Mar 29 2012

Why the UK government buys the Laffer nonsense

Posted by: Nick Shaxson in: Thoughts

About the Laffer Curve. First, read this, and the accompanying links, or this or this.

The very short version of this story is that a corporate tax-cutting ideology was cooked up by some U.S. politicians and quasi-mystics; some of them appear to have been borderline insane. Even Greg Mankiw, former chairman of President George W. Bush’s Council of Economic Advisors, has called Laffer’s adherents ‘charlatans and cranks’.

The economic arguments are complete nonsense, and the claims made by the Laffer Curve adherents have been so thoroughly debunked, time and again. Not least by the evidence.

And yet the UK government and tax authorities appear now to have signed up to this farrago of economic make-believe.

Against all the evidence, and all the economic pointers.

How has this been allowed to happen? Jonathan Chait, the author of a book about the emergence of the Laffer ideology, has a simple explanation, which I mention in Treasure Islands.

“The lesson for cranks everywhere is that your theory stands a stronger chance of success if it directly benefits a rich and powerful bloc, and there’s no bloc richer and more powerful than the rich and powerful.”

Well, yes, that seems to fit rather well in this particular case.

8 comments so far

Tim Worstall 3th March, 2012 5.05 pm

Err, Nick. Mankiw does not call those who push the Laffer Curve argument charlatans and cranks.

Rather, he says that those who state that we are always to the right of the peak are.

For, of course, to state that everyone who even utters the phrase is a crank is to blacken the names of Diamond and Saetz: you know the two guys who just tried to calculate where the peak was for income tax and the paper that every lefty has been drooling over?

So can we get back to reality: the Laffer Curve exists, the question is where it he peak. Dynamic scoring is just accounting for Laffer Effects (either way, whether we’re to hte left or the right of the peak) and tax incidence is such a basic part of economics that I still cannot believe that neither you nor Ritchie is willing to catch on to it.

Nick Shaxson 3th March, 2012 6.32 am

Timmy, timmy. All the evidence is that the peak of the supposed curve (which some have said is shaped more like a bowl of spaghetti than a curve) is so far towards the top of the tax bracket as to be effectively pointless as a basis for discussion. Just the other day, I wrote this:

“If the Laffer curve exists, then it is essential to know whether an economy lies on left of the sweet spot (where tax cuts reduce revenue) or on the right. The U.S. economist Bruce Bartlett reviewed estimates of where the sweet spot’ lies, and all suggested (or read this) that tax rates on both labour and capital would have to rise significantly from current levels to reach the spot – as high as 83 percent. In short, tax cuts reduce revenue.”

The evidence points in the same direction, every time. And yet tax-cutters keep insisting that opposite is true. Why so?

Finally, the incidence nonsense has been so comprehensively taken to pieces, as a basis for policy, I don’t know why you keep banging on about it. Here is one way it’s been knocked down. Here are a few others. And there are others too.

And there’s the small matter of this, too, which you for some reason seem to have been rather quiet about.

Eddie Torres 3th March, 2012 5.53 pm

See also this obituary on Jude Wanniski, former associate editor of The Wall Street Journal, staunch conservative Free Marketeer, and founder in 1997 of an “online learning center” called “Supply-Side University.” His “Two Santa Claus Theory” (1976) argued that US Republicans must become the tax-cutting Santa Claus to the US Democrats’ spending Santa Claus.

Key quote from David Warsh’s 2005 article following Wanniski’s death:

“Like most crackpots, Jude Wanniski went off on a tangent from real ideas. He fell in with a couple of University of Chicago dropouts, Robert Mundell and Arthur Laffer, in 1971, at a momentous time…”

Eddie Torres 3th March, 2012 5.58 pm

Also, in the same article David Warsh quotes Cato Institute president Ed Crane:

“When [U.S. Representatives] Jack Kemp, New Gingrich, Vin Weber, Connie Mack and the rest discovered Jude Wanniski and Art Laffer [in the 1970s], they thought they’d died and gone to heaven. In supply-side economics they found a philosophy that gave them a free pass out of the debate over the proper role of government. Just cut taxes and grow the economy: government will shrink as a percentage of GDP, even if you don’t cut spending. That’s why you rarely, if ever, heard Kemp or Gingrich call for spending cuts, much less the elimination of programs and departments.”

Eddie Torres 3th March, 2012 6.52 am

So, Laffer was a Chicago School “dropout” who then attracted a coterie of Supply Side “crackpots,” which morphed into a cult of Free Market “charlatans and cranks.”

Somewhere along the line they brought in Ayn Rand’s disciples, until one of them eventually admitted that there was “a flaw in the model.”

I’m pretty sure they also missed the part where Ayn Rand modelled her fictional SuperMen on serial killer William Hickman, took Social Security payments, and signed up for Medicare in her old age.

Tim Worstall 3st March, 2012 2.01 pm

“And there’s the small matter of this, too, which you for some reason seem to have been rather quiet about.

Snigger. Just because I attended the university 30 years ago does not mean that I am aware of every piece that you publish on a blog there.

“The process of competition between firms in a market bears absolutely no economic resemblance whatsoever to ‘competition’ between jurisdictions on tax. The former is generally beneficial, while the latter is always harmful.”

Complete and total nonsense.

We will all agree, at least I hope we will, that it is possible to have taxation that is harmful to the general economy? Say, the 130% of profits that the Soviet Union imposed immediately post NEP?

Excellent, thus competition between countries, the mobility of capital to take advantage of those different tax rates can, at least potentially, be beneficial. For the ability to exit means that governments will hesitate to impose taxes of such staggering stupidity.

So your “always harmful” is proven wrong.

“Finally, the incidence nonsense has been so comprehensively taken to pieces, as a basis for policy, I don’t know why you keep banging on about it.”

One must snigger again. For in your Guardian piece you actually work from the position that the tax incidence argument is entirely correct. You argue about whether it falls on employees of shareholders. Which is, clearly and obviously, insisting that it does not fall upon the company. Thus the tax incidence argument is correct. Corporation tax does not fall on the company. The incidence is upon some combination of shareholders and workers. Just as the theory of tax incidence insists.

You writing an article the premise of which is that I am correct does not disprove me now, does it?

Excellent, now we agree that the incidence of corporation tax is not upon the company but upon some conbination of workers and or shareholders we can now discuss the implications of this. We know that the proportionate burdens will depend upon the size of the economy (the smaller the more it falls upon the workers) and the mobility of capital (the more mobility the more upon the workers).

Now, you spend a large part of your life arguing that multinational corporations investing in small and poor countries should be taxed heavily on the profits they make by doing so. Yet, by definition, that capital being invested is multinational and thus mobile, plus they’re small economies. So you’re arguing that we should raise that very subset of corporation tax which falls disproportionately on the workers. In fact, by definition, that part of the burden that falls upon very poor workers.

It just doesn’t sound very progressive to me really: nor sensible even.

Nick Shaxson 4nd April, 2012 8.22 am

Oh dear. Time for some basic, elementary common sense. So you are saying that the process of competition between countries on tax resembles competition between firms in a market? I would suggest you don’t go down there. Martin Wolf: “The notion of the competitiveness of countries, on the model of the competitiveness of companies, is nonsense.” Go and have an argument with him. I’ve laid out my case, and I’m quite busy. I would politely suggest fighting other battles, as this one you will lose. And your Soviet Union example: you have just committed elementary howler #2. Correlation ain’t causation, now, is it? And now howler # 3. You are confusing responses by a single firm to tax rates with responses by the entire investment community to tax rates. Once again, the single example isn’t the whole. Take oil. Countries frequently impose effective marginal tax rates of 90%, and still the investors come, even though many individual investors shy away from very high tax rates. The oil is there, and the investors will come, whatever the tax rates, whatever the reason. But this argument can be widened. Take India’s telecoms market, for instance. A vast, lucrative pool of potential profits. India can impose quite high tax rates, and even though the investors will threaten not to invest in the face of high tax rates, many still will, because the Indian telecoms market is there. Higher taxes just mean a smaller share of net profits for them. But they are still net profits. And now let’s quote someone whom you may admire: George W. Bush’s Treasury Secretary Paul O’Neill. “I never made an investment decision based on the tax code…If you are giving money away I will take it. If you want to give me inducements for something I am going to do anyway, I will take it. But good business people do not do things because of inducements.” And on your last point about developing countries. Let’s take the example of ExxonMobil in Angola. Employing, let’s say, 2,000 people locally, of whom 1,000 are locals. And you tax them a bit more. What will happen? In your world, they will shut down Block 15, sack all the workers and then go and hunt for oil somewhere else, turning their back on 5 billion barrels in the ground?. It’s an interesting idea. You might find some alternative views elsewhere, in the real world. No, the tax will fall on wealthy U.S. shareholders. Very progressive, in fact.

Oh, and I notice that you still haven’t decided to engage on that thing I challenged you on.

UnlearningEcon 4st April, 2012 9.21 pm

Worstall it might help if your comments actually contained some substance instead of smug assertions intertwined with insults aimed at ‘lefties’.

The funniest thing is that empirically the ‘Laffer Curve’ as drawn by Arthur Laffer does not seem to exist – it’s upside down:

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