Featuring Dr. Arthur Laffer, Father of Supply-Side Economics [Part 11]
An Encounter With Thatcher (Part 1 of 2)

Dr. Laffer spoke with The Liberty and shared his memories of Margaret Thatcher, a former prime minister of the U.K. and an old acquaintance of his.

Interviewer: Hanako Cho

Cho: I want to ask you about your first impression of Margaret Thatcher.

Dr. Laffer: The first time I met Margaret Thatcher in ’77, it was with a guy from the London Economist, Brian Reading. I lived in Britain when I was young and worked there in Southampton. Also, my first wife was from the highlands of Scotland, so I knew Britain well and I was involved with the politics and economics there.

I was asked if I would like to meet with a member of parliament, a person named Margaret Thatcher. I went in to meet with her for a short meeting in her office when she was just a member of parliament at the time. [Her first impression] was unexpected. There wasn’t a subject she wasn’t an expert on, but she had an opinion on everything, and she was assertive. I didn’t get a good sense of humility.

The next time I met her, it was either during the election or just after the election. She was charming and wonderful. She had me meet with Sir Geoffrey Howe, who was the chancellor of the Exchequer.

The slow economic growth of the U.K. at the time was similar to that of today’s Japan, so Margaret Thatcher thought that she’d be able to revive the British economy through my tax cut policies.

She loved my tax cuts, which I was very famous for then, even before Reagan became President.

Cho: The Thatcher administration carried out two tax reforms, the first in 1979 and the second in 1988.

Dr. Laffer: Over the course of her two tax reforms, she dropped the highest tax rate from 83% to 40%. It was amazing. But in her first tax bill in ’79, she cut taxes on the income tax, which they call direct taxes in Britain, and then raised indirect taxes, which is the value-added tax (VAT) [or consumption tax].

I believe this was the effort of Geoffrey Howe. That was the Sir Geoffrey Howe tax cut. I did not like Geoffrey Howe, just so you know, so take it with a grain of salt when I say nasty things about him.

The next Chancellor of the Exchequer after Geoffrey Howe was Nigel Lawson. I spent a lot of time with him, and from then on, Thatcher and I got along enormously well.

In his previous job, Lawson was a journalist specializing in economics and he was an editor of The Sunday Telegraph and The Spectator. He had excellent abilities of policymaking and execution.

In ’79, I wrote a Wall Street Journal piece called ‘Margaret Thatcher’s Tax Increase,’ which outlined the following ideas.


’79 Tax Cuts Are Different From Supply-Side Economics

Since the British election in 1979, the fall in the London stock market was powerful evidence that something had gone wrong in England.

Before the election, Lady Thatcher was widely regarded as favoring lower taxation and increased incentives to production. The day she was elected, however, speculation spread that Thatcher would try to balance the budget. This was confirmed in an official budget that was released soon after, and this budget indicated a net tax increase.

Commentators around the world have described the Thatcher administration as a “resurgence of classical incentive economics.” But nothing could’ve been further from the truth.

Attempts to reduce the budget deficit and reform the previous administration’s antibusiness policies by introducing higher taxes were not sufficient to reestablish a vigorous British economy. Tax financed spending and higher taxes on labor were as bad, if not worse, than the previous Labour Party’s agenda.


Tax Reform That Created a Net Tax Increase

Thatcher’s tax reform lowered direct taxation, but since it has taken away more from indirect taxation, British estimates showed a net tax increase.

Moreover, that estimate underestimated the actual increase in tax rates.

The Thatcher administration raised the VAT to 15% on all non-exempt items. For non-luxury items, this resulted in a tax increase of seven percentage-points, and for luxury items, the tax increase was three percentage-points.

The tax policy was tilting in the direction of raising tax rates on primary consumer items of the middle- and lower-income groups.

The overall restructuring of the tax system increased tax rates for lower incomes and lowered rates for higher incomes. Tax increases for low-income earners would more than offset tax cuts for high-income earners.


A Tax Hike Impacts the Drop in Productivity

People do not work and invest to pay taxes. Increasing tax rates inevitably increase the cost of employing workers and acquiring capital. As these costs increase, fewer workers and less capital are demanded. On the supply-side, a tax increase will reduce take-home pay and after-tax returns to savings. Not only does this discourage workers from working, but it also takes away incentives to save. Therefore, a tax increase reduces both the supply and demand for hard work and capital. Output falls.

Consumption taxes, like the income tax, are also damaging to private incentives. The ultimate objective of work and savings is consumption. Irrespective of the stage at which the resources are obtained, people supply capital and effort to acquire net purchasing power.

The idea that only conflicts exist between different economic groups is erroneous, and supposedly competing groups, such as capital and labor or rich and poor, benefit each other.

What is important is that ‘higher taxes on the rich hurt rich and poor alike.’ Similarly, higher taxes on the poor make life worse off for both the poor and rich. If either group benefits, everyone gains. In other words, far from being adversaries, the lot of each group is tied to the success of all.


Falklands War Gets Thatcher Out of Trouble

Dr. Laffer: I was invited to two big lecture tours in Britain, and when I wrote this WSJ piece, I got official notices from both sponsors of my lecture tours in Britain that I was no longer wanted there. But Lady Thatcher never ever mentioned that to me. After this event occurred in the WSJ and they disinvited me from going to Britain, she still kept very close contact with me. I spent lots of personal time with her, and she even stayed at my house in California. She had an office in Chester Square, and my daughter, Rachel, worked for her in Chester Square for a year.

I don’t know of any other American at my level that worked over there in Britain with her at all.

It’s so surprising because the first meeting was so unpleasant. I should not have done that editorial in the WSJ even though it was true. She had one tax cut on personal income, and she had a tax increase onto VAT. The two exactly offset each other, and the economy turned south very quickly. Her poll numbers were awful.

Then, God gave her a little gift. The gift was the naval officers in Argentina who did an invasion of the Falkland Islands. Lady Thatcher took offense, and everyone, including Ronald Reagan, told her not to do it. Reagan said he would not support the effort. I think some of the colonies like Canada did support it.

But she took her big fleet down to the South Atlantic and won the war there. Her popularity went through the moon. If it had not been for the naval officers in Argentina who attacked the Falkland Islands, she never would have won re-election. She would have been a comma in history. But because she did this, she won the re-election in a landslide.

Featuring Dr. Arthur Laffer, Father of Supply-Side Economics [Part 11]
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