April 27, 2017--Laugher Curve

As I draft this, President Trump has not as yet revealed the details of his "massive" tax cuts.

In spite of this I can speculate what his multi-trillion dollar proposal will contain and how it will be paid for.

When the non-partisan Congressional Budget Office (CBO) finishes its scoring, they will find that most of the cuts go to corporations--where the effective rate will be cut from 35% to 15%.

Also, a large slice of the tax cuts will go to America's highest earners. There will, though, to put a fig leaf on the truth, be some tax savings for middle class people, mainly an increase in the deduction for dependent children. Then in regard to children, thanks to Ivanka Trump's influence, there will be tax credits to offset some of the costs of childcare.

Unless paid for, over the decade, these cuts will add multiple-trillions to the national debt. So there will be some attempt to show how the cuts will be paid for.

Nearly a trillion will be the result of repealing and replacing Obamacare. As noted here last week, the legislation inching its way through the House of Representatives is not a healthcare bill but a tax cut bill. This of course means it has no chance of passing in the Senate and probably not in the House. So chalk that trillion up to the debt.

The real savings to pay for the tax cuts will not be from savings at all but rather from extra tax income that will be the result of a dramatic rise in economic growth.

At the moment, the Gross Domestic Product (GDP) is going up by a tepid annual rate of less than two percent. The Trump proposal will show a growth rate of about twice that. They feel they can project that because tax cuts for wealthy people and corporations are stimulative to the economy. Growth will trickle down to average folks who will in turn use the extra income they derive from tax cuts and increased economic circumstances to buy cars and houses and stuff.

This assumption, this projection is based on bogus economic theory promulgated most prominently during the 70s. and 80s by Arthur Laffer. It is graphically most famously represented by the Laffer Curve which illustrates how tax cuts spur enough economic growth to generate new tax revenue which in turn cuts into the deficit.

Arthur Laffer in 1974

Here's the problem--

There is no historical or empirical evidence whatsoever that it works. When first taken up by Ronald Reagan during the 1980 Republican presidential primaries, George H.W. Bush, who was contesting for the nomination, memorably called it like it is--Voodoo Economics. Telling the truth helped cost him the nomination and the rest is history.

That history includes truly massive tax cuts under Reagan of just the sort of which Laffer would approve. And did approve. But it did not jolt the economy as promised and it was paid for, as Trump's will be, by adding trillions to the national debt. Over time, during the eight years of his presidency, Reagan nearly tripled it.

And if we need further evidence, when 20 years later, George (the son) Bush pushed another round of tax cuts through Congress, the economy collapsed and the debt doubled.

As the French would say, Viola.

On the other side of the ledger, there are other voila moments--the resulting state of the economy after Bill Clinton and Barack Obama raised taxes. Clinton raised them on the highest earners and the GDP increased annually, on average over his eight years, by 3.8%. Obama inherited a prostrate economy from George W. Bush and managed to more than halve the annual debt while the economy grew by about 2% a year.

One might, therefore, conclude that tax cuts of the Laffer kind do not follow the Laffer Curve but in spite of this here we are again with voodoo economics resurrected. Why anyone would believe Treasury Secretary Mnuchin that "The tax plan will pay for itself with economic growth" is beyond my comprehension.

He knows not all of us are economic illiterates and so he confesses that the preposterous 3-4% GDP growth rate is the result of "dynamic scoring." This is when growth rate projections are based not on observable reality but are derived from assumptions about where the economy will be as the result of various hypothetical actions. In other words, rather than projections based on a semblance of reality ("static scoring") economists such as Laffer and government officials such as Mnuchin just make things up. They pick a growth number out of the air that fits their theory and proclaim it to be the empirical truth.

These might be considered economic alternative facts. Let's see if the public and Congress will again take a sip of the Kool-Aid.