Wednesday, May 27, 2009

Art Laffer and Stephen Moore: All dogma, all the time!

No economist has ever taken one idea and milked it as far as Art Laffer has with his supply side/low tax theory. Not even Nobel laureate Milton Friedman was able to keep monetarism as much in the mainstream as Laffer has done with supply side economics.

Now don't get me wrong, I am all for low taxes. Like everybody else I hate it when tax time comes and for what it's worth, I think the United States should eliminate the income tax altogether. We don't need it. There are other ways to apply fiscal drag if necessary (although it hasn't been necessary for the past 80 years, even though we continue to get hefty doses of it) and we can impart value to the currency through measures that have nothing to do with taxation.

But for Arthur Laffer, every single economic problem that you can think of can be fixed by just cutting taxes. When it comes to simplicity and marketing, this guy is another Einstein, however, when it comes to serious economic intellect there's about as much there as a Ritz cracker.

In an article that ran in the WSJ (of course) over the weekend, Art Laffer and his sidekick, Stephen Moore of the WSJ Editorial Board, once again make their case for why low taxes are working wonders for states like Florida, Nevada and Texas and why California, New York, New Jersey and Connecticut--states now considering tax hikes on the wealthy to close budget gaps--are on a path to ruin.

As always, I will deconstruct their arguments.

Please read below. Laffer/Moore comments in italics; my comments are in bold.

With states facing nearly $100 billion in combined budget deficits this year, we're seeing more governors than ever proposing the Barack Obama solution to balancing the budget: Soak the rich.

All states with the exception of Vermont have a legal requirement of balancing their budgets, so they are bound by law or statute to do so. There are basically only two ways to balance budgets: raise revenues or spend less. Revenue growth is either achieved through higher taxation or stronger economic growth (output and employment). Taxation is considered bad while growth is considered good, however, achieving a growth rate higher than the national average without running deficits usually means having some comparative advantage causing the state to run a surplus with the rest of the nation. Typically, states do this by implementing policies that suppress wages. That can be achieved by keeping investment in infrastructure and education low, ensuring a less skilled and productive workforce.

Lawmakers in California, Connecticut, Delaware, Illinois, Minnesota, New Jersey, New York and Oregon want to raise income tax rates on the top 1% or 2% or 5% of their citizens. New Illinois Gov. Patrick Quinn wants a 50% increase in the income tax rate on the wealthy because this is the "fair" way to close his state's gaping deficit.

Connecticut, New Jersey, New York, California and Illinois are among the wealthiest states in the nation with per capita income far higher than the national average. They rank 1, 2, 6, 11 and 12, respectively. Oregon is 31st in the nation and they're proposing a 2% income tax on residents earning over $250,000. In addition, they are cutting laying off 1700 workers (reducing state income and output) and cutting education and infrastructure spending.

Chad Crowe
Mr. Quinn and other tax-raising governors have been emboldened by recent studies by left-wing groups like the Center for Budget and Policy Priorities that suggest that "tax increases, particularly tax increases on higher-income families, may be the best available option." A recent letter to New York Gov. David Paterson signed by 100 economists advises the Empire State to "raise tax rates for high income families right away."

Either raise taxes or implement policies that reduce income and employment or cut spending on education and infrastructure, leading to long-term losses in productivity and, by definition, the standard of living of the residents of the state.

Here's the problem for states that want to pry more money out of the wallets of rich people. It never works because people, investment capital and businesses are mobile: They can leave tax-unfriendly states and move to tax-friendly states.

And the evidence that we discovered in our new study for the American Legislative Exchange Council, "Rich States, Poor States," published in March, shows that Americans are more sensitive to high taxes than ever before. The tax differential between low-tax and high-tax states is widening, meaning that a relocation from high-tax California or Ohio, to no-income tax Texas or Tennessee, is all the more financially profitable both in terms of lower tax bills and more job opportunities.

Laffer and Moore fail to mention that ALL of the high tax states rank among the wealthiest in the nation when it comes to per capita income and gross state product. Yes, some will move, but are they saying a wealthy lawyer from New York will move to Tennessee to practice law, where the gross state product is one-fifth that of New York? Come on!

Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts.

Nevada, Florida and Texas rank 20, 23 and 25 in the nation, respectively, when it comes to per capita income. Florida and Texas both have per capita income below the national average and Nevada is only marginally above. In contrast, California, New Jersey and New York rank among the top in the nation in terms of per capita income and gross state product. The no-tax states may create more jobs, but they tend to be low paying jobs. The only reason they have a no tax policy is because they run surpluses that are mainly the result of trade with the rest of the nation. They are able to do this because of comparative advantage: low wages, few services relative to higher tax states.

Did the greater prosperity in low-tax states happen by chance? Is it coincidence that the two highest tax-rate states in the nation, California and New York, have the biggest fiscal holes to repair? No. Dozens of academic studies -- old and new -- have found clear and irrefutable statistical evidence that high state and local taxes repel jobs and businesses.

Greater prosperity? By what definition? The numbers speak for themselves. All the high tax states that Laffer and Moore mention--Connecticut, New Jersey, New York, California, etc--rank among the top in the nation in terms of per capita income and gross state product. They are merely spouting dogma here. What prosperity does Tennessee have? It ranks 37th in the nation in per capita income.

Martin Feldstein, Harvard economist and former president of the National Bureau of Economic Research, co-authored a famous study in 1998 called "Can State Taxes Redistribute Income?" This should be required reading for today's state legislators. It concludes: "Since individuals can avoid unfavorable taxes by migrating to jurisdictions that offer more favorable tax conditions, a relatively unfavorable tax will cause gross wages to adjust. . . . A more progressive tax thus induces firms to hire fewer high skilled employees and to hire more low skilled employees."

As I said earlier, a skilled lawyer or accountant in New York is not likely to move to Florida because of a tax break that will most likely be completely offset by a concomitant loss in earnings. Perhaps a restaurant or retail worker might move. Moreover, low tax states tend to invest less in education,infrastructure and other services, reducing long-term productivity and competitiveness.

More recently, Barry W. Poulson of the University of Colorado last year examined many factors that explain why some states grew richer than others from 1964 to 2004 and found "a significant negative impact of higher marginal tax rates on state economic growth." In other words, soaking the rich doesn't work. To the contrary, middle-class workers end up taking the hit.

Again, this is dogma. If anything most high tax states are high tax for a reason--they are incredibly lucrative places to live and work. That remains the case today. You don't see Florida, Nevada or Texas anywhere near the top 10 in terms of per capita income. High tax states are richer than low tax states. Laffer could state they're not all he wants, but it's just not true. It's merely his opinion, not fact.

Finally, there is the issue of whether high-income people move away from states that have high income-tax rates. Examining IRS tax return data by state, E.J. McMahon, a fiscal expert at the Manhattan Institute, measured the impact of large income-tax rate increases on the rich ($200,000 income or more) in Connecticut, which raised its tax rate in 2003 to 5% from 4.5%; in New Jersey, which raised its rate in 2004 to 8.97% from 6.35%; and in New York, which raised its tax rate in 2003 to 7.7% from 6.85%. Over the period 2002-2005, in each of these states the "soak the rich" tax hike was followed by a significant reduction in the number of rich people paying taxes in these states relative to the national average. Amazingly, these three states ranked 46th, 49th and 50th among all states in the percentage increase in wealthy tax filers in the years after they tried to soak the rich.

Yes, but Connecticut and New Jersey ranked 8th and 24th in gross state product, which increased 16.4% and 14.5% respectively.

This result was all the more remarkable given that these were years when the stock market boomed and Wall Street gains were in the trillions of dollars. Examining data from a 2008 Princeton study on the New Jersey tax hike on the wealthy, we found that there were 4,000 missing half-millionaires in New Jersey after that tax took effect. New Jersey now has one of the largest budget deficits in the nation.

The stock market was at a major low in 2002 and the Dow did not get back to its 2000 high until 2006. If anything, it was a modest period of market appreciation.

We believe there are three unintended consequences from states raising tax rates on the rich. First, some rich residents sell their homes and leave the state; second, those who stay in the state report less taxable income on their tax returns; and third, some rich people choose not to locate in a high-tax state. Since many rich people also tend to be successful business owners, jobs leave with them or they never arrive in the first place. This is why high income-tax states have such a tough time creating net new jobs for low-income residents and college graduates.

1. Rich residents leave: States with high concentrations of "rich" are often incredibly lucrative places to live (that's why people get rich there) and, therefore, there is a big disincentive to leave. A 1% or 2% increase in the personal tax rate is not likely to get them to go. The biggest factors causing people to go are often social: high or rising crime, poor schools, crumbling infrastructure, lack of services, etc.

2. Possible, but tax "avoidance" is practiced everywhere.

3. Again, the jobs that leave are probably not the high skilled, high paying ones. I don't see too many Wall street bankers moving to Tennessee.

Those who disapprove of tax competition complain that lower state taxes only create a zero-sum competition where states "race to the bottom" and cut services to the poor as taxes fall to zero. They say that tax cutting inevitably means lower quality schools and police protection as lower tax rates mean starvation of public services.

Yes in most cases, by definition.

They're wrong, and New Hampshire is our favorite illustration. The Live Free or Die State has no income or sales tax, yet it has high-quality schools and excellent public services. Students in New Hampshire public schools achieve the fourth-highest test scores in the nation -- even though the state spends about $1,000 a year less per resident on state and local government than the average state and, incredibly, $5,000 less per person than New York. And on the other side of the ledger, California in 2007 had the highest-paid classroom teachers in the nation, and yet the Golden State had the second-lowest test scores.

They even admit that New Hampshire spends less. New Hampshire is an aberration in that it is a low population with a high concentration of excellent universities and secondary schools that maintain high standards for education, generally.

Or consider the fiasco of New Jersey. In the early 1960s, the state had no state income tax and no state sales tax. It was a rapidly growing state attracting people from everywhere and running budget surpluses. Today its income and sales taxes are among the highest in the nation yet it suffers from perpetual deficits and its schools rank among the worst in the nation -- much worse than those in New Hampshire. Most of the massive infusion of tax dollars over the past 40 years has simply enriched the public-employee unions in the Garden State. People are fleeing the state in droves.

New Jersey is far bigger by population, has major urban areas that skew educational levels. However, it still has the the second highest per capita income in the nation and a growing state product. How is that a fiasco?

One last point: States aren't simply competing with each other. As Texas Gov. Rick Perry recently told us, "Our state is competing with Germany, France, Japan and China for business. We'd better have a pro-growth tax system or those American jobs will be out-sourced." Gov. Perry and Texas have the jobs and prosperity model exactly right. Texas created more new jobs in 2008 than all other 49 states combined. And Texas is the only state other than Georgia and North Dakota that is cutting taxes this year.

Compete with China? If he's serious and Perry wants Texas to compete with China, there's just one way to do that--implement policies that keep wages low, very low! (Perry should read, "The Wealth of Nations," by Adam Smith!) And Laffer fails to mention that the oil boom was behind Texas's outsized job gains in 2008. Let's see what it looks like in 2009 and 2010.

The Texas economic model makes a whole lot more sense than the New Jersey model, and we hope the politicians in California, Delaware, Illinois, Minnesota and New York realize this before it's too late.

What??? Texas ranks 23rd in the nation in per capita income. New Jersey ranks 2nd, Connecticut ranks 1st, New York ranks 6th. What is he talking about??? Why does a lower state product and lower per capita income be the goal that other states shoot for?

Bottom line: From 1946-1964 the top tax bracket in the United States was 91% and the economy grew at an average annual real rate of 3.6%.

However, from 1981-2009, under Arthur Laffer supply-side economics and where the top tax bracket is currently 35%, the average annual real GDP growth has been 3.0%!!

Arthur Laffer/Stephen Moore: All dogma, all the time!


Matt Franko said...

Right on with these 2, and all the other supply-side types.
My observations have been that they get the tax cut part right (increases deficit) but then they follow that up with spending freezes and their "growth increases tax receipts to re-balance the budget" (ie fiscal conservatism) and it blows the whole thing up.
They cannot make the connection between the deficits caused by their tax cuts and the corresponding increase in non-govt savings which enables the economic growth!
How can they not see that as WM says: "we just go from fiscal package to the next fiscal package"? Boom and bust, boom and bust, etc...


mike norman said...


Interestingly, many "post-Keynesians," like John Kenneth Galbraith and his son, Jamie (and most liberal Democrats) exhibit the same misunderstanding: They are for higher government spending and investment, but want to "pay for it" by raising taxes. Obama is a perfect example.

Insofar as Warren's comment: "We go from fiscal package to fiscal package..." that HAD been the case up until now, however, if this fails to revive the economy by 2012, we will see a militant conservatism take hold and while it might not get us on the gold standard, it will end the role of fiscal stimulus for good. Balanced budgets and fiscal austerity will become the new, "remedy." Then, we'll need another World War to lift us out of mass poverty. I am very concerned for my kids!

googleheim said...

As for the above two comments :

The Lauffer curve of taxes is very simple and very smart. It is a work of genius - but what good is it if no one uses the entire curve from left to right ??

It seems that for democrats and for republicans that we are always on the right hand side of the bell's hump - that taxes are toooooo high and that receipts from taxes are therefore tooooo low and that the economy is tooooo slow.

Never, ever do they see that certain portions of the economy - geographical, market-wise, or other denomination are on the left hand side such that taxes need to increase.

Here we have a full picture of the curve and it comes from the Pitbull whereas you'd never hear it on the tv or radio.

David said...

Funny that you use 1946-1964 as the time period. Because Hoover raised taxes from 25% to 65% then FDR raised them from 65-95%. But during that period of high taxes did not shorten the Great Depression. Economic growth did not improve after the Hoover or Roosevelt tax increases.

In the immediate post war period. The Republican majorities eliminated many of the anti-business regulations and regimes like the National Relief Association. They weakened the power Unions to collectively bargain in the Taft Hartley act. We opened our borders to trade with Europe through the Marshal Plan and the General Agreement on tariffs and trade GATT. Lowered tariffs and reduced the deficit which the Unions supported. So lets add this up deregulation less union power free trade and lower taxes that sounds like Reaganomics to me.

But also you fail to mention that after 1964 there were medicare medicaid LBJ's alternative minimum taxes higher property taxes etc.
After 1964 there were more taxes and not less taxes. So your focus on the income tax is short sided to say the least.

You have really selective stats. You don't factor in the Hoover Roosevelt years or the time period of 1965-1980 when Keynesian economics reigned supreme. It was Nixon that declared that we are all Keynesians now.

There are many things that effect the economy and therefore effect tax revenue. So to focus on tax increases or tax cuts as a cure all, is wrong.

If the government would take 100% of your income you would not keep working and the government would get 0 taxes dollars. So tax cuts do effect behavior which in turn effects revenue.

Also to say that the high tax states have the highest revenue and the best jobs is a bit misleading. Incomes are higher but so are the costs. If you make 60k a year in California but the cost of a home is ten times your salary at 600k are you really better off than some one who makes 40k but a home costs 120k only three times your salary?

But that calculation does not factor in higher property taxes higher income taxes in Taxes in the Northeast are 5k-10k higher than those in other lower tax states.

So the question is if there are better quality higher paying jobs in high tax states, why are people leaving them? The top 5 departure states were Michigan North Dakota New Jersey New York and Illinois. The top states that people move to are North Carolina Alabama Oregon South Carolina.

Your post has numerous errors, but I don't have time to correct all of them.