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Dr. Arthur Laffer (“Laffer Curve”) on the Current Economy at a Goldwater Institute seminar

Written by Subject: Economy - Economics USA
Dr. Arthur Laffer came to Phoenix to deliver a luncheon lecture on May 10, 2006. While I, and many others, found his talk on the current and future economic situation disturbing and effusively myopic, it was fitting that is was brought to us courtesy of the sponsors of the Goldwater Institute. This institute is named after the beloved (or despised, depending upon your persuasion) Barry Goldwater.

Goldwater was a maverick who personally listed many positive accomplishments in his life, with his elected status barely given a mention. He was a fiscal conservative with a libertarian streak, who often bucked his leadership in the U.S. Senate because his moral compass conflicted with their agenda. He would bask in the controversy and debate that he could instigate by his stubborn refusal to agree with the crowd.

So it was equally appropriate to attend a luncheon where the featured speaker emulated his own cartoon character from the past, to deliver the good news of our economy of the present, in a very entertaining manner. But I get ahead of myself. First, a brief history of Dr. Art Laffer:

Arthur Laffer is an supply side economist, who through contacts and fortuitous circumstance has been immortalized by "The Laffer Curve."

The concept is a graphic illustration of a facet of supply side economics, or “voodoo” economics depending upon which side you favor. The idea is that you can raise taxes only so much with a corresponding increase in tax revenue, until you hit a peak after which increasing taxes will actually result in a lower rate of increase in tax revenue. If this point has already been reached, then lowering the U.S. tax rates would result in more revenue, not less, coming into the treasury.

I happen to believe that this is quite accurate. But if you oppose lowering taxes for anyone, for any reason – and you know who you are – then you are no fan of Dr. Laffer. My problem with Laffer’s approach is it is a formula for government stealing the maximum labor from individuals at the threshold of tolerable discomfort to the average taxpayer. Unfortunately, whether the revenue is present or not, has now been amply demonstrated to have no effect on what elected officials will promise and spend.

Dr. Laffer is the first to admit that he did not come up with this economic concept. In fact he has written a rather nice monologue on the topic, linked below. The concept is certainly an old one, with contributions dating back centuries. I will let him briefly tell how it came to be called the Laffer Curve:

The story of how the Laffer Curve got its name begins with a 1978 article by Jude Wanniski in The Public Interest entitled, "Taxes, Revenues, and the 'Laffer Curve.' " As recounted by Wanniski (associate editor of The Wall Street Journal at the time), in December 1974, he had dinner with me (then professor at the University of Chicago), Donald Rumsfeld (Chief of Staff to President Gerald Ford), and Dick Cheney (Rumsfeld's deputy and my former classmate at Yale). While discussing President Ford's "WIN" (Whip Inflation Now) proposal for tax increases, I supposedly grabbed my napkin and a pen and sketched a curve on the napkin illustrating the trade-off between tax rates and tax revenues. Wanniski named the trade-off "The Laffer Curve."

[From: The Laffer Curve: Past, Present, and Future, by Arthur B. Laffer, Backgrounder #1765, http://heritage.org/Research/Taxes/bg1765.cfm]

While on the faculty of the University of Southern California, Dr. Laffer played a key role in the writing of Proposition 13, the still-controversial California property tax cap initiative that spawned a host of similar laws around the United States and is generally credited with launching the tax revolt of the 1970s and 1980s.

Dr. Laffer became influential during the Reagan administration as a member of Reagan's Economic Policy Advisory Board (1981-1989).

In 1986, Laffer was a Republican primary candidate for the US Senate in California. He lost.

No joke, unbeknownst to him, the always “working every angle to get laid” computer game character Larry Laffer of the famous Leisure Suit Larry series of DOS based computer games was named after him. I suspect Dr. Laffer loved this, as if anything became clear at the talk, Dr. Laffer is appropriately named. He loves to joke … and what is wrong with that? It is probably why he looks less than 45 years of age, for a 65 year old man. To be an entertaining economist is to have people pay attention instead of nodding off.

[source: http://en.wikipedia.org/wiki/Art_Laffer]

So visualize the cartoon character, Larry Laffer wearing a cheerleader dress, enthusiastically bouncing around the stage on his hairy legs and you are ready for the lecture on how wonderful our economy is and will be. (excerpts of Dr. Laffer’s speech below)

“I recently turned 65 years of age … and in my lifetime, I have never experienced an economy that comes close to performing like the current economy.” Unemployment is 4.7%. Real GDP [gross domestic product] growth for the last 13 quarters has run between 3 and 5%. It has been stable, solid, steady.

“I study “profits,” as defined by the Bureau of Economic Analysis, at the U.S. Department of Commerce. They look at the stated profits from tax returns. “This data is unlikely to reflect businesses overestimating their profits on their tax returns. They take these profits and put them on an accrual basis. They use replacement costs for sales out of inventories. They have hundreds of economists that go out and estimate the real lives of plant equipment expenditures, capital. They use replacement costs for appreciation. They have quarterly records on this data going back over a century that can be compared.” Over 6 million corporations today, that can be examined.

“If you look at profits in the United States today, profits are the highest they have ever been in our nation’s history. Not only are they the highest, but profits as a share of GDP are the highest they have ever been. Profit margins are the highest they have ever been, even compared to the go-go 60’s under John F. Kennedy.”

‘Look at inflation. There is no inflation in this economy. You talk about oil prices. We have high oil prices, because the economies of Japan, Europe, China are taking off just as ours are. What do you think would happen to the price of oil if these markets fell?’ [That is, oil prices are currently rising because demand is exceeding supply, not because of inflation. He discounts war as a cause for the higher oil prices we see today, which I disagree with him on, but otherwise I accept his thesis that global demand is “forcing prices into the true market value for oil.”]

“We have a scarce natural resource called oil. When you have a global boom, what is supposed to allocate these resources? The same thing is true of spot commodity prices. This is economics at work. It is not a problem. It is a solution.”

“If you look at interest rates today, where the long bond, the ten year bond is yielding 5%. Anyone remember what the prime was back in 1981? They were at 21.5%. Can you imagine what our market would look like today with a 21.5% prime?”

“You all know that recently interest rates have risen? This is a sign of higher inflation, everyone says. It is not! You can break that long bond yield into two components: The TIPS yield. The Treasury Inflation Protected Securities, which is the real rate of return. And the residual which is the expected rate of inflation.”

“All of that increase in the long bond yield has come about as a result of the TIPS yield. None of it has come about due to a higher expected increase in inflation. This yield reflects the private sector’s expectations of the real rate of return on capital over the next ten years. That is a reflection of a tremendous faith in the strength of the US economy over the past eight months. ”

“Don’t let anyone tell you that these higher real yields are a bad sign. They are the essential element [sic] in prosperity going forward.”

“I love to look at tax rates. If you own capital today, there are only two ways you can get returns: You can get dividends, and you an get capital gains. The federal tax rates on capital gains today are the lowest they have been in my lifetime.”

“The four [rate] killers of a bull market, the items that will bring an economy rapidly to its knees:

1. Fiscal policy. Taxes. We are unlikely to see a tax rate increase in the next two years.”

“2. Monetary policy. High inflation and high interest rates. Paul Volcker came into the Federal Reserve and instituted a rule of spot commodity price stabilization, that today continues to be practiced. Fed policy is in great shape and is not going to kill this economy.”

“3. Trade policy. Any restrictions on the trade and flow of goods across a national boundary; tariffs, quotas, restrictions on trade – any of these things, including immigration bills … when you get high quality labor at low cost, DON’T SEND THEM HOME. Outsourcing [for example China] is wonderful, imports are great.”

“Free trade is an essential element of pro-growth. What are the chances we will have a trade protectionist bill in the next two years? It is pretty small. We have never been less protectionist in our history, nor has the world.”

“4. Incomes policy. All those things that are not fiscal, monetary or trade policies. They are generally all the ways that government can indirectly get at businesses: regulations, restrictions, requirements, minimum wage, wage and price controls, health care … in all of these indirect ways government effects business.”

Q&A (select):

"1. Flat tax: None of the flat tax proposals are ideal. What you really want is a flat tax across ALL income. You may want to exclude “sin taxes,” that is “taxes put into place on an activity that is designed to reduce or prohibit that activity. And you do not want to have an initial exemption of income. What this does is not help the poor, but create a huge dead weight revenue loss to cause those tax rates to go higher.

The best flat tax I have ever seen was the one proposed by Jerry Brown. It eliminated ALL federal taxes … every single one [including those called fees, etc. like social security], and replaced it with two flat taxes: a business rate based upon net sales, and an individual rate on personal unadjusted gross income. If it had come to a revenue neutral position the rate would have come to 11.8%, and there would have been no other federal tax."

"2. You will never win with spending limits. No one [voters] out there finds spending offensive. They like their roadways, the teachers, the firemen, etc. They really dislike their taxes. So if you want to win, you will always propose tax limitations.”

"3. The national debt today is fine. If you take today’s debt and the 10 year bond yield, and assume the national debt in the steady state will be paying the 10 year bond yield. And you take this series back to the beginning of time. Steady state interests as a share of the GDP is the lowest it has ever been. I mean really low. So we are in fine shape. The national debt and the deficits today are exactly what they should be. If I let you borrow all you want a 2% and lend at 10%, how much should you borrow? Borrowing is not bad, in and of itself. It is when you do it and how you do it.”

"4. You don’t want to starve the beast. My view is that government should be our instrument for doing things right. When tax rate revenues rise, tax rate reductions should be automatic."

The audio (in mp3 format) from Dr. Laffer’s talk can be heard courtesy of the Goldwater Institute here (unfortunately the Question and Answer period is not included):

http://design44.phpwebhosting.com/media/audio/5-10-06_Dr_Art_Laffer.mp3

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