Economist Arthur Laffer: ‘All Taxes are Bad’

E-newsletter Issue #47 | May 27, 2010

Renowned economist Arthur Laffer had a simple message to attendees at The Council of State Governments’ Economic Summit of the States:

“If you tax people who work, and pay people who don’t, don’t be surprised if you find a lot of people not working,”  Laffer said on the closing day of the summit May 23.

Laffer, a member of President Reagan’s Economic Policy Advisory Board who now serves as the founder and chairman of Laffer Associates, an economic research and consulting firm, is best known for the Laffer curve. The curve illustrates how lower tax rates change people’s economic behavior and stimulate economic growth, which can then lead to increased tax revenues under certain situations. It is a major tenet of supply-side economics, which theorizes that changes in tax rates influence economic activity, with high tax rates negatively influencing people’s behavior.

“People and businesses respond to government policies. They really do,” Laffer said. 

He noted that in response to specific government tax policies, people can change the composition, timing and location of their income, as he did when he moved from California to Tennessee to take advantage of the fact that Tennessee has no personal income tax. 

As a result, state tax policy decisions can have big consequences on the amount of revenue generated. Laffer compared the nine states with no income tax with the nine states with the highest income tax rates over the last 10 years. The nine with no income tax have experienced higher revenue growth rates, higher productivity growth and lower unemployment growth. 

Similarly, he looked at the 11 states that have introduced a progressive income tax in the last 50 years. Each of those states has experienced a decline in gross state product as a share of the total U.S. product and a decrease in revenue as a share of the total state tax receipts. 

Laffer concluded that a tax structure that includes a progressive income tax “not only causes a state economy to grow more slowly, but leads to a lower standard of living, lower productivity growth, and thwarts expectations of revenues.”

Laffer encouraged state policymakers to think about the consequence of tax policy decisions.

“All taxes are bad, but some are worse than others,” he said. “You should tax in the least damaging fashion, and spend in most beneficial fashion.” 

To that end, he advocates a low flat tax with no deductions as the optimal tax structure because it provides the fewest incentives to avoid reporting taxable income.

Laffer predicts hard times ahead for states, particularly in 2011 when the Bush tax cuts expire. He sharply criticized the recent federal stimulus package and bailouts.

“Have you ever heard of a poor man spending himself into prosperity?” he asked. “You can’t bail someone out of trouble without putting someone else into trouble. There is no free lunch. No tooth fairy. No Father Christmas. I’m sorry to tell you that, but you can’t just print money and expect it to help the economy.”

Raising taxes during a recession is a particularly bad idea, said Laffer, as it “unbalances the budget of the citizenry.”

Minnesota Sen. Kenneth Kelash expressed concern that Laffer’s sole focus on taxes did not take into account the many other factors that influence behavior. Specifically, Kelash asked Laffer to explain why Fortune 500 companies are so often headquartered in states with higher taxes.

Laffer acknowledged that there are indeed many other factors, but that taxes are among the most important.  Noting his career-long focus on tax policy, he joked that “to a hammer, everything looks like a nail.”

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