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Don't Bet on the Cover
on March 2, 2010
Arthur Laffer is one of those pragmatic economists who seeks the most efficient way to accomplish a goal. He is the founder of Supply Side theory which is often conflated with Monetarist or Austrian economic thought, but which differs from the others in viewing taxes as central to understanding how an economy does (or does not) function. Writing again with co-author Stephen Moore, this book follows up their immensely popular "End of Prosperity" with a series of suggestions for how the United States can escape what is turning into a long term recession.
Good economics, Laffer argues, is not a "liberal" or "conservative" philosophy; it is simply the application of relatively easy to understand principles to solve problems in political economy. Those who assume that supply side writers have a natural affinity for the political right will be moderately surprised by the praise Laffer gives to the presidency of Bill Clinton and the ideas of Al Gore. But good economics does require a reasoned, thoughtful approach to policy issues. Reactive policies based on panic and fear are generally poor substitutes and Laffer is very critical of both the current administration and the previous one for their responses to the current economic crisis. President Obama, Laffer notes, is a very smart man, but his policies are counter productive to his own stated agenda.
Laffer offers numerous examples of how Obama's policies in fact frustrate economic recovery. His goal of "energy independence" for example ignores the benefits of trade and the comparative advantages that come from it. Generally speaking, if some parts of the world are oil rich but consumer poor, it is in the interest of both the US and these other countries to trade. But Obama's policies compound the problem by actually limiting the productive ways we could achieve greater energy independence. His administration is opposed to nuclear energy, one of the few forms of energy production with minimal carbon emissions (Laffer is neutral on the "science" of global warming, but for the sake of discussion assumes that limiting carbon emisions is a legitimate policy goal) which could easily be used in the United States to supplant power facilities that burn coal and other fossil fuels. In addition, the administration is actively opposing off shore drilling. Obama assumes that by doing so he is helping protect the environment. What he fails to recognize is that oil demand does not diminish just because the United States, which has an unblemished off shore drilling record, declines to access its reserves. If we do not, other countries, many of whom do not have the environmental protections that we do, will drill. Indeed, even as the US has failed to drill off the shores of Florida, the Cubans have done so. And the criticisms that Laffer and Moore offer of Obama's energy policy could be extended many times over to his approach on health care and "job creation" with government stimulus bills.
The bulk of the book, however, concerns tax policy, which is more or less what one would expect of the senior supply side scholar in this country. The proposal to increase taxes on the wealthy (those making more than $250,000 a year) and limit or cut taxes on the poor and middle class is counter productive. In classic supply side fashion, Laffer argues against his critics (notably Jared Bernstein) that raising taxes on the wealthy simultaneously reduces tax revenue from them and also short circuits economic growth. Supply side theory has many political critics, but few informed ones, and the numbers bear out Laffer's argument on both counts. Because the wealthy are so easily able to defer income and find other tax dodges increasing taxes on them does not generate new revenue.
The more radical claim of supply side though is that cutting taxes from the wealthy benefits the poor. (Mostly liberal) critics claim that cutting, or at least not increasing taxes on the "wealthy" benefits only them but not "the poor" whom they argue will face an increasing "gap" between their wages and the wages of the wealthy. This claim is also demonstrably false. The basic premise of the critic's argument is the assumption that the "poor" are a static group. But the reality is studies of the poor over time do show marked improvement. In the period from 1975 to 1998, to cite one of Laffer's more remarkable statistics, over 98% of the households ranked poor were no longer so. Similarly, in just the 10 years from 1996 to 2005 the income of the typical "poor" family increased from $15,000 to $31,000 in real terms. The reason the statistics cited by the critics fail to note this sort of phenomenal growth is that poverty is essentialy a function of a) youth and b) immigration. So as heads of households rise out of poverty, they are replaced by a new group of unskilled workers who become the new "poor" used by liberal critics to show the great disparity between poor and wealthy. But when measuring the gains of actual people as opposed to groups, one cannot argue against the fact that tax cuts for the wealthy were enormously successful at creating wealth across the board.
Needless to add, Laffer and Moore do not think allowing the Bush tax cuts to expire at the end of 2010 will do much to promote economic recovery. Nor do they think a tax increase will result in increased revenue for the government. But the bulk of Laffer and Moore's book is arguing for substantive tax reform as opposed to merely cuts. Some of their arguments will even surprise the crowd who think supply side theory is simply an apology for the wealthy. Laffer and Moore suggest the US abandon its current tax code in favor of a flat tax on income with almost no deductions. They do make an exception for mortgage interest, but that is about it. They even suggest taxing unrealized capital gains yearly, a modification that would do more to "soak the rich" than even the most extreme demands for a tax increase on "those making more than $250,000." The bill for Warren Buffet alone would run into the billions. But a flat tax would have a number of advantages over our current tax code, the most obvious being that it would give the markets a degree of certainty they lack now and would encourage, rather than discourage, growth. Laffer and Moore even propose rolling the payroll tax into the flat tax.
In all, I found this a thoughtful and cogently argued book. Laffer is indeed correct that, if the goal is to maximize government revenue then, to a point (and that point, all evidence suggests, is no higher than a 33% marginal rate) tax cuts, not increases, will do the trick. He is certainly correct that a single flat tax could easily replace our income, payroll and corporate taxes and incidentally save the US billions of dollars just in the cost of collections. And on his policy analysis, he is for the most part correct: a carbon tax is more effective than a cap and trade proposal; high minimum wages do hurt the poorest members of society, free enterprise zones are more cost effective than government welfare programs, and so on. But at some point, I think one has to move beyond the approach of a pragmatic economist. We should ask ourselves, is maximizing government revenue really a good thing? Do we really want a carbon tax instead of a cap and trade scheme if, as we now know in the aftermath of the CRU email and data release, the "science" of global warming is little more than the political agenda of small group of "scientists" who spend much of their time trying to silence their critics? If free enterprise zones are so effective, why limit them to only the poorest neighborhoods?
But an even more important question lurks between the lines of this book. As Laffer notes in the introduction, Mr. Obama is a smart man. He surely knows his tax policies do not match up well to his stated objectives, to say nothing of his purported concern for the environment. He must know that taxing those corporations that waste the fewest natural resources to subsidize those that waste the most (can anyone say "GM?") is counter productive. And yet, he pursues these policies anyway. Laffer charitably suggests that brilliance in one area need not imply the ability to pass Econ 101, but I suspect the problem is of a different nature. The stated policies of Obama do conflict with his stated agenda, but they do not conflict with the agenda of certain corporate lobbies which stand to benefit from the massive government intervention that is happening in the economy. On p. 152, Laffer notes, "No one with good intentions would ever advocate a tax increase" given the facts. At this point, I think it is fair to question the intentions of our rulers. But in any event, I doubt the policy recommendations in this book will be implemented any time soon. So I recommend this book to readers as a delightful intellectual exercise in what might have been. In the meantime, the most likely path facing the United States is 20 years of so of recesion much like Japan has experienced, probably with a massive dose of inflation. A "return to prosperity" is exceedingly unlikely. Readers of this book, at least, will be able to understand why.