Interview was conducted in December, 2023

The Liberty interviewed Dr. Arthur B. Laffer, the father of supply-side economics, to hear his thoughts on the Kishida administration’s “conditional” corporate tax cuts.

Interviewer: Hanako Cho

 

Cho: Japan’s wages have not risen over the last 25 years.

Dr. Laffer: Japan is engulfed in a whole zeitgeist, in a whole philosophy, of redistributing income.

Let me try to explain something. How you do your taxes really matter and that’s why marginal tax rates are so critical. It’s really important to understand there’s a difference between how much you collect in taxes and how you collect those taxes.

Why do I talk about tax rates? Imagine we have a person who makes $100,000 a year and pays $25,000 in taxes.

Let’s imagine that person pays a tax rate of 25% on every dollar he or she earns, okay? You have a tax rate of 25% on $100,000 which gives you a total tax bill of $25,000.

Now, what if I changed the tax structure so that the person still pays $25,000 in taxes, but instead of being a flat tax rate of 25% across the board, the person pays nothing on the first $50,000 and pays 50% on the second $50,000. Now, facing a tax rate of 50% on the margin, that person will find leisure more attractive than he or she would at a flat tax of 25% as in our first scenario. Therefore, that person will earn less than $100,000 because the marginal trade-off on the last dollar is more friendly to leisure than it is to work compared to the first case. Do you understand?

Now, imagine I do another case. Let’s imagine I tax the first $50,000 of income at 50% and tax the next $50,000 at 0%. At $50,000, the person pays $25,000 in taxes, and then anything that person earns after that, he or she pays nothing. That person will work more than he or she would at a 25% tax rate across the board because on the margin, at the tax rate of 0%, work is more attractive than leisure. Therefore, that person will go on and earn more than $100,000.

As with the second case, there is very little on earth that discriminates more against income, earnings and production than a progressive income tax – whereby tax rates increase the more you earn. When we talk about progression taxation in Japan, in the United States, in almost every country in the world, they have the completely incorrect tax structure for production, output and employment.

People make a choice, “Do I work an extra hour or not?” and that depends upon how much you’ll earn after tax.

The higher the progressive tax rates, the less people will work more. If you really want production, what you want is “regressive taxes” with lower marginal tax rates. We jokingly call it the heart attack model of production. This is the way of making a society more prosperous. This is the best way of helping the poor and the minority.

You want to make sure that you unleash the productive and entrepreneurial spirits of those who are the single most productive people in your society. Generally speaking, those people make the most money and are those who invent things, make the capital gains, that do all that stuff. It’s very important that you keep your eyes on what you’re really trying to do in a society and you’re trying to make that society more productive and produce more goods and services so that you can provide incomes for all the people in your electorate.

 

A ’Disease of Intellectual Ignorance’ Within Japan’s Government Destroys People’s Work Ethic

Cho: The Kishida administration proposed a tax reform where if companies increase total employee pay by 3% year-over-year, 15% of the increased amount can be deducted from their corporate tax payments.

Dr. Laffer: This is all part of redistribution. (*1 Editor’s note: Dr. Laffer sees Japan’s conditional corporate tax cuts as redistribution in the sense that they will only cut taxes for companies that raise wages, thereby redistributing income from companies with high production efficiency to companies in the red with low production efficiency.)

The same goes for providing social security to retired, older people. Now, I, being 83 years old, love older people as you can imagine. But it is a very big mistake to redistribute income from young workers to old people who do not work. If you take from young workers and you give to old retirees, that is called a redistribution of income from young workers to old retirees.

By taking wages away from those workers and reducing their after-tax income, they reduce the incentives for those workers to work. Those workers will work a little bit less than they otherwise would have worked. Now, by giving that money to the old workers, that will provide [the elderly] with an alternative source of income other than working. Even though a lot of them don’t work, there are some who work part-time or work at schools to make an extra dollar or two. [The redistribution of income from young workers to older people] will provide them with income other than working so they, too, will work a bit less.

Every time you take money from young workers and you give it to old retirees, you reduce the production of young workers and you reduce the production and income of old retirees as well. The theorem here is exactly the same as it is in the United States: every time you redistribute income from the young workers to the old retirees, you reduce production, output and employment in Japan. The more you redistribute income in this way, the greater will be the decline in total income. This policy will not solve the income gap. Instead, it will make the poor people poorer.

You asked me the fundamental cause for why Japanese people’s wages have not increased for 25 years. All of your society is focused on redistribution of income rather than on the creation of income, and therefore, it is dedicated to taxing people who work and giving the money to retirees, people who don’t work.

Japan has substituted an enormously wonderful work ethic for a disease of intellectual ignorance in its government. Your government officials are ignorant of what makes the world work.

People don’t work to pay taxes, Hanako. People work to get what they can after tax. It’s that after-tax incentive that motivates people to quit one job and go to work for another job or work overtime and to develop the skills and the knowledge to make more money, to invent things. If you deprive them, through taxes, of the fruits of their labor and their intellects, they won’t do it.

That’s why I started off this discussion with you on the flat-rate tax, the progressive tax and then the regressive tax. It shows you exactly how to stimulate the work, output and employment: you want to have the lowest possible marginal tax rates on the broadest possible tax base. You provide people with the least incentives to evade, avoid or otherwise not report taxable income.

In 1989, we all considered Japan the next challenge. I mean, Japan’s market cap of equities was the same as the U.S. in 1989. The period that everything stopped was in 1989 when you put your first VAT in Japan – I think it was the 1% consumption tax. You’re still doing it to this day.

How much more evidence does your country need to say, “Don’t make that mistake again next year?” It’s the definition of being insane. The definition of being insane is when you keep doing the same thing over and over again expecting a different result. Your government is ignorant in the extreme because they don’t see the damage they’re doing.

 

‘Higher Wage Growth Without Productivity Is Inflation’

Dr. Laffer: The one wonderful trait the Japanese government had was they kept a stable yen.

Countries that depreciate their currencies suffer higher inflation than those countries that appreciate their currencies. The one country in the world that had not caught this disease was Japan. Now, the Japanese government has given up the one good thing they’ve been doing.

By weakening the yen and making the yen depreciate relative to the U.S. dollar, you’re now seeing for the first time in history, Japan having inflation.

Your example to me on the Japanese government urging for wage increases is an exact example of this disease. Your government believes that higher wage growth is good for the country.

Of course, that’s not true. Higher wage growth without productivity is inflation, and that is not good for your country.

Then, to allow tax breaks for increasing wages is double-down dumb because you increase that wage growth. Increasing wages without productivity is inflation. So it means you’re causing higher inflation and, at the same time, lower productivity, which means you will get real growth declining and inflation increase. This is a double mistake.

 

Dr. Laffer on ‘What is Productivity?’

Cho: How do you believe productivity is determined?

Dr. Laffer: There are three types of productivity.

There’s Hicks-neutral productivity, which is capital-embodied productivity. If you have more and better machines with the same workers, the output per worker will increase because of the more productive capital. Taxicab drivers without taxicabs are not very productive, but with more taxicabs, their wages will go up. What would our conversations be like without Skype or without a computer? It’s a really huge increase in the skills of the capital stock and making us far more productive.

The second type of productivity we talk about in economics is called labor-embodied productivity. For example, brain surgeons earn more income than do taxicab drivers because they have a lot of capital in their brains on how to do surgeries. Nuclear physicists, great businesspeople, terrific machinists, they all make more than day laborers because they are more skilled. If you increase the skills if workers, they will become productive.

Now, I used these categories in very broad terms for you, but it’s not just capital productivity. It’s capital productivity in agriculture, in machine working, in making cars. I looked at in terms of labor and capital, but really, there are thousands of types of capital and thousands of types of labor. And if you increase the amount of capital, worker productivity will increase because it is complementary with capital.

Now, there are people who aren’t very good economists, who believe that all productivity comes from capital. These people are called Keynesians, basically. Then, there are people who believe that all productivity comes from labor. This is sort of Marxist – the labor theory of value.

Then there are those of us, supply-side economists, who believe that there are three sources of productivity. Labor and capital are good, yes. If you make smarter, better educated, more skilled workers, you’re going to get more output per worker; and if you have more capital per worker, in other words they have more capital to supplement their work and help them work, you’ll also have more output per worker.

The third source is general systems like better highways, better education, better legal systems, better tax structures and such. You’ll get more output per worker. Those are called supply-side economists, and we believe in all three forms of productivity.

The other group stresses capital, the other group stresses labor and we stress output. That is clearly the only sensical way of looking at the world.

 

The Best Policy for Japan Is One That Creates the Greatest Productivity

Dr. Laffer: Our dream for Japan, our dream for America, our dream for the world, is to let the government do policies that create the greatest amount of productivity for the economy.

Now, what creates the greatest productivity for the economy?

A low-rate, broad-based flat tax. Government spending restraints. Sound money. Stable prices which give you much more productivity for the economy. Minimal regulations so that we don’t go beyond the specific purposes at hand. Free trade.

These five pillars of prosperity that I’ve always talked to you about are directly translatable into making the whole economy more productive. Government should try to create the greatest generalized productivity.

What beyond that should the government do? The answer is, “Nothing.” The government should get its stinking fingers out of the economy and let the people in the economy decide whether it’s worthwhile doing productivity in the labor through better education or though on-the-job training or through better machines by developing better computers.

The private sector, in weighing profit and loss and looking at incentives, determine how much goes into labor productivity and how much goes into capital productivity. All of these should be business decisions made by people seeking out profit, not government.

This is what your government doesn’t understand. They think they’re smarter than you are. And they’re not.

The Japanese government is dissipating the work ethic of Japan by bad taxes and now by monetary policy, bad regulations, bad trade policies.

It worries me a lot that Japan is not learning and is not doing the right things. You can ill afford to allow yourself to just spiral back.