Laffer’s Latest Curve Ball

By John Miller

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The Bill Gates Income Tax

It’s one thing to believe in bad policy. It’s quite another to push it on others. But Mr. Gates Sr.—an accomplished lawyer, now retired—and his illustrious son are now trying to have their way with the people of the state of Washington.

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. ...

If Washington passes Initiate 1098, ... it’s economic suicide. Over the past 50 years, 11 states have introduced state income taxes ... and the consequences have been devastating.

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 [the nine states with no income tax].

—Op-ed by Arthur Laffer, Wall Street Journal, October 5, 2010

Arthur Laffer throws yet another curve ball.

Arthur Laffer surely does know a thing or two about bad policy and pushing bad polices on others. In the 1980s and again in the last decade he was wrong about national tax policy and damn pushy about it. Now he is pushing the same bad tax policy on state governments.

Laffer, the supply-side economist, is best known for the “Laffer curve,” supposedly penned on the back of a napkin, which purports to show that lower tax rates will collect more tax revenues than higher tax rates by encouraging an explosion of economic activity.

A nice doodle, but, as it turned out, not such good tax policy. The Reagan tax cuts of the 1980s and the Bush tax cuts of last decade both slashed the tax rates for the rich as Laffer recommended. But in neither case did the lower tax rates cause the economy expand enough to recoup the revenues lost due to reducing rates. In both cases the tax cuts opened up large budget deficits. The 1981 Reagan tax cuts were followed by an economic expansion that grew no faster than the typical economic expansions of the last sixty years, and the 2001 Bush tax cuts were followed by an economic expansion that grew more slowly than any economic expansion in the last six decades.

But Laffer is undeterred. He is peddling more of the same as he inveighs against Washington State Initiative 1098, which would tax state residents with incomes over $200,000 at the same time that it lowers its property and business taxes. Laffer calls the Washington initiative, which would do much to boost progressiveness of the state’s tax code, “economic suicide.”

Why? Taxing the rich through progressive taxation is counterproductive, according to Laffer. He offers what is supposed to be a simple and clear demonstration in his opinion piece: the economies of the eleven states that have introduced a state income tax in the last 50 years have underperformed the nine states with no income tax.

While Laffer’s demonstration of his claim is indeed simple, it is hardly clear. As it turns out, the nine states with no income tax are no more prosperous than the eleven states that enacted an income tax over the last 50 years. Laffer uses per capita income to measure economic performance. But average per capita income for the no income tax states, at 101% of the national average in 2009, did not exceed, but just matched, the average for the eleven states that had adopted a state income tax.

It is true that the relative position of the eleven income tax states has slipped over the years, as Laffer emphasizes. At the time of the enactment of their income tax, the per capita income in the eleven had averaged 118% of the national average. But the relative position of the no-income-tax states has declined over the last 40 years as well, if not by as much, from 104% of the national average per capita income in 1980.

So the choice, even as Laffer defines it, is between regressive taxes, no higher a standard of living, and slowing economic growth, on the one hand, and progressive taxes, no lower standard of living, and economic growth that had slowed from a higher starting point, on the other hand.

That hardly constitutes a persuasive case that “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,” or for putting those states on a suicide watch. Nor is it a compelling reason to give up on progressive taxation.

The problem with Laffer’s claim is yet more fundamental. No single table or comparison can establish how taxes affect economic prosperity or economic growth. Surely the decline in the position of U.S. manufacturing in the global economy, especially the position of the U.S. automobile industry, tells us more about the fortunes of the Illinois, Indiana, Michigan, Ohio, and Pennsylvania economies (five of the eleven states that have adopted a state income tax in the last fifty years) than does whether or not those states have an income tax.

When economists have tried to look more seriously at the relationship between level of taxation and economic growth, attempting to hold constant the impact of other determinants of growth to isolate the tax effect, those statistical analyses “have come to no consensus,” reports economist Joel Slemrod, director of the Office of Tax Policy Research at the University of Michigan.

Laffer, as his opinion piece makes clear, is not the least bit serious, and for that reason policymakers and voters in Washington State, or other states considering adopting an income tax, should not let what he writes in the Wall Street Journal stand in the way of enacting a progressive state income tax that does no more than to ask those who have benefited the most to contribute the most.

John Miller teaches economics at Wheaton College and is a member of the Dollars & Sense collective.

Sources: Arthur Laffer, The Bill Gates Income Tax, Wall Street Journal, October 5, 2010; Joel Slemrod and Jon Bakija, Taxing Ourselves, fourth edition (The MIT Press, Cambridge, MA, 2008) p. 118; Per capita personal income, Bureau of Economic Analysis, Survey of Current Business.

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