party out of power wants to attack the party in power, they complain bitterly about rising deficits and debt and what terrible burdens “we” are imposing on “our grandchildren.” This is a political argument with no real basis in either the historical record or good economic theory. What politicians and their economist enablers following Arthur Laffer have discovered is that they can have their rhetorical cake and eat it too by claiming that their particular brand of tax cuts pay for themselves but that all other government borrowing remains irresponsible. Thus, when President Obama proposed a mixture of tax cuts and spending increases to stimulate the economy in the wake of the financial crisis of 2008 and the Great Recession of 2009 (when the economy was hemorrhaging 700.000 jobs per month), Republicans in Congress decried the big increase in deficit spending and demanded all the stimulus be in the form of tax cuts because, somehow, those would not be damaging deficits.
Despite the hypocrisy displayed by the Republicans who are now embracing the Trump tax cut, I still believe that any proposal that reduces the demonization of deficits in the mind of the public is a positive step. I wish Democrats would not attack Trump’s proposals because they will increase the deficit. [For a discussion of general issues related to deficit spending, see Meeropol and Sherman, Principles of Macroeconomics 341-357.]
In fact, increasing the deficit by spending on infrastructure, research, investment in humans (such as with nutrition programs, education spending or health care spending) will in the end REALLY pay for itself in future economic growth. These are much better reasons to run deficits rather than cutting taxes for billionaires.
The proposals by these four economists and the vague outline presented by the Trump Administration are based on bad theory backed by bad history. They need to be refuted and vigorously opposed. I urge everyone reading this to watch closely when the actual proposal is introduced into the House of Representatives. Reagan-style tax cuts making the rich ever richer while throwing crumbs to the rest of us will be repeating history for the second time --- this time as farce!
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author (with Howard Sherman) of Principles of Macroeconomics: Activist vs. Austerity Policies.
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