Monday, August 02, 2010

Laffer's Laugher

The Big Con is back.

You would have thought that it died with the increase in tax revenues, decline in the budget deficit, and robust economic growth after President Clinton raised income taxes in the face of unanimous Republican opposition. If not, you were sure it died after George W. Bush cut income taxes and cut income taxes and brought a decline in revenues and an explosion of the budget deficit.

But a bad idea cannot die. On July 13, Minority Leader Mitch McConnell (R-KY), the presumptive Majority Leader if the GOP were tragically to take control of the Senate, told Talking Points Memo

There's no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue, because of the vibrancy of these tax cuts in the economy.

As Bob Somerby pointed out, "the chance that McConnell thinks any such thing is vanishingly small. We know he doesn’t believe this dumbest idea for a perfectly obvious reason: McConnell isn’t 'economically illiterate.' Neither are the other big players in his party’s caucus."

That would include Arizona's Jon Kyl, who had a couple of days earlier argued that tax cuts should not have to be offset, which he added represented the majority view in the Republican caucus. And it would include most Bush Administration economists, who expected a cut in revenues from a cut in income tax rates.

But the aptly-named Arthur Laffer and the Wall Street Journal persist despite all evidence to the contrary. Recognizing that one cannot speak ill of the dead- or at least of the assassinated- Laffer joins other conservatives in praising President Kennedy, claiming

When President Kennedy cut the highest income tax rate to 70% from 91%, revenues also rose. Income tax receipts from the top 1% of income earners rose to 1.9% of GDP in 1968 from 1.3% in 1960.

Stunningly misleading, at best, as the website observes from Consumer Price Index data provided by the Bureau of Labor Statistics:

The Kennedy tax cuts are another favorite supply-side myth; many claim that once the tax cuts went into effect in 1964, income tax collections grew. But as you can see from the chart below, growth in income tax collections sharply dropped off:

Federal Income Tax Collections (Constant dollars, CPI-U) (3) (first column, the year; second column, receipts; third column, percent change from previous year)

1961........................................ $138,069 ---
1962........................................ 150,567 (+9.0)
1963........................................ 155,375 +(3.2)
1964........................................ 156,804 +(0.9) < tax cut takes effect
1965........................................ 154,475 -(1.5)

In 1965, the economy was in the fifth year of a nine-year expansion, and for income tax collections to see negative growth was, again, most uncharacteristic. Income tax collections did rise in 1966, but by this time President Johnson was accelerating the economy with Keynesian deficit spending on the Vietnam War. (These deficits he hid by unifying the federal budget with Social Security.) The greater economic activity resulted in more tax collections, and to disentangle any alleged supply-side benefits from the Keynesian benefits is all but impossible.

Obsessed with the impact of tax rates upon economic growth, Laffer argues President Franklin Roosevelt

raised the highest personal income tax rate to 79% from 63% along with a whole host of other corporate and personal tax rates as well. The U.S. economy went into a double dip depression, with unemployment rates rising again to 20% in 1938. Over the course of the Great Depression, the government raised the top marginal personal income tax rate to 83% from 24%.

But as economist Brad DeLong notes

The interruption of the Roosevelt Recovery in 1937-1938 is, I think, well understood: Roosevelt's decision to adopt more "orthodox" economic policies and try to move the budget toward balance and the Federal Reserve's decision to contract the money supply by raising bank reserve requirements provide ample explanation of that downturn. And once those two factors had run its course the continuation of Roosevelt's policies was no obstacle to an investment recovery driven by war-related exports monetary expansion produced by capital flight from Europe.

But as Jonathan Chait notes, "supply siders don't believe in the business cycle. They believe tax rates determine everything." And Laffer's central thesis is that cutting taxes increases revenues. Franklin Roosevelt did increase the tax rate more dramatically than has any president in American history. Nonetheless, Tom Huppi compares the growth in tax collections (from the first year to the last year) for all presidents from FDR to Bush 41. The second largest adjusted for inflation) was 6.4%, under Gerald Ford; the largest, under Roosevelt, 121.3%.

But the most telling evidence comes from the two most recent administrations, in which Bush 43 lowered taxes (impact, on graph below, from Center on Budget and Policy Priorities from CBO estimates) and Clinton 42, who raised taxes. Of the latter, Chait observes

Not only was the deficit cut in half, in keeping with Clinton's goal, but it disappeared altogether, to be replaced by a surplus. This was not merely a product of a stock market bubble, either; productivity, after two decades of stagnation, began growing nearly twice as fast. And despite predictions that soaking the rich would sap their entrepreneurial energies and cause them to report less income, the highest revenue growth came from those same rich who were supposed to be adversely affected. The supply-siders turned out to be spectacularly wrong in every particular.

Cut taxes (for the wealthy) and revenues increase! Tell your friends who are overweight: eat more Oreos, chocolate cake, Butterfingers- and lose weight!

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