STAFF NEWS & ANALYSIS
US Tax Collapse Coming?
By Staff News & Analysis - June 08, 2010

Laffer: 2011 'Tax' Collapse Coming … Tax hikes expected to hit after the expiration of the Bush tax cuts will cause today's corporate profits to tumble next year — probably right after a stock market collapse, says economist Arthur Laffer, chairman of Laffer Associates and inventor of the Laffer Curve. "My best guess is that the train goes off the tracks and we get our worst nightmare of a severe 'double dip' recession," Laffer says. "Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts," he wrote in the Wall Street Journal. "Tax rate increases next year are everywhere." Laffer says the coming hikes — coupled with the prospect of rising prices, higher interest rates and more regulations next year — are causing businesses to shift production and income from 2011 to 2010 to the greatest extent possible. "As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be," Laffer says. – MoneyNews

Dominant Social Theme: Cut those taxes!

Free-Market Analysis: One of the miracles of the years of former President Ronald Reagan (from a mainstream media perspective, anyway) was the boost the American economy received from tax cuts. And one of the prominent advisors to Ronald Reagan and his "kitchen cabinet" was Arthur Laffer, the developer of the Laffer Curve. This is a fairly simple graph that illustrates how tax revenue goes up when taxes are cut. This is why Arthur Laffer is so sure that the "sunset provision" of the Bush tax-cut plan will cause further havoc with the US economy. Laffer rightly points out that taxes are likely going up throughout the United States even if they do not rise at a federal level.

Of course it is also worth pointing out that there is significant economic havoc anyway in the United States and throughout the West. While some of it may be attributed to taxes, a good deal likely cannot (see other article in today's Bell on the inflation-deflation meme). And presumably, there is a point at which the effectiveness of tax cuts as a revenue finally decreases. It would for instance, be impossible to have NO taxes and still generate additional tax revenue. But Laffer's point was well received at the time – in the 1980s – by free-market conservatives and fought tooth-and-nail by America's leveling Democratic class. (He has a point now as well, as tax hikes must always act as a drag on an economy.)

Ultimately, Laffer won the day and the Reagan Administration, with Congress, instituted tax cutting measures. (The administration also removed certain tax loopholes which cost American taxpayer billions, but that's a story for another day.) The result of the Laffer graduated-income tax cuts seem fairly indisputable. The economy did well under Reagan (or well within the context of mainstream interpretations) and even seemingly under Bill Clinton who did not seek to significantly roll back tax cuts – mainly because of Congressional opposition.

But what is the dominant social theme we are after here? It is this: "Tax-cutting is a wonderful, free-market way to stimulate Western economies – and over-taxation is generally the enemy of growth and civil society." While this may seem intuitively obvious on its surface, it remains something of a promotion from our perspective – within today's US economic context – because it leads people away (at least a little) from thinking about other issues pertinent to Western economies.

The most attention must still be paid to reforming monetary policy, our view. We certainly do not want to downplay fiscal policy, for as free-market proponents we believe taxes are most destructive to entrepreneurship and, generally, to the quality of life. But monetary policy is even more important, especially now, given the great debate about the primacy of the Federal Reserve, etc. We are reminded of this point by the interview that we did a while back with the famous free-market oriented economist and commentator George Gilder. It was Gilder who spelled out at least one important reason for Laffer's fiscal emphasis as follows:

"Like many movement libertarians, [Ron Paul] always prefers the quixotic ideal (radical spending cuts) to the feasible improvement of lower tax rates," Gilder states. … And then he adds of Ron Paul, that, "by opposing defense spending and American power he has become a shill for the enemies of capitalism and freedom." He also states in answer to the next question about the impact of the US Tea Party movement, "[They are] a fully beneficial force as long as they stress tax cuts rather than spending cuts. Lower tax rates are good in themselves. Lower spending always ends up focusing on defense."

To read the full Interview with George Gilder, Click Here.

For us, this put the Reagan administration and its purported free-market policies in a different light. Regardless of whether Reagan fully understood the impact of his emphasis on fiscal policy, his administration's adoption of the Laffer Curve approach to economic growth realigned and controlled the way people saw the free market at the time. The movement toward laissez faire was much influenced, therefore, and its energy focused on cutting taxes rather than examining the role of central banking and its impact on the larger economy.

Fast forward to the 21st century. On a mainstream TV program, free-market thinker and financial advisor Peter Schiff bet Arthur Laffer a dollar that the West, and specifically America, were facing hard times in the later 2000s. Laffter took the bet and claimed any downturn would prove to be fairly insignificant. We don't know if Laffer paid up, but he was clearly wrong, and the reason he was wrong, in our view, was likely because of a free-market philosophy that emphasizes fiscal rather than central banking.

To watch that famous Laffer/Schiff debate, Click Here.

Laffer was wrong because he didn't, and doesn't, apparently, pay enough attention to monetary policy. And to some degree this may be a purposeful avoidance. We can see from George Gilder's statement that Laffer and other mainstream conservative-oriented thinkers want to focus on fiscal policy because when monetary policy is discussed, the conversations eventually turn to larger issues of how modern fiat-money economies operate and why, in America, anyway, the military industrial complex is so lavishly funded. The Laffer Curve was, perhaps, a free-market prophylactic, protecting the powers-that-be from a larger conversation about the West's monetary and military posture.

Today, thanks in large part to the Internet (and Congressman Ron Paul among others), the West – and America in particular – is having that conversation nonetheless and threatening to usher in another great societal-shifting reformation. Changes are coming both sociopolitically and economically. We would argue that Laffer's tax conversation, while important and timely, should be viewed within the context of America's larger (and growing) argument over money stuff and how to circulate it.

After Thoughts

It will be interesting to see if the larger conversation is in some sense refocused on fiscal as opposed to monetary policy. If the primacy of this meme is somehow re-established, the evolution of the US monetary conversation might well be diminished at least a little by a mainstream media grateful to focus on realigning certain elements of the graduated income tax rather than dramatically changing the banking system. Again, both fiscal and monetary issues are important from an economic standpoint (in fact taxes are intimately linked to the operation of central banking), and surely people can concentrate on more than one thing at a time. But the redirection has apparently happened before. Investors, therefore – trying to figure out where the American economy is headed – will want to take note of the evolving economic conversation about the crisis and, especially, where the emphasis is placed.

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