Laffer’s curve and voodoo economic development

by Sherry Robinson | May 12, 2012 | Filed under: Opinion

Remember the Laffer Curve?

In 1974, Arthur Laffer, a University of Southern California economist, drew a curve on a cocktail napkin.

“I have a weakness, like Janis Joplin, for Southern Comfort – but just three times a week,” he told me in 1996, when he was here to speak at a benefit.

As a member of President Reagan’s Economic Policy Advisory Board, Laffer argued that tax rates had risen to the point that they weakened incentives to work, save and invest; as a result, both economic activity and government tax revenues were suffering. Tax cuts, he argued, would spur growth without being inflationary because they would yield higher tax revenues and increased savings to offset the initial drop in the government’s tax take.

Laffer illustrated the idea with the Laffer Curve (which he kindly drew for me and signed).

Daddy Bush famously called Laffer’s ideas “voodoo economics.”

Critics argued in 1996 that taxes as a percentage of gross national product had been constant for 40 years, which disproved the theory. Laffer countered that after Reagan reduced tax rates, “we had the longest expansion ever.” He added that 1996 wasn’t a good time to talk about taxes because the economy was strong.

“When we came in the prime was 21 percent and inflation was 14 percent. The patient was dying. During good times they think our stuff is stupid and silly. At some point they’ll call us back again.”

And so they have.

Laffer is popular lately with Republican governors in several states, where he’s paid to advise on reducing or eliminating taxes. His gospel is the same: People and businesses leave states with high taxes and move to states with lower taxes. He moved from California to Tennessee because Tennessee has lower taxes and no income tax.

Economists from the other side of the fence say the analysis is faulty. States with no income tax have revenue sources – usually energy – that nobody else has. Our current president has said, “It doesn’t work. It has never worked.”

Recently, Richard Anklam, executive director of the nonpartisan New Mexico Tax Research Institute, addressed the Economic Forum in Albuquerque. I think of Anklam, who grew up in Ruidoso, as Dr. Reality.

Like Laffer, he has his own moving story: His father moved to Texas because it has no income tax. His father forgot that he didn’t pay much state income tax on his retirement income, but now he’s saddled with a much larger property tax than he had here.

“Emotional decisions,” Anklam said.

Unemotionally, Anklam talked about New Mexico’s tax system. “We have a higher than average corporate income tax in a low-tax region,” and it’s been static for 20 years while other states have reduced rates.

“We’re excessively reliant on incentives,” he said, and our incentives make us “more or less competitive.” But if you’re not eligible, “you’re left with a pretty onerous tax situation.” Texas, he said, offers no incentives.

He offered a quick appraisal of several successful bills from this year’s legislative session. One measure that requires counties to send an estimate of property taxes “doesn’t fix tax lightning” and “will only confuse people.” Another will help the construction industry and relieve pyramiding of gross receipts taxes.

A third, SB 212, by Sen. Tim Jennings, D-Roswell, was “one of the better, pro-business bills we had, and nobody knew it.” It’s unsung because you need to be a CPA to understand it, but, among other things, it reduces tax documentation and allows many small businesses to file withholding returns annually instead of quarterly.

Then came the inevitable question about taxation as an obstacle to economic development.

Anklam repeated a familiar mantra among economic developers that relocating companies have a laundry list of wants. “Is it all about taxes? Absolutely not.”