Trump’s got some big tax cuts on the table. But where will all that money end up? I’ll tell you.
Picture this. It’s 1974. America. Cars are long and brown. Suit pants are tight and brown. Mary Tyler-Moore was the bombshell I’ll always remember.
It’s the early afternoon. Dick Cheney and Donald Rumsfeld walk into a bar. It’s the Two Continents Restaurant in the Washington Hotel.
Across the yellow and brown paisley carpet, over near the puffy, golden-brown curtains is a serious and dashing young economist. Arthur Laffer. He rises to meet them.
President Gerald Ford has just put a bunch of tax hikes on the table. Cheney and Rumsfeld are spewing. They are ideologically opposed, but the only thing more unpopular than tax hikes is debt, and the US government is piling it on.
They need a way to stop this tax-hike madness in its tracks. Enter Arthur Laffer.
Over lunch, Arthur explains that there is (theoretically) a tax rate that maximises government revenue. There was an optimal tax rate.
He also says that, counter to what most people think, raising taxes doesn’t always increase total revenue.
He put it like this. If the tax rate was zero, then the government’s take is nothing. Zero percent of anything is zero. However, if the tax rate is 100%, then the government takes everything and all economic activity ceases. Why work if the government takes everything you’ve got? At this point, the government’s tax take is also zero. 100% of zero is zero.
So somewhere between the zero take at zero percent, and the zero take at 100% is an optimal tax rate that maximises government revenue.
Arthur got out a napkin and drew a diagram to help them understand what he was saying. It looked like this:
He never invented the concept, and it was never particularly insightful, but this is what is now known as ‘the Laffer curve’. It made him famous and made his career. He’s still banging on about it.
Apparently Cheney wasn’t so impressed with it at the time, but others could see the implications.
If the tax rate was currently set higher than the optimal tax rate, then decreasing the tax rate could actually increase government revenue.
And if that was true then it was a magic pudding. You could give everybody a tax cut AND increase government revenues and pay for everything you needed to do.
The central idea was that tax cuts would spur economic activity and tax revenue would actually increase. There were no losers. Only winners.
(Apparently at this point Rumsfeld got so excited he bombed some remote north Asian villages.)
And so Cheney and Rumsfeld, with the intellectual cover Laffer provided, started pushing for the idea to become Republican policy.
The idea took a little while to take hold. Maybe due to modesty. There was no way of proving where the country currently sat on the Laffer curve.
It could be that the tax rate was too high. But it could also be too low, in which case cutting taxes would actually decrease revenue. There’s no practical way to know. You can’t test it.
But by the time Regan was running for office, it was a central platform. It became known as supply-side economics.
It also became known as trickle-on economics, in the sense that if you gave tax cuts to the rich, they would go and trickle on poor people.
“Edwards and I got so high last night old chap, that we stumbled into the servants quarters and took a trickle on Jeeves. Fwah fwah fwah.”
Oh no, hang on. Trickle-down. It was trickle down economics. Give money to the rich and it would trickle down through the rest of the economy, like salty champagne.
Really, how any body took these ideas seriously at the time I have no idea. But they did. And the tax cuts happened.
And the economy under Regan had a dream run for a while. And it cemented supply-side economics into conservative political lore.
Don’t get me wrong. I’m not against tax cuts, but I think you need to be clear why you’re doing them. Cutting taxes so you can maximise government revenue is a bit silly. I don’t even think ‘maximising government revenue’ is a worthwhile aim.
(We should be aiming to keep revenue to a minimum, subject to achieving our social goals.)
But the real fallacy I think is imagining that tax cuts will have a permanent affect on activity.
At best they create a temporary stimulus to the economy, that slowly works its way through the system, and ultimately disappears from the growth rate stats.
That is, tax cuts cause a level shift (which might be awesome if that’s what you need), but not a permanent change to potential growth rates.
And in a mature economy, where consumption is maxed out, like in Australia – then that tax-cut stimulus will trickle-down and pool in the prices of fixed-assets – property to be specific.
And this is what we saw with Regan. Supply-side economics created a land-price boom that took ten years to work through the system.
And now there’s Trump. He’s definitely the most aggressive trickle-on’er since Regan (especially if you believe the Russian dossier).
Modelling shows that most of his proposed tax cuts will go to the top 1% of income earners, who are right now giddily trickling their names into the snow outside the White House.
Laugh it up, but we know that property and land will be the ultimate beneficiaries of the tax cuts.
And if other countries feel competitively pressured to follow Trump’s tax cuts, then we’re potentially looking at another global land-price boom.
People will argue about how good tax cuts are for the economy.
But land, as always, will have the last laugh.
How will Trump’s tax cuts reshape the world?