New President Should Aim for Overcoming a Secular Decline
An Interview With Arthur B. Laffer

(Interviewer: Hanako Cho)


Cho: It seems like the $433 billion Inflation Reduction Act will be passed in the U.S.

Dr. Laffer: It’s a smaller version of the Build Back Better bill, but it’s still a huge [spending]. That’s not a minor version. The Inflation Reduction Act will not prevent inflation nor will wages catch up. The U.S. economy has taken a sharp turn for the worse.

The political environment is also worsening. The Republicans have been in this battle between Trump and anti-Trump, and that has split the party dramatically. It looks like the Senate will not go Republican. I would put the chances of the Republicans taking control of the Senate quite low. Maybe 20, 30%.

Now, it looks like the Republicans will still take the House, but I think their margin of victory is going to be much smaller. That’s where we are politically. All of that portends to a much deeper, longer decline.

Cho: You think that the U.S. is headed toward a secular decline if things stay like this, right?

Dr. Laffer: I’m going to make a distinction with you on a recession versus a secular decline.

A recession is something that happens every four to seven years, and it goes up and down, up and down, up and down. A secular decline is when the trend goes down.

Let me give you an example. In February 1966, the Dow Jones Industrial Average hit 1,000. 16 and a half years later, in August of 1982, the Dow Jones Industrial Average was down to 777. Now, the price level had tripled in those 16 and a half years so in inflation adjusted numbers, in August of 1982, the number was really 235.

If you look at it, it went from 1,000 to 235. That’s a 76.5% decline in the value of America’s capital stock. We declined at an average annual compound rate of negative 7% per year for 16 and a half years. That is what I’m talking about as a secular decline.

Today, I’m very concerned, not so much about a recession as I am about secular decline in the economy of the United States. It’s becoming more and more socialist, more and more government control, more and more irreverence towards democracy, more and more towards top-down autocratic behavior, and these are adding to the decline.

Japan is also in the midst of a really bad secular decline in the society. The Nikkei Stock Average was at 38,900 yen in December of 1989. Today it’s at 28,000 yen. So it’s down 30% over 30 years. That’s a secular decline. Japan is in the midst of a really bad secular decline in the society. The same thing that has happened in Japan is happening here in the U.S.


More and More Americans Stopped Working

Dr. Laffer: We’re about 5.5 million jobs short of where we would be on trend.

When I look at this, I find the one thing that really hits me the most on the data, on the numbers, is that so many people have left the la.
bor force. The participation rate has dropped precipitously. I mean, it has gone from 67.2% under Clinton to now a little bit over 62.1%. That’s a huge drop. 10 million people have left the labor force.

Now, when they leave the labor force, they no longer are considered unemployed. That’s what explains the unemployment number being very low.

Cho: Many people call it the Great Resignation, right?

Dr. Laffer: Yes, exactly. That’s the key problem, and that’s the problem to the secular decline.

They’re getting paid off [with unemployment benefits], so they decide they don’t want work at Walmart anymore. That’s inviting the secular decline.


Supply-Side Prevents Depression Stemming From Inflation

Cho: How can we prevent a depression and the secular decline that stem from inflation?

Dr. Laffer: Keynesian economics and supply-side economics solve this problem quite differently. Let me explain it to you the way I would my students.

Let’s imagine we have a problem that the price of apples is rising. I’m going to use apples as the example rather than GDP.

Larry Summers is saying that if the price of apples is high, you should reduce the demand for apples. If you take purchasing power away from people so that the demand for apples falls, you can lower the price of apples, but in so doing, you will also reduce the quantity of apples. You’re shifting the demand curve to the left, and you’re moving down along the supply curve so you get less quantity and lower prices. That’s what Larry Summers is talking about.

He thinks we can solve the inflation problem by reducing aggregate demand. This will cause a reduction in the total production of apples, which will be a recession, a depression, a decline. He is saying it will take 5 years of 5 or 10% unemployment. Several million people will lose their jobs.

My answer is somewhat different.

Take the quantity of apples again. Now, let’s imagine we have an increase in the production of apples. What will happen to the price of apples? Well, if you have a huge increase in the supply of apples, this will shift us along the demand curve, and the price of apples will fall.

When you increase the incentives to produce goods, you will reduce inflation and also lead to a very strong economy.

When the quantity of apples produced increases, there is no recession, depression, secular decline or any of that.

Larry Summers argues that we have to reduce demand, and Arthur Laffer argues we have to increase supply, and these are two diametrically opposed views of the world.

It’s just a very simple difference in how you’d like to control inflation. I’d like to control it with growth, and Larry Summers wants to control it with contraction. Larry Summers is very popular with the Keynesian left-wing crowd, and I’m fairly popular with the right-wing, conservative, free-enterprise crowd. So that’s the whole difference there.

The Fed policy is also important in solving this problem.

Now, what the Federal Reserve has done is it’s been raising the discount rate, but it’s controlling the long-term bond market totally and buying up bonds on their balance sheet.

Today in the United States, the long bond, the 10-year bond yield, is 2.7%. Who in their right minds would ever buy a 10-year U.S. government bond that yields only 2.7%? No one would ever buy that bond. They can’t tighten the money supply, and that’s adding to inflationary pressures going forward. There’s no amount of raising the discount rate by 75 basis points that’s going to [reduce inflation].

We need to do two things. The Fed should stop trying to fix prices and let interest rates seek their own level, which may be 14, 15% yield on the long bond. It would tighten up on money and make it attractive for people to buy government bonds.

The next thing we need to do is supply-side reform, which would be tax cuts, regulatory reform and free trade policies. We need to increase the supply of goods and services. That’s the key way I would get control over inflation and a secular decline in the U.S. economy.


The Only Solution for Democratic States Drowning in Debt

Dr. Laffer: The supply-side solution is also vital for dealing with large government debt.

U.S. federal debt as a share of GDP is at about a bit less than 130%. Not five years ago, it was at 80%. Japanese debt levels are enormous. We’re just becoming as large as Japan in federal debt in the United States, and that has made a huge burden placed on our economy.

The real problem here is that with higher interest rates, interest expense on the national debt goes way up. That means the deficit gets larger and larger.

You’re having this death spiral of higher interest rates leading to increase in even more debt and even higher interest rates.

This is the dilemma we have in the world today, and this is why it’s so important right now to get a supply-side revolution.

Sound money, free trade, minimal regulations, low-rate, broad-based flat tax and spending restraint. That’s what’s desperately needed to solve the debt crisis, the global secular declines, and it really is the only thing for making the economy look better in the future.


Major Economic Reforms to Propose to the President

Cho: If we have a Republican president, what kind of reform would you propose?

Dr. Laffer: Let’s say the new president takes office in January of 2025. It then takes a year for you to get policies put in place and judges appointed, department heads and all of the stuff. So the earliest you can expect to see major reform would be in 2026, maybe even 2027.

What would be the major reforms I put in then?

Obviously, you know my view on taxes. I would get rid of all federal taxes except for two: a corporate value added tax and personal unadjusted gross income tax. I’d have one flat tax on business net sales, and from the first dollar to the last dollar, no deductions, no exemptions, no exclusions, just everyone pays the same rate on everything, on the value-added tax, bingo!

Across the board, and I’d have a flat tax on personal unadjusted gross income, again with no deductions, no exemptions, no exclusions. All of these taxes will be picked up at the company level, not at the individual level.

Let’s say the income tax is 13%. If a company owes you $100, they send $13 into the government and give you $87. You don’t even have to file a tax return. That would be the reform I would do for taxes that’s right along the lines of Jerry Brown’s reform that I did long ago.

Then I would do medical transparency, where people have to know what the price of healthcare is ahead of time so they can make rational choices as to what they want to do with regard to their own health. That would be a huge plus for the U.S. economy.

I would then do welfare reform to make sure that unemployment benefits and welfare benefits are kept very low, so they don’t create the very problem we’re trying to solve.

If you pay people too much for being unemployed, not only will it help those who are unemployed, it will also make those who are employed want to be unemployed. So you need to be very, very careful on welfare reform.

With regard to the chronic poverty in the United States, I would put in what I wrote in 1972 which are called enterprise zones. I would put in tax-free zones in the most depressed areas of the U.S., basically in the black neighborhoods in the inner cities and anywhere where we have a large amount of concentrated poverty. And I would get rid of the income tax there, get rid of the payroll tax there, get rid of regulations, restrictions, requirements there, get rid of minimum wages there, and really make these areas attractive for businesses to come and locate so that they can locate their production facilities at a great advantage where the unemployment and poverty problems are the worst. That is a really important thing in the long run for the U.S.

And one I would also do is current currency reform. I would try to move the U.S. dollar back to where it was before Nixon, to where we have a sound dollar that’s based on stabilized prices, period. I would even consider going back to something like a commodity standard or gold and silver standard. I would consider that very seriously.

Now, there are a lot of other things I would do as well. I’d sell off all the gold in Fort Knox. I wouldn’t keep all these things there.

I would decontrol oil again and bring back production as much as we could.

There are a lot of other things, but the basic ones are transparency in healthcare, welfare reform, tax reform and currency reform. That’s what I would do to bring us back to a stable value dollar, no inflation, maximal production and good free market economics in all industries, one of which would be universities, by the way. I would do a major economic reform. Universities are superbly subsidized, and they don’t provide good educational processes here anymore.


What Would Dr. Laffer Do If He Went Back to the Founding Fathers’ Era?

Cho: What would you do if you went back to the Founding Fathers of the United States and contribute to constitutional provisions?

Dr. Laffer: If I went back to the Founding Fathers of the United States, and I hate to say it, but ‘Founding Old, White, Male Fathers,’ all right? It’s a very different world than we have today. And I like the inclusion very much today of women and different ethnic groups. But back then it wasn’t. Back then it was a very different world. Everyone looked just like me: old, fat, white and male.

If I did go back there to the Founding Fathers, one of the reforms I might put in there is merit pay for politicians.

It’s very hard to figure out how to do it, but if they figure out how to do it, they can figure out how to corrupt it, and that’s the problem.

But I think what [the Founding Fathers] put in there was really amazingly prescient.

I mean, I may tweak some parts, but I don’t think I’d do much. What I would do is I put in sunset provisions. Absolutes are never good in a dynamic history of a civilization.

I would put it in some of the provisions in the Supreme Court.

For example, did you know that black people in the Constitution were considered three-fifths of a person? They weren’t a whole person. They were three-fifths of a person. That should not have been in the Constitution.

If anything, if they’re going to put something like that in there, put in the sunset provision so that people can change it naturally without doing constitutional amendments, which are very difficult. I would do that.

I would put absolute prohibitions on some of the tax things that were done, but those are pretty much the only things. But I would put in sunset provisions to make sure that the constitution can be kept modern or at least more modern.

Cho: Would you include clauses regarding small government and sound money in the Constitution?

Dr. Laffer: I think they put it in. I think they already had it in there.

They didn’t have a tax problem like we have today. In 1910, total government spending, state and local included, was 3% of GDP.

How could they have foreseen a 40, 50% of GDP by the government? They couldn’t have.

Now they had it in the Constitution that the income tax was illegal, but that was changed by the 16th amendment to the Constitution.

But everything there is 2020 hindsight. I wouldn’t change the tax provisions in Article 9, Section 4 of the Constitution. They thought they had a very good balance between federal and state rights.

Remember, the states were independent countries before the union. All these 13 colonies were self-governed, so they wanted to make a very weak central government. And they did.

But as time went on, the central government became stronger and stronger. Now, the central government is much stronger than the state and local governments. That’s sort of what had to happen.

Would you have allowed the civil war to take place and have now two countries, the south and the north? I don’t know what the right answer is there, even looking at it historically. I mean, we lost more people in the civil war than we did in all other wars combined. It was just a horrible event. Would we have allowed secession from the United States? I don’t know.

New President Should Aim for Overcoming a Secular Decline
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