Cue the Laffer track when reading latest Wall Street Journal column on Initiative 1098

October 6, 2010 | John Burbank

A new assault on economic wisdom written by Arthur Laffer claims taxing the wealthy will stymie personal income and tax revenue — but it’s a textbook example of using selective data to support a predetermined conclusion.

Arthur Laffer is the originator of the “Laffer curve”, a theoretical premise that as tax rates decline, tax receipts will grow because the decline in tax rates will generate greater economic activity. This notion was used perhaps most famously by Ronald Reagan to promote his administration’s economic policies. But of course, quite the opposite happened when Laffer’s premise was put into practice.

When Reagan cut taxes in 1981, the economy went into a tailspin and tax receipts fell. Individual tax and corporate receipts, in constant dollars, did not reach the level they had been in 1981 until 1987, even accounting for population and productivity growth. By comparison, the Clinton tax increases on the wealthy in 1993 were followed not only by multi-year economic growth, but also by an increase in federal tax collections — so much so that the government was running a surplus at the end of the century.

The same pattern of declining tax receipts and stagnant economic activity followed after the Bush tax cuts in 2001 and 2003. Total income was $2.74 trillion less during the eight Bush years than if incomes had stayed at 2000 levels. Average taxpayer income was down $3,512, or 5.7 percent in 2008, compared with 2000. Had incomes stayed at 2000 levels, the average taxpayer would have earned almost $21,000 more over those eight years — almost $50 per week.

Given the actual history of tax increases and cuts, and revenue growth and decline, it’s no exaggeration to say the Laffer Curve has been thoroughly debunked. It is amazing that Arthur Laffer is still considered a reliable and predictive economist — though it helps to have a platform like the Wall Street Journal.

Laffer sums up his ideology with this statement: “(T)hose 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.” Okay, so let’s compare, starting with those states Laffer highlights in his column.

They are Connecticut, New Jersey, Ohio, Rhode Island, Pennsylvania, Maine, Illinois, Nebraska, Michigan, Indiana, and West Virginia. It is an odd collection of states, those which have adopted an income tax in the last fifty years!

The first thing to note is that most of the states Laffer calls out — Ohio, Rhode Island, Pennsylvania, Maine, Illinois, Nebraska, Michigan, Indiana, and West Virginia — have something thing else in common besides an income tax:  a manufacturing sector in long-term decline that has also been hammered by the nationwide recession. In fact, manufacturing jobs make up more than 10% of the total payroll in those states – a fact Laffer rather conveniently overlooks.

Laffer also fails to recognize that two of the states he mentions — Connecticut and New Jersey — have quite high average personal incomes relative to the rest of the country. Connecticut has best per capita income in the country, topping $54,000. That’s $19,000 more than in our own state. New Jersey is not far behind, at over $50,000. It doesn’t seem that an income tax significantly dampened the standard of living there.

Nor has it in other states with an income tax. In fact, accounting for state population size, the average per capita income of those states with the highest effective tax rates of 6.5% or greater on the top one percent of taxpayers — California, New Jersey, and New York — is $45,000. The average income of the seven states without an income tax — Alaska, Nevada, Florida, Wyoming, South Dakota, Texas, and Washington — is $38,000.

So the top tax states generate $7,000 more in personal income than the no-income-tax states. That’s 18% more personal income. That’s nothing to sneeze at, or to bury with false data.

How about the rich people — where do they live? Proportionally, there are almost twice the number of rich people in Connecticut and New Jersey than in our state. And that is not because of the weather! These states’ effective income tax rates on the top one percent are 4.9% and 6.5%. Ours is zero now, and will be 4% with Initiative 1098 in place.

In fact, millionaires tend to favor the states with the highest per capita state and local tax revenues. According to Phoenix Marketing International’s most recent report, the states with the highest concentrations of millionaires in 2010 were Hawaii, Maryland, New Jersey, Connecticut, and Massachusetts. Effective state income taxes for the top one percent of taxpayers in these states are 5%, 5.8%, 6.5%, 4.9%, and 4.2% — all higher than I-1098’s effective tax rate of 4%. And all five of these states are among the top ten states for highest per capita state and local tax revenues.

Perhaps millionaires might – all things being equal – like to pay lower taxes; but it seems they’d rather not to give up the great schools, high-quality public amenities like museums and parks, and sound infrastructure that our taxes make possible.

UPDATE: Sightline’s able analysts also take on Laffer’s column – it’s worth a read: Wall Street Journal Flunks Math. Again.

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Posted in An Inclusive Economy

Comments

  1. Winslow P. Kelpfroth says:

    Both Laffer’s article and Burbank’s response contain the same logical fallacy: the single cause error, technically, ‘Post hoc ergo propter hoc’. Any economy has millions of moving parts and it is not possible to honestly ascribe any fiscal observation to a single factor, although Laffer’s article has the benefit of multiple observations over the years and is more likely to reliably forecast the outcome of 1098 than Burbank’s rebuttal.
    It is true that after the tax hikes during the Clinton administration federal revenue increased, but that time coincided with the internet bubble. There would have been an increase in federal revenue even if tax rates had remained the same as during the Reagan administration, although this cannot be proven with the same confidence that one would have in conducting a chemistry experiment. Similarly, the economy was entering a recession during Reagan’s first term. Federal revenues did decline during that time, but I assert that those revenues would have declined even without the tax cuts.
    1098 is just the camel’s nose under the tent, folks. There’ll be more to come.

    • You’re half right. Laffer’s article does suffer from fallacious reasoning – as this post by Sightline well illustrates: Wall Street Journal Flunks Math. Again. John Burbank’s rebuttal simply points out that the observable facts don’t support Laffer’s claims – in other words, that the tax cuts supported by Laffer’s theory failed to stop those recessions (much less grow the economy), and failed to improve people’s standard of living. You assert a counterfactual – that revenues would have declined – perhaps even further? – without the tax cuts. What observable facts or data do you have to support your assertion?

      The camel’s nose is a mirage.

  2. Winslow P. Kelpfroth says:

    Tax revenues decline in every recession. Isn’t that what’s happening now?
    By the way, comparing average incomes between states with and without income taxes doesn’t tell the whole story without including the median incomes. In Washington the median income is about $58000 and in Connecticut it’s about $63000. The difference in the medians is less than the difference in the averages. And having spent some time in Connecticut, I perceived that the cost of living is higher than in Washington.

    • Yes, tax revenues tend to decline during a recession, though at different rates depending on the tax. But Laffer theorizes that cutting taxes will increase revenues and improve people’s standard of living. The data doesn’t show that has happened.

      As for comparing average incomes vs. median, or adjusting for cost of living, quality of life, etc. you should tell Laffer. He is the one who uses “personal income per capita” (i.e., average income) to measure of standard of living — and his own data doesn’t even support his conclusion.

  3. Stan Sorscher says:

    Arthur Laffer’s theories are rhetorical vehicles used to justify lower taxes. His ideas were bogus when introduced, and have been discredited even by his political allies in previous administrations.

    The real point of the column is that we will have more growth, more prosperity and better futures for our children if we make public investments in social services, education, physical infrastructure, our justice system and other important public goods.

    Next question; how do we pay for it? An income tax should be one part of a well-designed tax system. Arthur Laffer has nothing useful to tell us about that.

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