Continued Feature on Dr. Arthur Laffer, Father of Supply-Side Economics [Part 6]
Reagan's Major Tax Cuts: Approaching The Flat Tax

We spoke with Dr. Arthur B. Laffer who helped bring President Reagan’s major tax cut proposals into effect and aiding in initiating how these proposals were formed, as well as fostering their importance. 


President Trump’s Economic Advisor

Dr. Arthur B. Laffer

Born in 1940. After graduating from Yale University, Dr. Laffer received his MBA and Ph.D. in economics from Stanford University. Dr. Laffer is the founder and chairman of Laffer Associates, an economic research and consulting firm. He is also known as the father of supply-side economics, which became the foundation of Reaganomics. Dr. Laffer was an economic advisor to President Trump’s 2016 presidential campaign. He has authored many books including “The End of Prosperity: How Higher Taxes Will Doom the Economy — if We Let it Happen” (2008) and “Trumponomics: Inside the America First Plan to Revive Our Economy” (2018).

(Interviewer: Hanako Cho)

—President Reagan took office in January 1981 and signed the Economic Recovery Tax Act in August 1981.

Dr. Laffer: I also did a lot on that bill. I modeled it after the John F. Kennedy tax cuts in the 1960s which were a 30 percent tax cut across the board. It was a bill called Kemp-Roth which was named after my friend, Representative Jack Kemp, and Senator William Roth.


Laffer’s Involvement in Kemp-Roth Tax Cut Bill

Dr. Laffer: There were people who wanted a tax cut, and there were people who wanted spending increases. To convince Jack Kemp, I said, “You should do this,” because his full name was Jack French Kemp. His initials are JFK, which is exactly the same as President John F. Kennedy’s initials. I said, “Just think. If you do Kennedy’s tax bill, you will be ‘JFK II’ in American history!”

He loved it. It satisfied his vision of himself. So we won the war there, and that’s when he came up with a 30 percent tax cut across the board.

It involved going through all of the academic work and what happened in the past periods very carefully and precisely with Kemp. It takes a long, long time to nicely and correctly convince someone of good policy.

One of the big mistakes we made was that we phased in the tax cuts until the tax cut took full effect in January 1983. I’ve said this before, but when you know there’s going to be a bargain next week, you won’t go shopping this week right? The economy drastically worsened in ’81 and ’82, and unemployment climbed to its peak of 10 percent.

Once the tax cut took full effect on January 1, 1983, we had the biggest boom ever. I think from January 1983 to June 1984, that year and a half period, the U.S. economy grew by 12 percent (8 percent annual compound rate).


Reagan’s Virtue During the Presidential Election

Reagan won the election in 1984 by a landslide. We won every state in the union except Minnesota, which was the state that Walter Mondale was from.

Walter Mondale was the Democratic opponent of Ronald Reagan, and he was a very fine man. After we were showing huge leads in all the other states, the campaign advisers wanted to take all of the money and use it to campaign against Mondale in Minnesota and defeat him in his home state. And Ronald Reagan said, “No, you are not going to do that to this man. Stop spending money in Minnesota. He deserves to win his own home state.” Do you know of any politician that’s ever done that?

This shows you the depth and content of Ronald Reagan’s character. He did not want to insult and hurt Walter Mondale because he was such a fine man.


Breakthrough of 1986 Tax Cuts

—During the Reagan administration’s second term in 1986, the Tax Reform Act was passed.

Dr. Laffer: This was a compromise proposal by Patrick Moynihan, a Democratic senator from New York, Representative Dan Rostenkowski and Bob Packwood, a Republican senator from Oregon. The proposal cut the highest marginal income tax rate to 28 percent and the lowest rate to 15 percent. It also reduced the number of tax brackets from nine to two: 15 percent and 28 percent. That was it. In exchange, we got rid of all of these deductions, exemptions, exclusions and loopholes. It was an incredible tax bill. Can you imagine that tax bill in Japan, Germany, Britain or America today? No.

There are 100 members of the U.S. Senate, and there were 97 votes in favor of that tax bill. Every left-winger voted for it, from Teddy Kennedy, Joe Biden to Al Gore. They all voted for it because they knew it was right.

—Then shouldn’t Biden be supportive of tax cuts?

Dr. Laffer: Don’t expect him to be. Politicians are neither moral nor immoral. They are just amoral. If the popular answer is moral, they’ll be moral. If the popular answer is immoral, they’ll be immoral.

Ronald Reagan was able to eliminate all of the political divisiveness in America and brought Democrats together with the Republicans. It was a period of incredible prosperity and harmony.

—It was because of your contribution, right?

Dr. Laffer: I had written a paper in 1984 called “The Complete Flat Tax.” In that paper, I got rid of all federal taxes except for sin taxes: alcohol, tobacco, firearms, that type of tax. Instead, I put two flat-rate taxes at 12 percent, one on business net sales and one on personal unadjusted gross income. I wrote it in 1984, but I’d been thinking about it for years before.

I worked with Bill Bradley and Dick Gephardt on their bill. I worked with Jack Kemp and Bob Kasten on their bill. That was the one I really had pushed even more than the other, and the ’86 Tax Act was really my baby at that time.

Many religious leaders in the past have agreed with the idea of a flat tax. The Bible itself talks about a tithing, which is 10 percent. If you look at Ibn Khaldun, an Arab scholar of Islam during the Middle Ages, he understood supply-side economics perfectly. He understood that it’s wrong to adopt heavy taxes.

However, I’m an economist and I believe in empirical numbers. You cannot tax an economy into prosperity. And a poor person cannot spend himself into wealth.

There was a man who ran for President on my flat tax and my ’84 paper. It was Democratic candidate Jerry Brown in 1992. He raised the flat tax rate from 12 percent to 13 percent to pay down the debt, based on my ’84 paper. He got the second largest number of votes in the Democratic primary, almost beating Bill Clinton.

Jerry Brown never won, but it was Reagan who put it into practice. In fact, Russia adopted that 13 percent flat tax as well. Richard Vedder, an economist here in Ohio went to advise Putin on economics, and he took my tax bill to Putin. Putin used it to write his own 13 percent tax bill.

I used it with Lady Thatcher as well. We dropped the highest rate to 40 percent in Britain with the same tax bill. I was working with her very closely, along with Sir Geoffrey Howe, Sir Keith Joseph, Nigel Lawson and Alan Walters. In fact, Lady Thatcher used to come and stay at my house. It was fun times for me, and it was a good productive time for the world. The economies did pretty well. I tried to convince Japan, but I wasn’t very successful now, was I?


Does Trickle-Down Exist?

—Some people who are against supply-side economics criticize that there wasn’t a trickle-down economy during the Reagan era. How do you respond to this criticism?

Dr. Laffer: I don’t like the word trickle down. I don’t dislike it, but it’s not a correct image.

If it’s just a tax cut, you can’t tell whether it will be good or bad. But if it’s a tax reduction, that’s when you know it’s good.

Trickle-down economics puts lots of money in rich people’s hands; those rich people will spend that money, and it will trickle down to the waiters, servants and poor people.

The truth of the matter is, when you cut tax rates, you make additional hours of work more attractive. You make work more attractive than sitting there in leisure. You make high-paying jobs more attractive than the low-paying jobs. And so you change the whole calculation of work effort and investments.

In the 1970s, many investments were put into place to use tax shelters because you got special deductions. We cut tax rates and got rid of all these deductions, exemptions, exclusions and credits. Therefore, we made work much more attractive relative to non-work. We changed high-paying, productive work to make it much more attractive than low-paying, unproductive work. We made it much more attractive to work 48 hours than 40 hours. In other words, we reduced the barriers to making more money after tax.

People don’t work to pay taxes. People work to get what they can after tax. It’s the after-tax incentive that motivates people to work really hard. And that’s what we utilize with all of our tax cuts, be it Proposition 13, Thatcher’s tax cut in Britain, or the ’81 or ’86 Tax Act with Ronald Reagan. The whole purpose was to make work more attractive for everyone. It wasn’t meant to give money to rich people so they would spend it and poor people would make money.


Reduction in Highest Marginal Tax Rate Drives Economy

Let me give you a good example. When John F. Kennedy came into office, the highest marginal income tax rate in the United States was 91 percent. The lowest tax rate was 20 percent. Therefore, if you were a high-income person and you made a dollar, you were allowed to keep nine cents. If you were a low-income person in the lowest bracket, you were allowed to keep 80 cents for every dollar you made. That was your incentive to work.

Kennedy cut the highest rate from 91 percent to 70 percent, and the lowest rate from 20 percent to 14 percent.

By cutting the 91 percent rate to 70 percent, that is a 21-percentage point cut, which is, as a share of 91, a 23-percent cut (note: cost of government) in the highest tax rate. By cutting the lowest rate from 20 percent to 14 percent, that’s a six-percentage point tax cut. If you divide six by 20, that’s a 30-percent cut (note: cost of government) in tax rates on the lowest income group.

But now let’s look at what happened to the after-tax incentives. Now at 91 percent tax rates, if you earn a dollar, you’re allowed to keep nine cents. But at a 70-percent tax rate, if you earn a dollar, you’re allowed to keep 30 cents. Your incentive for working goes from nine cents to 30 cents on the dollar. That’s a 21-cent increase on the dollar and a 233-percent increase in incentives.

Now let’s go to the low-income person. By cutting the rate from 20 percent to 14-percent, that’s a 30-percent cut in that tax rate. At the lowest bracket, there’s a seven-and-a-half percent increase in incentives from 80 cents to 86 cents on the dollar.

If you do a cost-benefit analysis, the cost-benefit ratio in the highest bracket is 1 dollar of cost to 10 dollars of benefit because there’s a 23-percent cut (note: cost of government) for a 233-percent increase in incentives (note: cost of government). It’s a 1-to-10 cost-benefit ratio. At the lowest bracket, it’s a seven and a half percent increase in incentives for a 30-percent cut, so it’s a 4-to-1 cost-benefit ratio. So that is why you always want to cut the highest tax rates. The cost-benefit ratio is the highest in the world at the highest rates.

That’s what we did in the ’81 and ’86 Tax Acts with Reagan. That’s what we did with Thatcher. But that’s not trickle-down. Our opponents always call it trickle-down because they don’t understand economics. Trump understands the benefit of cutting the highest tax rates, by the way. He’s great.

Continued Feature on Dr. Arthur Laffer, Father of Supply-Side Economics [Part 6]
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