Posted by: Dirk | December 9, 2016

A comment on the trickle-down economics of Arthur Laffer, 2017 Trump edition

The FT writes about Laffer endorsing Trump’s policy of tax cuts for the rich:

Although tax rates in most countries rose throughout the 20th century, which was by far the best century in economic history, Mr Laffer is unbowed. “When [taxes] went up [countries] did very poorly and when they went down, they did very well,” he says.

I would like to back up the criticism of the FT at the start of the first sentence with a chart taken from FRED2:

fredgraph-6

The blue line shows you tax receipts on corporate income divided by GDP. The red line is real GDP growth. Now Mr Laffer claims that cutting taxes leads to higher GDP and hence more tax income, so that the tax intake of the government will not decline even though rates have been cut. Wikipedia, though not authoritative on the subject of economics, gets it reasonably right when it says: “Generally, economists have found little support for the claim that tax cuts from current rates increase tax revenues or that most taxes are on the side of the Laffer curve where additional cuts could increase government revenue.”

If Mr Laffer would have been right, then one should have expected that with lower marginal tax rates from the 1980s onwards, when Reagan cut them being advised by Laffer, the tax intake would not go down (much) since higher GDP growth would lead to higher tax intake. However, the figure shows that the blue line falls and stays down. The (red) economic growth rates also do not go up to reach the levels of the 1950s-1970s. Remember that the US was not destroyed after WWII, like so many other countries, so no claim can be made that economic growth is more difficult to achieve after the post-war boom had fizzled out.

Laffer’s trickle-down economics did not do well empirically. Whether a cut in taxes stimulates the economy is a different question, and also any changes in tax rates might be overcompensated by changes in government spending taking place simultaneously. This, I believe, was part of the bait-and-switch under Ronald Reagan (tax cuts for the rich, but huge increase in government spending on defence) and will be part of the Trump policy, too. Nothing new here.

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Responses

  1. You miss the external sector

  2. […] Laffer’s trickle-down economics did not do well empirically. Whether a cut in taxes stimulates the economy is a different question, and also any changes in tax rates might be overcompensated by changes in government spending taking place simultaneously. […]


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