Art Laffer On Washington State's Personal Income Tax Initiative

Art Laffer took on the Bill Gates, Sr. and Jr., of Washington state, in one of yesterday's Wall Street Journal editorials. The Gates' are pushing hard for the state to institute a new personal income tax.

Here's how Laffer described it,

"Mr. Gates Sr. has personally contributed $500,000 to promote a statewide proposition on Washington's November ballot that would impose a brand new 5% tax on individuals earning over $200,000 per year and couples earning over $400,000 per year. An additional 4% surcharge would be levied on individuals and couples earning more than $500,000 and $1 million, respectively.

Along with creating a new income tax on high-income earners, Initiative 1098 would also reduce property, business and occupation taxes. But raising the income tax is the real issue. Doing so would put the state's economy at risk.


To imagine what such a large soak-the-rich income tax would do to Washington, we need only examine how states with the highest income-tax rates perform relative to their zero-income tax counterparts. Comparing the nine states with the highest tax rates on earned income to the nine states with no income tax shows how high tax rates weaken economic performance."

Laffer's a good, empirical economist. He immediately took ends of the distributional spectrum of US states with respect to tax rates, and found,
"In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51%, and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%.
 
Over the past 50 years, 11 states have introduced state income taxes exactly as Messrs. Gates and their allies are proposing—and the consequences have been devastating.
 
Over the past decade, the nine states with the highest tax rates have experienced tax revenue growth of 74%—a full 22% less than the states with no income tax. Washington state has done better than the average of the nine no-tax states. Why on earth would it want to introduce a state income tax when it means less money for state coffers?


What's true for those states with the highest tax rates is doubly true for the 11 states that have instituted state income taxes over the past half-century. They too have lost huge sums of tax revenue."

Here's the revealing table from his editorial.

As a sort of coup de grace, Laffer offered this,
 
"A final thought for those who want to punish the rich for their success: As the nearby chart shows, those states with the highest tax rates, and those states that have introduced state income taxes, have seen standards of living (personal income per capita) substantially underperform compared to their no-tax counterparts."
 
I won't quote his parting shot to the Gates, but you can guess the nature of it.
 
Just focusing on Laffer's statistics and chart, it's a stunning picture that he paints. With the publication of this piece, why would any state be mad enough to initiate a personal income tax? Or raise the rate of one it already has?
 
Laffer doesn't mention it, but, surely, the same relationships must hold between countries, as well.
 
He has done a wonderful job providing clear, unmistakable evidence that higher tax rates depress standards of living and output. Period.

Looks Like We'll Be Getting More Unemployment

Thanks to the vote of deceased West Virginia Senator Robert Byrd's replacement, and the Senate's two stealth Democrats, Snowe and Collins, both of Maine, the Senate proceeded to end debate about extending unemployment benefits for the eighth time. The $34B price of this benefit will, once again, be furnished by borrowing, rather than cutting other government expenses or discretionary spending.

As Art Laffer wrote recently in the Wall Street Journal,

"On the face of it, the idea that higher unemployment benefits won't lead to more unemployment doesn't make much sense."

Here's what yesterday's lead Journal staff editorial had to say on the topic,

"In the immediate policy case, Democrats are going so far as to subsidize more unemployment. If you subsidize something, you get more of it. So if you pay people not to work, they often decide . . . not to work. Or at least to delay looking or decline a less than perfect job offer, holding out for something else that may or may not materialize.

The economic consensus—which includes Obama Administration economists in their previous lives—couldn't be clearer on this. In a 1990 study for the National Bureau of Economic Research, labor economist Lawrence Katz found that "The results indicate that a one week increase in potential benefit duration increases the average duration of the unemployment spells of UI recipients by 0.16 to 0.20 weeks." "

To highlight the failure of the current administration's economic efforts to facilitate the creation of, or directly create jobs, the same editorial opened with this scathing passage,

"Presidents typically invite Americans to appear at Rose Garden press conferences to trumpet their policy successes, but yesterday we saw what may have been a first. President Obama introduced three Americans—an auto worker, a fitness center employee and a woman in real estate—who've been out of work so long they underscore the failure of his economic program. Where are his spinmeisters when he really needs them?"

I don't think anyone with any common sense really believes that extending unemployment benefits has anything to do with job creation, do you?

But, thanks to the Senate, we're going to actually see more unemployment, as the federal government votes to pay people more and longer not to work.

How's that for sensible economics? And with money borrowed in your name.

Art Laffer In The WSJ On Unemployment Insurance

Art Laffer wrote a superb piece in yesterday's Wall Street Journal entitled Unemployment Benefits Aren't Stimulus, exposing the folly of too lavish and long-lived unemployment insurance.

Employing a simple series of thought experiments, Laffer debunked several myths regarding paying high levels of unemployment insurance. For example, he wrote,

On the face of it, the idea that higher unemployment benefits won't lead to more unemployment doesn't make much sense. Imagine what the unemployment rate would look like if unemployment benefits were universally $150,000 per year. My guess is we'd have a heck of a lot more unemployment. Common sense and personal experience indicate higher unemployment benefits will make unemployment less unattractive and thereby increase unemployment even in the Great Recession. As the chart nearby clearly shows, since the 1970s there's been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today don't have the data to back up their claims.

Then he addressed another argument for high and long unemployment benefits,

The second point made by the Obama administration is that unemployment benefits are a great way to stimulate demand. Increased unemployment benefits operate quickly and the recipients spend what they get, which makes these stimulus funds the best bang for the buck.

Here again the facts are in dispute. Studies have shown that previous stimulus spending—much of which was also targeted for the poor and unemployed—was to a large extent saved and not spent. But I'm not going to rest my case on the obvious failure of Washington's prior stimulus packages. Based upon the above logic (as described in the January 2009 white paper co-authored by White House economists Christina Romer and Jared Bernstein) the administration forecast that the unemployment rate would be a little above 7.3% in the third quarter of this year. That isn't going to happen.

The flaw in their logic is that when it comes to higher unemployment benefits or any other stimulus spending, the resources given to the unemployed have to be taken from someone else. There isn't a "tooth fairy," or as my former colleague Milton Friedman repeated time and again, "there ain't no such thing as a free lunch." The government doesn't create resources. It redistributes them. For everyone who is given something there is someone who has that something taken away.

While the unemployed may spend more as a result of higher unemployment benefits, those people from whom the resources are taken will spend less. In an economy, the income effects from a transfer payment always sum to zero. Quite simply, there is no stimulus from higher unemployment benefits.

To see this, imagine an economy that produces 100 apples. If 10 of those apples are given to the unemployed, then people who otherwise would have had those 10 apples now won't. The stimulus of 10 apples for the unemployed is exactly offset by the destimulus of 10 apples for those people from whom the 10 apples were taken.

But wait.....there's more! Laffer then examined the behavioral effects of lavish unemployment benefits.



To see these effects clearly, imagine a two person economy in which one of the two people is paid for being unemployed. From whom do you think the unemployment benefits are taken? The other person obviously. While the one person who is unemployed may "buy" more as a result of unemployment benefits, the other person from whom the unemployment sums are taken will "buy" less. There is no stimulus for the economy.


But it doesn't stop there. While the income effects sum to zero, the substitution effects aggregate. The person from whom the unemployment funds are taken will find work less rewarding and will work less. The person who is given the unemployment benefits will also find work relatively less rewarding and will therefore work less. Both people in this two-person economy will be incentivized to work less. There will be less work and more unemployment.


Not only will increased unemployment benefits not stimulate the economy, they will at the same time lower the incentives for people to work by reducing the amount people are paid for working and increasing the amount people are paid for not working. It's pretty basic economics.

I found this last phenomenon quite interesting. Laffer points out that by implicitly or explicitly taxing workers to transfer their wages to the non-working, the government cuts the value of work and, presumably, reduces the incentive to work. Multiply that over a few hundred million workers, and you have France, I guess. You certainly have less motivated and productive US workers.

Laffer's final point is one which others, including me, have made,


My suggestion would have been to take all $3.6 trillion and declare a federal tax holiday for 18 months. No income tax, no corporate profits tax, no capital gains tax, no estate tax, no payroll tax (FICA) either employee or employer, no Medicare or Medicaid taxes, no federal excise taxes, no tariffs, no federal taxes at all, which would have reduced federal revenues by $2.4 trillion annually. Can you imagine where employment would be today? How does a 2.5% unemployment rate sound?



If this doesn't debunk Nancy Pelosi recent idiotic remarks regarding the best approach to create jobs is to increase unemployment benefits, nothing will.

Art Laffer In Today's WSJ

You can't say Art Laffer is ambivalent about his opinions. His editorial in today's Wall Street Journal, entitled Tax Hikes and the 2011 Economic Collapse, holds nothing back.

Despite having been Reagan's economic adviser, Laffer didn't write a partisan piece. While parenthetically noting which administration has chosen to raise taxes, he concentrates almost exclusively on empirical evidence of tax rate increases and decreases, and associated economic activity.

On the strength of just this evidence, Laffer projects the coming rise in existing tax rates, and new taxes, at the dawn of 2011, into a renewed recession. Thus the article's title.

The details of next year's tax rate hikes are chilling. Did you realize that the top personal federal income tax rate rises to 39.6% from 35%, a 13% increase? Or that the highest dividend tax rate rises to the same 39.6% rate from 15%? How about the capital gains tax rate rising by 33%, from 15% to 20%?

These are stunning marginal increases which, as Laffer illustrates, are sure to have compressed economic activity into this year, in order to escape these coming higher rates.

This quote from Laffer's piece puts his opinion right out in the open,

"Consider corporate profits as a share of GDP. Today, corporate profits as a share of GDP are way too high given the state of the U.S. economy. These high profits reflect the shift in income into 2010 from 2011. These profits will tumble in 2011, preceded most likely by the stock market."

Laffer's observations seem so simple and intuitive, yet don't seem to be generally acknowledged. He writes,

"It has always amazed me how tax cuts don't work until they take effect. Mr. Obama's experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011.

If you thought deficits and unemployment have been bad lately, you ain't seen nothing yet."

Nobody can say Laffer hasn't placed a rather large stake in the ground with his prediction of the US economy returning to recession next year, absent relief from the coming tax rate increases.

Art Laffer's Recent WSJ Piece

Noted economist Art Laffer wrote a sobering piece in yesterday's Wall Street Journal. I would have gotten to his piece later yesterday, but a number of searches which brought people to my blog were about Laffer and the Journal, so I knew he must have written a new editorial.

There are quite a few economists who write on the pages of the WSJ from time to time. Brian Wesbury, one of my favorites, has been absent for some time. But those who still contribute include Robert Barro and Alan Reynolds, to name two more.

While not a degreed economist myself, I have studied the discipline with great interest since my freshman year in college. I've read a number of basic texts, including Keynes' work, and one of his contemporary critics, Michael Hutt.

I've come to feel comfortable reading and evaluating various economists' monographs. In this vein, Laffer's recent piece is very troubling.

Without going into details, Laffer addresses the 1930s as the milestone by which current fiscal and monetary powers that be are measuring themselves. Laffer begins by discussing the initially too-tight monetary policy of the Depression, and current Fed Chairman Bernanke's determination to avoid making that mistake again.

At this point, Laffer takes a turn into tax policy. Framing Smoot-Hawley as a tax, which it most assuredly was, he provides evidence of enormous increases in a myriad of tax rates. He observes,

"The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I'd give to all who will listen, it is that the U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s."

Laffer then cites the current slated rise in state tax increases at 3.1% rate, the highest in almost twenty years. Further, he notes the 'cap-and-tax' legislation and health care levies as heading in this wrong direction.

He then turns to Milton Friedman and Anna Schwartz on the subject of gold.

Following the twists and turns of the period's gold policy, Laffer notes two rather obscure facts. First, FDR forcibly took gold from the US populace at $20.67/ounce, then, less than a year later, devalued the dollar to $35/ounce. He both seized assets, and unintentionally sparked inflation, with two gold-related actions.

And this was technically fiscal policy, because, as Laffer points out, it was FDR's doing, not the Fed's.

Laffer concludes with a rather astounding statement of facts. The consequence of FDR's actions, in concert with the Fed, by mid-decade, produced consumer price inflation of roughly 15% from 1933-37, during a period of double-digit unemployment.

He finishes his editorial with these words,

"The lessons here are pretty straightforward. Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon.

My hope is that the people who are running our economy do look to the Great Depression as an object lesson. My fear is that they will misinterpret the evidence and attribute high unemployment and the initial decline in prices to tight money, while increasing taxes to combat budget deficits."

There's no getting around what Laffer is saying. He bemoans the fact that fiscal tax policy can easily exist with lax monetary policy, ushering in a lethal economic brew of stagflation. That is, high unemployment, deficits, and high inflation. Because economic management is split between an administration and the Fed, this is a perennial risk.

As Laffer notes, Bernanke is already doing his part to over-inflate money supply. The current governments, state and federal, are repeating the mistakes of FDR's administration during the Depression, raising taxes to new heights.

This is the type of economic piece which causes me do dispute James Grant's recent cock-eyed optimism.

I had lunch earlier this week with my friend, B. He is a PhD with a focus on the history of monetary systems. He is currently concerned about inflation. As a member of a prominent think tank's board, he frequently participates in conferences and discussions of selected topics. Recently, he presented a paper concerning the sources and consequences of the recent financial debacle. B, and his colleagues, all fear hyper-inflation far more than a Depression.

And they are all pretty convinced we are headed in that direction. As Laffer notes, just because we have retarded economic activity today does not in any way mean we can't, or won't, also manage to ignite serious inflation.

The Fed had doubled the monetary base in the past year, as Laffer pointed out early in his editorial. The Fed is buying Treasuries, monetizing our own debt, too. The financial markets have responded by using the printed money and Fed cash to push up asset prices and keep interest rates low. Laffer remarked on this yesterday afternoon, on Neil Cavuto's Fox News program. With so much government liquidity flooding markets, he explained, of course equity prices are on a tear, as are commodities. But Laffer sees this sparking inflation within a few years.

Laffer quoted the esteemed late Milton Friedman,

"Inflation is, everywhere, a monetary phenomenon."

And monetary policy is probably the easiest in our Republic's history. Printing presses wide open and Congressionally-legislated deficits doubling through the next decade.

We have, as Laffer noted, a nearly-exact replay of the Great Depression's monetary and fiscal mechanics now in full swing. Monetary easing combined with fiscal irresponsibility that is resulting in higher tax burdens.

This is why I don't see an imminent, nor prolonged real economic recovery underway in the US at this time.

Art Laffer Again On the Coming Hyper-Inflation

Last October, shortly before the November election, economist Art Laffer wrote a blistering piece in the Wall Street Journal, on which I wrote this post.

Before knowing of the extensive governmental intervention into autos and, planned, into healthcare, Laffer wrote,

"If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."

In last Wednesday's Journal, Laffer was even more bleak. He wrote,

"Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That's more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers' expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs -- such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid -- are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10 (see chart nearby). It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless. The currency-in-circulation component of the monetary base -- which prior to the expansion had comprised 95% of the monetary base -- has risen by a little less than 10%, while bank reserves have increased almost 20-fold. Now the currency-in-circulation component of the monetary base is a smidgen less than 50% of the monetary base. Yikes!

Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.

In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession. While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it's a Hobson's choice. For me the issue is how to protect assets for my grandchildren."

Laffer's a pretty smart guy. His insights into the likely hyper-inflation dovetail neatly with his October piece. It's hard to see how inflation won't be coming barrelling into the US economy soon. Those who keep saying they are more worried about deflation seem to have forgotten the Carter years.

Given the expanded monetary base, how on earth will inflation not roar ahead, with so many dollars shoved into international portfolios?

Frankly, I'm at a loss as to understand how the equity markets can have risen some 30% in two months or so, with these numbers available for all to see.

Art Laffer's Editorial In Today's WSJ

Economist Arthur Laffer wrote a notable editorial in today's Wall Street Journal entitled, "The Age of Prosperity Is Over."

It would be difficult to understate the sense of gravity that Laffer conveys in this piece. There's no way to adequately quote just a few of the passages and do the piece article justice.

Perhaps one way to begin is to let the graphic accompanying the editorial, seen nearby, speak for itself. If I'm not mistaken, it is meant to portray the familiar 'Monopoly Man' in tatters.

Just the same, here are a few passages from Laffer's piece, to give you the main points in his argument,

"When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction.

But here's the rub. Now enter the government and the prospects of a kinder and gentler economy. To alleviate the obvious hardships to both homeowners and banks, the government commits to buy mortgages and inject capital into banks, which on the face of it seems like a very nice thing to do. But unfortunately in this world there is no tooth fairy. And the government doesn't create anything; it just redistributes. Whenever the government bails someone out of trouble, they always put someone into trouble, plus of course a toll for the troll. Every $100 billion in bailout requires at least $130 billion in taxes, where the $30 billion extra is the cost of getting government involved.

If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan's tax cuts, Paul Volcker's sound money, and all the other pro-growth, supply-side policies.

The stock market is obviously no fan of second-term George W. Bush, Nancy Pelosi, Harry Reid, Ben Bernanke, Barack Obama or John McCain, and again for good reasons.

These issues aren't Republican or Democrat, left or right, liberal or conservative. They are simply economics, and wish as you might, bad economics will sink any economy no matter how much they believe this time things are different. They aren't.

The consequences of these actions were disastrous. Just look at the stock market from the post-Kennedy high in early 1966 to the pre-Reagan low in August of 1982. The average annual real return for U.S. assets compounded annually was -6% per year for 16 years. That, ladies and gentlemen, is a bear market. And it is something that you may well experience again.

Yikes!

Then we have this administration's panicked Sarbanes-Oxley legislation, and of course the deer-in-the-headlights Mr. Bernanke in his bungling of monetary policy.

There are many more examples, but none hold a candle to what's happening right now. Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity."

Strong stuff, to be sure. And make no mistake, Laffer is an economic heavyweight. It is chillingly easy to see his predictions coming true with sickening results for the next 15 or so years.

Then, on the other hand, we have Brian Wesbury calling attention to 'internet time,' as I discussed in this recent post, which links to my original piece on Wesbury's observation, here.

To me, the question is whether Wesbury is correct, and voters will stop a second round of the socialization of the US economy- and society- which will make FDR and LBJ look like fiscal and social conservatives.

Or is Laffer correct, and US voters will cling to fear and government handouts, causing a long winter of economic sluggishness and the temporary- we hope- vanishing of the risk-taking, innovative economic behavior that so distinguishes the US economy?

I don't see Laffer's comparison of the current situation with Hoover from 1929-32. A much better one would be with FDR's NRA and, to some extent, the over-regulation of the US economy in the early 1970s- precisely when Laffer served in George Schultz's OMB. Perhaps, too, with elements of LBJ's large-scale, expensive social programs of the mid-1960s.

Laffer's piece does one really good thing. It reminds us of a possible, extremely bad economic result if the current financial and economic situations are resolved badly, with too much government control and spending.

Hopefully, reality will stop far short of Laffer's chilling prediction of doom. Perhaps due to the effects predicted by Brian Wesbury.

As I noted in a discussion with my business partner yesterday, no two financial or economic crises are ever identical.

In this case, the easily- and freely-available information both to and from average Americans, and, thus, among them, via the internet, short circuits much of the ability of government or a favorable, liberally-biased press to hide the truth.

Wesbury believes that this will create "real political pain" for the politician who gets it wrong.

Let's hope he's correct, so the full extent of Art Laffer's gloomy prediction never comes to pass.