The 1970s were a period of major upheaval in the United States. Prices were going up, output was going down, and faith in the U.S. political system was going out the window. In the midst of the political upheaval, and with a loss of faith in Keynesian prescriptions for economic stabilization, a heretofore-obscure Wall Street Journal editor mapped an economic strategy for Republican resurgence and the Reagan revolution—famously depicted in this clip from Ferris Bueller's Day Off:
I was recently recommended this roadmap, the ostentatiously named How the World Works by Jude Wanniski. Regardless of one’s political persuasions, the book is worth reading if for no other reason than its marked impact on economic policy in the United States and around the world. A justifiably controversial figure—he found common ground in economics with Louis Farrakhan and endorsed John Kerry for President after calling President Bush an imperialist—Wanniski was foremost a conservative intellectual who disseminated his ideas advising the presidential campaigns of Ronald Reagan, Jack Kemp, Steve Forbes, and Bob Dole. In the case of President Reagan, Wanniski fell out of favor because he famously lacked modesty; his ideas had no such ill fortune. So what were these ideas?
John Maynard Keynes, arguably the most influential economist of the 20th century, posited during the 1930s that the great depression was the result of suppressed aggregate demand and inadequate government intervention. As a solution, he suggested that government deficit spending could compensate for diminished consumer spending to boost growth. While this is a very simple accounting of the Keynesian model, it is the basic premise. Wanniski viewed the cause of the great depression—and many other historic upheavals from ancient Rome to the stagflation of the 1970s— differently. Wanniski believed tax policy, and more specifically tax hikes—whether through progressivity, government growth presaging future tax hikes, or inflation pushing incomes into higher real rates— have invited all major economic collapses and faltering empires. Consequently, the best way to encourage growth is to concentrate policy toward creating the right incentives for exchange in the marketplace through low taxation, free trade, and a gold-backed currency to maintain faith in exchange and the debtor/creditor balance. Focus would be shifted to producers (the supply-side) and everyone would benefit as growth increased government revenue, in spite of rate reductions.
The Laffer Curve
Arguing against a proposed tax increase by then President Ford, economist Arthur Laffer sketched the following curve onto a napkin at a dinner table with Wanniski and Ford aides Dick Cheney and Donald Rumsfeld:
The Laffer Curve--as Wanniski coined it— is on the surface uncontroversial, while in its application it can be extraordinarily so. The curve shows that, for any given point in time, there is one specific tax rate that will maximize government revenues. At points on the curve to the left of the maximizing rate, if the already low tax rate is increased, revenues will increase. If, however, the tax rate is to the right of the maximizing point, a further increase in the tax rate will actually reduce government revenues—producers ‘on the margin’ will no longer be incentivized to grow or start their enterprise and will, according to the model, produce less or evade taxation. In contrast, if the tax rate is at a point to the right of the maximizing point and the tax rate is cut, the ensuing economic growth will outweigh the rate reduction and revenue will increase.
It is on this last point that the curve engenders controversy. George H.W. Bush, running for President in 1980, termed it “voodoo economics” and the political left has long derided it as “trickle-down economics”. Either way, the Laffer Curve was fully embraced by President Reagan and has made tax-cutting a mantra of nearly every Republican, and some Democrats, ever since.
What does the economic evidence say?
There is little dispute that there is a revenue-maximizing rate of taxation. At 0% no revenue is collected for obvious reasons and at 100% people are either producing for the glory of their despot or doing nothing. Somewhere in between there is an optimal rate that accounts for the elasticity of response (i.e. an X% tax change leads to an X% change in compliance/production), but the political left and right are at loggerheads over what that rate is. Dylan Matthews of the Washington Post collected an array of purported expert opinions of what this rate is (for various taxes, but here I will focus on the top federal personal income tax bracket) with the responses ranging from 15% to 70%.
Econometrically arriving at a specific rate is extraordinarily difficult because production and (tax) evasion are influenced by virtually every policy. Controlling for this vast array of relevant variables to identify the causal impact of a tax change on revenue is thus nearly impossible—and never without controversy.
Read my lips: no new taxes!
Wanniski, who was not a trained economist and never claimed to be, provides a vast array of anecdotal evidence to support his theory—including the tracking of market fluctuations during congressional debate over the Smoot-Hawley Tariff Act in 1929 and the debasement of Roman currency post-Aurelius in 180 A.D. Regardless of what you think of his arguments and their subsequent policy consequences, the book is worth a read. As the title implies, Wanniski takes a wide and long view of the world and provides plenty of uncontroversial and interesting analysis of past political events and economic forays.
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