Monthly Archives: November 2017

Arthur Laffer vs. The Beatles

The Laffer Curve has been a favorite bit of Republican pixie dust since the Reagan years, the core idea of “voodoo economics.” So simple that the idea fits, famously, on a cocktail napkin. If the tax rate is zero, the government receives no income. If the tax rate is 100%, the government also receives no income because no one is willing to work for nothing. Therefore, the idea goes, there must be a curve in-between zero and 100 that contains a point where government revenue is maximized.

The pixie dust part comes from claiming that current tax policy puts us on the side of the curve where reducing rates will actually increase revenue. That’s where The Beatles come in.

Taxman” is a tune that shares the feelings of the high earning musicians when they learn that they are paying a marginal tax rate of 95% on their income. “There’s one for you, nineteen for me,” says the taxman.

And what happened then? Was that the point when The Beatles downed tools and went on strike for a lower tax rate? No. They just grumbled and kept on making hit music.

Nobody stops working because they pay a lot of taxes. That is the craziness of the Laffer Curve. 95% rates aren’t enough to stop people from working. During wartime, top tax rates in Britain went to 98% and people still worked hard.

So by the argument of the Laffer Curve itself, we now know which side of the curve we are on. If we want to maximize revenue, raise taxes.

Of course, the government is not in the tax-farming business. We don’t want a revenue-maximizing rate. We want a rate that allows us to pay for the government services we want and to pay off previous debts. That rate is still higher than what we have today. And it is a progressive rate, where very rich people pay a lot in taxes.

(Yes, there is a difference between the marginal rate and the actual, blended rate. But for those making millions of dollars a year, the difference is small and not one that invalidates the argument against the Laffer Curve.)


Follow the Money

Where does a corporate tax cut go? Let’s follow one billion dollars as it gets diverted from the IRS into the financial system.

Megacorp gets a billion dollar tax cut. However, on the same day as the money arrives there are no billion-dollar opportunities waiting for investment. Company management invests in new product lines and billion dollar capital investments such as factories with an outlook and schedule of years of planning. A tax cut could be taken away by the next administration – it isn’t a reliable source of funding.

It isn’t reliable, but it is a windfall. Found money goes into quick return financial shenanigans such as stock buybacks and retiring corporate debt. This what happened to the Bush tax cuts in 2004.

OK, Megacorp spends 800 million on stock repurchase and 200 million on retiring corporate debt. Where does the money go?

Most common stock is held by funds – retirement funds, pension funds, and insurance funds. Most corporate debt is held by similar funds. So almost the entire billion dollars is injected as cash into the funds. Funds have rules for what to do with the cash from non-recurring sources – reinvest it. (The same for recurring sources such as dividends and interest payments. The point is that it won’t be a direct or immediate distribution.) So one billion dollars is almost immediately invested into the financial markets.

The money will eventually find its way out of the funds in the form of distributions to individuals at retirement. At this point, many years after it was given to Megacorp, it starts to turn into consumer spending that benefits the pensioners and retirees and the larger economy. During that time inflation and management fees have cut into the amount, though general market growth may have offset that.

And, of course, it will be taxed. But the tax will be paid by a retiree, not by Megacorp.

Bottom line: Corporate investment uses reliable funding sources and has a long timeline. Tax cuts don’t fit that description. The money does eventually trickle into the consumer economy years afterward. Infrastructure investment would create more jobs, immediately, than any tax cut.