I.O.U.S.A. (58 page)

George Schultz, Milton Freidman, Ronald Reagan — all of our group — really knew what they were doing on economics. It was much more fun. I didn ’ t have to bear the consequences of my own actions.

One time period that was very tough, and we deferred the tax cuts. As you know, the tax cuts were phased in. If you know they ’ re going to cut tax rates next year, what do you do this year?

You defer all the income you can. By phasing in the tax cuts, we created the recession/depression of 1981 – 1982. If you think this is revisionist history, go back and read my piece in
Barons
in 1981, where I talked about how we were going to have a deep recession/depression in ‘ 81 and ‘ 82 because we phased in the tax cuts. That was the only time period that was really, really tough.

The president had been shot by Hinckley, and he was in a very different frame of mind than he was when he was really healthy.

I was really, really concerned that Bob Dole, George Bush Sr., Dick Darman, and Dave Stockman — what I call the anti - Reagans — were going to convince the president to reverse the third year of the tax cut. As it so happened, he didn ’ t waver. He stuck with it, and you can see how the fi lm played. It was just a beautiful era, and I really enjoyed being there. It was loads of fun.

Q:
In the early 1980s, you actually stopped the rise of the size of
the federal government. The size of the federal government
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grew from 3 percent GDP in 1913 and by 1980 it was at
20 percent and rising rapidly. Ever since the policies that you
worked for in the 1980s were enacted, we have been at 20

percent or lower. Can you talk about that?

Arthur Laffer:
The best way of reducing federal government, in my view, is to make it unneeded. When you have lots of people unemployed, when you have lots of people hungry and times are really awful, it ’ s really very hard for the government to resist the temptation of government to come in and try to solve the problem. The government can ’ t solve the problem by writing a check, because that check comes from workers and producers. It doesn ’ t come from the tooth fairy. But the temptation is for the government to try to do it.

The history of the Great Depression is a classic case. Roosevelt, with the New Deal, did nothing to reduce the depression. Amity Shlaes ’ s new book [
The Forgotten Man,
HarperCollins, 2007]

clearly makes the case that they added to it. During the Great Depression, we raised the highest federal marginal income tax rate from 24 to 83 percent. We put in state and local income taxes and sales taxes. Is it any wonder it was the longest, deepest depression ever? You can ’ t solve a depression by raising taxes.

With Reagan, it worked so nicely because by cutting the tax rates and creating the prosperity, it really reduced the need for government. The other thing that reduced the need for government, if I may be so bold, is that Ronald Reagan really understood the Soviet Union. He used an old Jack Kennedy line that the best form of defense spending is always wasted. Whenever you fi nd yourself in a situation where you ’ re required to use your military hardware and prowess, that is a clear sign that you didn ’ t spend enough. Reagan used defense initiatives with regard to the Eastern Bloc and the Soviets. He and Lady Thatcher literally collapsed the Soviet Union and thereby reduced the need for us to have as big of a defense establishment as we otherwise had. It was a perfect combination of creating the prosperity and destroying the Soviet Union through a strong defense that really led to us being able to control federal government expenditures. Now we ’ ve c17.indd 233

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got to fi gure out a way to control state and local expenditures, but that ’ s a story for another time.

Q:
Okay. Talk about defi cits. Do defi cits matter?

Arthur Laffer:
During the Reagan era, the defi cits were very, very large. That was the only way to bring back the prosperity. Are defi cits bad per se? No. Are they good per se? Absolutely not. If I ’ m willing to lend to you at 2 percent, risk - free, and I can borrow from you at 5 percent, risk - free, how much should I borrow? I should borrow all that I can. It ’ s a guaranteed spread. Now, reverse those numbers. I ’ m lending to you at 5 percent and borrowing from you at 2 percent. How much should I borrow? Zero.

Borrowing is neither good nor bad. It ’ s a tool. You really want to look at the spread. When we came in in 1980, ‘ 81, our country was in the trash heap of history. We had a really underperforming economy. We were just like a venture capital or private equity fi rm.

We took over this company that had been run into the ground, and of course we needed to borrow money to be able to cut the tax rates, to put the executives back, and create incentive plans to control infl ation. The defi cits went up but, in my view, that led to lower future defi cits and a control of government debt and also control in government spending.

Q:
You talked about the Clinton era. That led to the closing of the
debt clock. Has that mood of fi scal discipline reversed itself in
recent years?

Arthur Laffer:
Clinton did exactly what you ’ re supposed to do as president during his eight years. When you have a really prosperous economy and everything ’ s going pretty well, do you need to spend all of that money and have huge defi cits? Absolutely not. That ’ s when you pay down your debt. Clinton even ran surpluses in the federal government. He did a great job. If you look at the national debt as a share of GDP, or steady - state interest payments as a share of total GDP, it really dropped like a stone.

Now, take George W. Bush. He comes into offi ce on January 20, 2001. He won the election in 2000. The markets had peaked in March of 2000 and there was an incipient nascent recession c17.indd 234

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coming on that was really serious. In addition to that, eight months after he ’ s in offi ce, you get the attack on America and this huge need to increase spending for security. Here he has a recession and the need for security. What ’ s the guy supposed to do? Raise taxes on the last three people working? I don ’ t think so.

Clinton provided Bush with a fi xed fi scal fl exibility to be able to do what was right in 2001, 2002, and 2003, given the circumstances of our country. Bush, quite appropriately, cut tax rates to stimulate the economy after the huge market crash of 2000, 2001, and 2002. He did that correctly and he increased security spending dramatically. Both of those were necessary for the health of our country. Without Clinton ’ s control of spending and reduction of the national debt as a share of GDP, Bush never would have been able to do that. It was a perfect one - two punch. Now we ’ ve had the defi cit come way back down again.

It ’ s, what, the fi fth smallest budget defi cit in the last 45 years?

When you have prosperity and economic growth you should pay down the debt or at least let it grow much more slowly than the economy. But I thought the Clinton/Bush era was perfect from the standpoint of economics.

Q:
The defi cit has gotten out of control. We just crossed the $ 9

trillion mark. You now have a wave of populous support for tax
cuts. What would happen to the defi cit if you raised taxes?

Arthur Laffer:
You ’ ve got a national debt of $ 9 trillion. Bill Safi re ’ s comment on this, he called these numbers
megonumbers.
He spelled it M - E - G - O, which he claimed stood for My Eyes Glaze Over. That ’ s a lot of money.

Would you like to see that number start coming down again? Of course you would. There are two ways that we talk about doing that today: number one, by controlling government spending, and number two, by raising tax rates. Controlling government spending has lost favor in the Congress. You have a Democratic House. You have a Democratic Senate. You have all of these national health schemes. They aren ’ t really willing to address the spending issue, which is what really needs to be brought down.

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So they are talking about raising tax rates, especially tax rates on the rich.

I ’ m going to use Sir Robert Peel ’ s phrase here: If they raise tax rates on the rich, they are going to be thwarted in their expectations of revenues. There are no tax rates that I can think of that fi t more into the prohibitive range of the Laffer curve than tax rates on the rich. Capital gains, upper income brackets, dividends, inheritance taxes: If you raise those, not only will you not reduce the defi cit, you ’ re going to explode the defi cit. You ’ ll cause people to be unemployed. You ’ re going to cause huge amounts of harm, hardship, and suffering in the U.S., and you ’ re not going to reduce the defi cit. These people are on such a bad path.

The way you bring the defi cit under control is not by raising tax rates. The way you bring it under control is by controlling spending, and, unfortunately, in the last eight years, the U.S. has lost its direction in trying to be economical in government spending.

These guys are going to come in and try to increase spending and raise taxes on the rich and, if they do that, mark my words, you are going to see a tragedy in the U.S. economy of biblical proportions.

Balancing the budget by cutting spending is wonderful. Trying to balance it by raising tax rates on the rich is ridiculous and is pandering.

Q:
Is there a time when tax cuts are bad things?

Arthur Laffer:
Sure. There are lots of times when tax cuts are a bad thing. You need to have tax rates suffi cient to collect the requisite revenues to provide government services. You need defense, you need welfare, and you need all of these other programs. You do need them, I think. I ’ m not a Libertarian. All tax, except for sin taxes, do damage. Sin taxes are good because they exist not so much to collect revenues as they do to stop you from doing things like alcohol and tobacco. Those taxes don ’ t hurt the economy, but all other taxes hurt the economy. All taxes are bad so, in a tax system, you want to collect the requisite revenues while doing the least possible damage you can to the economy. You want to develop a tax code that ’ s the least harmful tax code.

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To my way of thinking, that ’ s a true fl at tax. That ’ s what I ’ d like to see: a real fl at tax, Jerry Brown ’ s fl at tax, that 13 percent fl at tax. Do you remember that one in 1992? That is the perfect tax code for the U.S. economy. You get rid of all federal taxes except for the sin taxes and, in their stead, have two fl at - rate taxes. No deductions, no exemptions. Implement a fl at tax on personal unadjusted gross income and a fl at tax on business net sales. If you did that with the static revenue situation, you would be able to collect enough revenue — no Laffer curve in this one — to match all federal revenues with a tax rate of about 11 percent on each. That ’ s what you really need to do today to make sure you do the least damage with your taxes.

Q:
Is it correct that you moved to Nashville because of the tax
situation?

Arthur Laffer:
That ’ s true, I did. Taxes were a very important part of my consideration. As a Californian, my highest marginal tax rate was 10.3 percent and, with the problems with the alternative minimum tax, it probably won ’ t be deductible for very long. Here in Tennessee, there is no state income tax at all. You don ’ t have a preferred item that you ’ re deducting, and therefore, you don ’ t even come close to your AMT, either. It ’ s a great place to live: great housing and great people. Not that California isn ’ t terrifi c — it is, but it ’ s really fun here.

Q:
Can you talk about David Walker? He and Paul Volcker think
that the political system is broken, because you have the people
who want to cut spending on one side and the people who
want to raise taxes on the other side.

Arthur Laffer:
The Concord Coalition. I ’ m not a member of it, and I do disagree with it when they talk about raising taxes, but the Concord Coalition is completely correct on wanting to control government spending. If the Concord Coalition, with Walker and Volcker, were to be able to be successful and get rid of all of this pork, it would be spectacular.

Would you like my solution? Whether you like it or not, I ’ m going to tell you. If a congressman or a senator does something that c17.indd 237

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causes harm to the United States, what happens to that person ’ s salary? Nothing. If a congressman or a senator does something that promotes economic growth and prosperity and a bull market, what happens to that congressman or senator ’ s salary?

Nothing. It makes no sense whatsoever that, no matter how these people behave, their compensation is unrelated. We need to do what corporate America does. If you saw two companies, exactly identical, and Company One had a CEO who had no stock options, owned no stock, and was paid a fi xed salary, and Company Two had a CEO with a very small salary and a lot of stock options, which company would you prefer to invest in?

Of course you want to invest where the people who make the decisions are incentivized to make good decisions. I want to put Washington, D.C., on commission.

Let me give you a hypothetical. Let ’ s say that you elect a new congressman, a new senator. The day he or she takes offi ce, you give that person $ 5 million worth of stock. He or she is allowed to keep all the capital gains, tax - free, and is held personally liable for all the capital losses. I guarantee you these people would vote differently. The reason that you have these misdirected policies by these silly politicians is they are not incentivized to vote in the correct way. If you told them that their salary would grow dramatically if the stock market or the economy performed, they ’ d never go for these stupid policies they vote for. They ’ d never go for these pork barrels. They ’ d never go for this pay/go stuff. They ’ d do what was right for America. But the reason they don ’ t do what ’ s right for America is there ’ s nothing in it for them.