439: Laffer Curve and Reaganomics, A Game-Changer in Global Economics!

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It is my great pleasure to welcome Dr. Arthur Laffer. I had the pleasure of meeting him many, many years ago when I was about 24 years old and have wanted to have him on the show for quite a. As you probably know, he is the creator of the Laffer Curve, which became such a huge influence on the economy, on fiscal policy, and maybe indirectly monetary policy as well, and the Reagan revolution. So it's a great pleasure to have him here today. Arthur, welcome. How are you?

Thank you very, very much. I'm doing very well, thank you. I'm a little bit older than you are, still 83, but enjoying life enormously.

And you are a busy man, still wielding a massive amount of influence. And I see you all the time in the media, on television, television, et cetera, and you're busy writing books and doing all kinds of great stuff. But you know, I'd like to start out, Arthur, maybe just have you talk a little bit about what is the Laffer curve? Is the napkin story true? You know, that's kind of legendary and lead into maybe what it means for us today. Can it tell us anything about where we're going in terms of the economy and so forth?

Sure. Well, let me. If I can't, but I'll take a few minutes on this if that, if that's okay. Sure. You know, people respond to incentives. Economics is all about incentives. And there are two types of incentives, positive incentives and negative incentives. And obviously taxes are a negative incentive. They tell people what not to do. So when you tax something, you always get less of it. And that, you know, if you're talking about income, that you can get less of it because people earn less. You can get less of it because they shelter their income more, get on more deductions. You can get less because they move to a different location that change the location where tax rates are different. You can get less because of the composition of income. You can get it in capital gains or ordinary. You know, there are all sorts of ways people can get around taxes, although these ways are expensive and usually if you're in the very top groups there, the, the people who really focus on tax rates, high tax rates, are the rich. And they have the means as well to shelter the, to change their income. They can change the volume of their income, they can change the location, they can change the composition, they can change the timing of their income. So all of these things have to be considered as a whole in there. Now, with that having been said, at zero tax rates, when tax rates are zero, obviously the government will collect no revenue whatsoever. People will produce like Madden or an income like Madden, not shelter or do any of that stuff, but there will be no revenue because tax rates are zero. Now, at 100% tax rates, if you went to the office instead of getting a check, you got a bill. Sooner or later you'd have to quit your job because you'd be so poor. So at 100% tax rates, there will be no output. And even though it's a high tax rate, there will be no base upon which to tax. And you'll also get zero revenues. Now, quite obviously, if you lower the tax rates from 100% to 99 to 98 to 97, sooner or later someone's going to come back into earning income, taxable income, and paying it. And likewise, if you raise the tax rate from 0 to 1% to 2%, it just draws a relationship there between tax revenues and tax rates. And there are always two tax rates that collect the same amount of revenue. One very high tax rate which has a high rate on a small base, and one low one which has a low tax rate on a larger base. Right. You know, and you can just see that intuitively. That's just a very common sense thing. It's been around in economics for a thousand years. In the Mukwadima, it's been there. But for some reason in the 40s and 50s and even maybe earlier in the 30s, it had just been forgotten. And everyone always assumed that whenever you raise tax rates, tax revenues would rise by the exact same amount. Right. And, you know, I and a couple of others brought it back into play in the 1960s and 1970s, and it caught fire like, like, like anything. It just was like a wild prairie fire just spreading everywhere. And it's now in common use all over the place. Everyone who.

So, Arthur, it begs the question, is there an optimum rate? And what is that optimum rate?

Well, I would say optimum is a funny word. There's a maximum rate, which you never want to be at, but that rate is the tax rate that would give you the most tax revenues. Why you would ever do that? Because you really want to do the most good for society. Which would not be the most tax revenues would be the proper balance between private income and government revenues. But it depends on several things that are very important. How long you're willing to wait. If you raise tax rates in the first day, you're going to collect a lot more revenue. But then as time goes on and people learn how to avoid it, you're going to collect less. So it depends on how long you're willing to wait. It depends on the size of the tax base. With low tax bases and high rates, people escape and leave and they're just all sorts of things. I think the concept of an optimum rate or a maximal rate is really not a good concept. But what you want to have is the lowest possible tax rate on the broadest possible tax base. So you provide people with the least incentives to evade, avoid or otherwise not report taxable income. And you want the broadest possible tax base so you give them the least number of places where they can put their income to avoid paying taxes. That's sort of the way I look at it. And that's the correct. That's sort of the north star of a tax system. And any tax change that moves you towards the lowest rate and the broadest base is good. Anything tax system that moves you away from that ideal is bad. Yeah.

So it's a balance between economic activity disincentivizing people, voting with their feet, or evading or avoiding or, you know, doing what they're going to do and being willing to pay the government a certain share and keep their productivity high at the same time.

You got it. It's exactly correct. You know, all taxes are bad, but some are worse than others. Right. And a low rate, broad based flat tax is the least damaging tax, but it's still damaging. You know, we tax people who speed on freeway. And why do we do that? To get them to stop speeding. We tax cigarettes. Why do we do that? To get them to stop smoking. We tax alcohol. Why do we do that? To get them stop being drunk. Yeah. In the same sense, why do we tax people who earn income? Why do we tax people who employ other people? Why do we tax people?

Stop employing people, stop earning income.

But don't think that we don't do it for that reason. We tax them to get the revenues to run government. But don't for a moment think that that other effect doesn't take place. It does. And anyone who pretends it doesn't is missing the whole point of economics.

So Arthur, does the Laffer curve or any of your work, regardless of the Laffer Curve, what does it inform us about where we are today and where we're going with economy, et cetera?

I mean, as I said, the ideal should be a low rate, broad based flat tax with the exception of syntaxes which you want to tax because you want people to stop using them. But other than that, we are moving away from that recently under Biden and dramatically now under Trump. We moved towards the North Star with Biden and what's following it, we're moving away from it. You want to never, ever, ever have the highest tax rates high. My book, along with Brian Dimitrovic and Dr. Jane Sinkfield, that book really shows unambiguously that whenever you raise tax rates on the rich, the rich pay less in taxes. Less. Whenever you lower tax rates on the rich, they pay more in taxes, they earn more and they shelter less and they pay a lot more in taxes. Plus you get the residual benefits of a good economy when you cut tax rates. A bad economy when you raise tax rates. And the last one which should shock them, but they never listen, they never ever listen, is when you raise tax rates on the rich, the biggest damage is done to the poor, the minorities and the disenfranchised. The Great Depression was not good for poor people, believe me when I tell you that. And it was caused by raising tax rates. World War II was horrible for low income people. So high tax rates on the rich is counterproductive in every single sense. You want a low rate, broad based.

Flat tax, you know, when tax policy changes, for example, Trump, Biden, et cetera. How long does it take for this effect of the Laffer Curve to kind of work its way through the system? Is it an instant or is it a two year lag time or, you know, anything?

There's something that works even before it happens. For example, if you know they're going to raise capital gains tax rates next year, what do you do this year? You realize all your capital gains now. So people will preempt a tax increase, preempt a tax cut by deferring income, you know, and that's exactly what Reagan did. In 81, we passed a tax bill that cut the highest tax rate and but we deferred the implementation of it. So everyone deferred their income. And that's why we had the recession depression of 81, 82 was because of the deferral there. That's some of it's preemptive. Some of it's at the same time and some of it takes a long, long time to adjust to. And you know, when you look at these things, I think the dynamic adjustment is always in place and people search for more tax shelters, search for easier ways to move, better professions to be in. So the time of a full adjustment may be 100 years. I'm exaggerating, but a lot of it's preemptive, a lot of it's immediate. And then you have a lot of it is also just sort of trickles in over the period of time. Tends to, with high tax rates, tends to destroy the production base. When you look at places like Ohio with their property tax. Ohio property tax rates are very, very high. They're very low in Tennessee. My home in Cleveland, Ohio, which was as good as my home here, now sells for $375,000. My home in Nashville, Tennessee, which is the exact same as the home I was raised in in Cleveland, now sells for four and a half million. I pay more in property taxes, but I get all the benefits of appreciation, which I never got, which our family never got in Ohio. So you can destroy a place. Look at Detroit, look at all of these cities that have just been destroyed. That's a long run, horrible process of degradation that occurs with high tax rates as people continuously move out, continuously find ways around the tax codes until they're finally ended up in total impoverishment.

Yeah. And you know, you were involved with Howard Jarvis back in the late 70s and behind Prop 13, which I have for a long time said Arthur, that if it wasn't for Prop 13, the California property market would have never had the kind of expansion it did.

Yeah, Prop 13 and all the effective things that went along with it is the only blowhole that allows air to come to the California economy. If you really think about it, California is one of the highest tax states in the nation with one exception and that's property taxes. There is one of the lowest ones in the nation. The huge increase in property values are untaxed, unrealized capital gains are not taxed. You can transfer your unrealized capital gains to your descendants on a step up basis which no other income group is. You've got Prop 13, which some people now because of the 2% per annum being the most property tax bill can increase. You've got that such that people, some people are down in tax rates in California 0.4%, you know, there, which is really a very preferred one. And if you do do sell a property you do have the exemption of 250,000 for a couple every two years, which is exempt from taxes federal, state and local. So there has been a huge effort in California to protect property income. And that is the only reason California is not West Virginia. Believe me, your insight is completely correct.

I just never want to live in a place where the government is so desperate to fund their programs that they become predatory on the citizens.

You know, well, that's where they are in California. That's where I left.

They've been there for.

And it was Schwarzenegger who did it, right? Yeah. I mean, Schwarzenegger. I was on the Council of Economic Advisors with Schwarzenegger along with Milton Friedman and George Schulz and some of my mentors in life. And, and you know what? When he reversed and went to the other way, I just said I'm getting hell out of Dodge. And I wrote a paper, California, who are you and why I'm leaving. And I came to Tennessee. It's a lot more fun earning income with lower tax rates. Yeah. I just want to mention that to you.

You can build wealth a whole lot faster. I like, I like to liken it to what Reagan said when I talk about how I left California. I didn't leave California. California left me.

You can cure crazy with medication.

You can cure ignorance with education, but there ain't no fixing stupid.

Yeah.

And Reagan learned and he became the best president ever because he learned from the mistakes he made and he learned from the observations of other people and how to do it. I was with him the whole time, as you may know.

Right.

And you know, and, and it was just amazing seeing this journey of this person and how he became the greatest president ever because he saw what happened to him and he, and he said, oh my. He won the first election against Evan G. Pat Brown by over a million votes. He won the second election against Jesse Unruh by only 600,000 votes. And the population of California is bigger then. And then Houston Flournoy in 1974 was defeated by Jerry Brown Jr. Jerry. Jerry Brown, you know, so it's amazing how he observed the politics there and he saw how Prop 13 worked and he became an avid tax rate reduction because he saw the results and he learned from it and he did it right. He's not like all these other sort of pig headed politicians. I'm right. And I'm never changing my mind, you know, and the socialists are that way. And Reagan was not. Reagan was that one of the most effective people in politics ever because he wasn't idiot. He did what was right all the time. And that's why I love Reagan so much.

Most definitely the greatest turnaround story in in world history was radiomics.

It is. And he did it over, you know, Johnson, Nixon, Ford and Carter. The Four Stooges. The largest assemblage of bipartisan ignorance ever put on planet Earth. And he flipped it around to create the huge political economy growth. And you know, Reagan learned these other guys, you know, I use a Kentucky phrase, if I may, on these other guys. You know, they ain't no lesson learned from the second kick of a mule. And you know, when you're so stupid to do it again and hope for a different outcome, there's just no fixing stupid.

Yeah, absolutely right. And we will see how it goes. Arthur, I know you are a very busy man nowadays. Just give us any of your thoughts on what we can expect in the future. Inflation, deflation, stagnation.

This election is really serious and it is one of those transitional elections there. I think if Biden is reelected and the Democrats take the House and the Senate, I think you'll have much more and maybe even worse of the same. My view is that if the House and or the sand or the Senate is taken by Republicans, Biden administration would be a stagnant one, but not exceptionally horrible. It just wouldn't be. But if you got Donald Trump in there with the Republican House and Senate, now that the riff raff has been cleaned out, I think you could have one of the biggest positive growths that this country has ever seen. You know, I'm an economist. That's all I think about is economics. By the way, I'm not into how you do speeches or what your personal life is like or any of that stuff. But on economics and substantive policy issues, Donald Trump is probably the best president I've ever seen in one term. I mean, he was hit by the pandemic, which God forbid, but his operation warp speed was amazing. His deregulation of energy was phenomenal. The Tax Cuts and Jobs act was phenomenal. I could go on and on and on. Transparency in medicine. These are things that could make America not only great again. Which was Reagan's quote, by the way. Trump got it from Reagan. And you can not only do that, but he could really turn this world around dramatically, both internationally and domestically and politically and socially. He could make it really a great, great world again. And that's what I'm hoping for.

I couldn't agree more. It's just unfortunate that so many people have kind of fallen for the rhetoric, because the Trump policies, which many of them Biden has actually kind of continued, you know, which is he didn't get.

Rid of the tax cuts, let me tell you that. You know, but when you look at people, people do deserve the governments they get. They really do. I mean, it's your choice, go ahead, vote the way you do. But the earth you are scorching is your earth too. And you know, when I, when I look at democracy and when I look at places like California and places like Detroit and other places in the world and I look at Biden's election and all this stuff, you know, it reminds me of, you know, if you ever want to sour on democracy, just have a five minute conversation with an average voter.

Yeah, no question about it. I always say that Detroit is the poster child for big government disaster.

So it is, it is exactly that. And you know, democracy often, unfortunately, a democracy is two wolves and a lamb deciding on what's for dinner.

All right. Absolutely. Well, Arthur Laffer, thank you so much for joining us. We really appreciate having you.

My pleasure. Thank you very much.

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