During the late 1970s in the U.S., there was a great revolt by taxpayers that could well be compared with the Boston Tea Party incident. Dr. Arthur Laffer helped resolve the movement and became a celebrity. And this was the opening chapter of the revolution of supply-side economics.

(Interviewer: Hanako Cho)

—Last time, we discussed the state of the U.S. during the Great Depression. Similar to the 1930s, the 1970s was a time of recession for the U.S.

Dr. Laffer: At the time, President Johnson’s Great Society reform increased welfare spending. With the increased welfare spending came double-digit inflation and a recession all around the U.S.

The state of California was not an exception. California residents’ dissatisfaction with rising taxes exploded. There was no ceiling on the valuation of property taxes, so a few thousand residents experienced home foreclosures.

In 1976, California residents who could no longer endure heavy taxes raised Proposition 13 on the ballot and launched a great tax cut movement.

Many economists opposed the tax cut, arguing that it would result in a fiscal budget deficit and subsequently close down public services such as schools, libraries and firehouses.

—You supported Proposition 13 and contributed to the tax cut movement. Essentially, you became famous by implementing supply-side economics in California, a state that compares in size with France’s economy.

Dr. Laffer: I didn’t do it to support Proposition 13. Let me tell you what happened.

I taught at the University of Southern California (USC)’s business school at the time. Just like I was at the University of Chicago, I was a very popular teacher and I had very large classes.

I loved my students more than life itself. They’re the reason I live, the reason I exist. I mean, I just really loved my students. I have always apologized to my students for having to give them grades because I am required by university regulations to grade them. I am not their master when I’m the teacher, I am their servant. When I teach a class, I am the employee and [the students] are the employers, in my view. I hated giving grades because I am there to serve them, not the other way around. So, at the end of the semester, I told them I would try to make it up to them by giving myself a final exam in the class.

—How did you take this exam?

Dr. Laffer: What I did was I took a major public policy issue at the time and did an analysis of that issue as if I were taking an exam. I tried to do it in a reasonably short paper, around 1,500 to 2,000 words. But I would take a major political economic issue and write a paper on it with everything on the four corners of that paper.

You know how economists are: students would say, ‘You told me we’d have high inflation and the inflation didn’t come.’ ‘Oh, that’s because of this and that.’ Economists are always making excuses to as to why they’re wrong, and I did not want to do that with my students.

Every semester, I came in for the final exam and handed them my paper which was an analysis of some major issue and what I thought would happen. They could look at this paper in the following years and see if I was any good or not.

Taxpayer’s Revolt

Dr. Laffer: Paul Gann and Howard Jarvis, two California residents, were the primary authors of Proposition 13, leading the taxpayer’s revolt. It was their fifth attempt at a constitutional amendment. They had a proposition that would reduce property taxes from 2.7 percent of market value to 1 percent of market value. Now, that’s a huge property tax reduction. They also had some other provisions in their proposition. For example, any tax increase in the state of California required a super majority vote, which meant that tax increases or special taxes must be approved by a two-thirds vote in the legislature.

Their proposition became known as Proposition 13 on the ballot. And this got a lot of attention.

In June of 1978, I was giving a fundraising speech in San Francisco for USC.

I was pretty famous by then because of my Nixon years and involvement with Reagan. I wasn’t famous like I am now, but I was quite famous in the University to do fundraising dinners and all sorts of stuff.

I was in San Francisco with a big crowd, and someone asked me, “Dr. Laffer, do you have any opinion on Proposition 13 on the ballot?”

And I told him the story of what I did with my students and how I gave the paper to my students for a final exam so they could later tell me if I was any good or not. I said, ‘It is exactly 1978’s ballot that I took my final on, and I just finished my complete analysis of Proposition 13. I have the paper for it.’

The next day, I think I got 1,500 requests for that paper.

Tax Revenue Won’t Decrease With Proposition 13

Dr. Laffer: I believe that many people at the time understated the supply-side effect and overstated the negative impact of tax revenue as a result of Proposition 13. Let me briefly introduce my paper that I handed out to my students:

Property tax revenue will fall by less than [the static forecast of] $7 billion because property values will rise, and new construction activity will expand. Both of these effects will expand the tax base, and thus lead to less property tax revenue loss. In later years, property tax receipts will fall by less than $7 billion annually. Take, for example, a $100,000 home, paying taxes of 3.5 percent of market. Taxes would be $3,500 per year without Jarvis. If Jarvis passes, the tax rate would fall to 1 percent of market, but tax receipts would be greater than $1,000. Using a discount rate of 10 percent, the approximate receipts would initially be $1,250, reflecting a rise in the market value of the house to $125,000.

In short order, the higher values of homes would encourage more new construction and an enlarged property base. As this process progressed, total property values would rise by far more than the 25 percent of the example.

Tax revenues elsewhere would expand absolutely. Social welfare mandated spending would fall. With property taxes lower, businesses will expand their activities within the State. This expansion will create new jobs, more investment and higher real wages. Sales, incomes and other forms of activity will expand. Sales taxes, income taxes, etc. all will rise. In addition, State outlays for social welfare will fall (unemployment compensation, rent subsidies, medical, etc.).

Tax revenues in future years will be reduced by less or, quite conceivably, even expanded as a result of Jarvis-Gann. When combined with the healthier economic base and less social welfare expenditures, the State should shortly be back in a surplus condition.

Joint Press Conference With a Democratic Governor!

Dr. Laffer: The paper that I wrote for my final exam became published everywhere, and I was on the cover of magazines. It was amazing. All of a sudden, I blew right into the big headlines and everything.

The night passed in California, everyone ranging from intellectuals, large businesses to small and mid-size enterprises opposed Proposition 13 except for the voters. In June of 1978, Proposition 13 won in a landslide with a 62-34 vote.

On the day residential voting took place, I got this phone call, around six or seven o’clock, from Democratic Governor Jerry Brown. I pick it up and he says, ‘Arthur, I need you to be in my office first thing in the morning. Proposition 13 has just passed. The government of California needs to make sure it works well, and we need to do a careful analysis of it at the state level. Would you please come to my office first thing in the morning? I’ve already gotten your ticket on the first flight from Los Angeles to Sacramento.’

Later, we held a joint press conference. Everyone knew that I’ve been supporting state governor Reagan, so the press was shocked to see us holding a press conference together.

I have an interesting memory from that time. Before the press conference, Governor Brown leans over to me and whispers, ‘I do hope you don’t take this opportunity to dump all over me.’ So, I put him at ease and said, ‘Governor, I’m not here to make you look bad. I’m here to do good work for the people of California and you’ve done a great job.’

Politicians are politicians. It was exactly what Nixon would do, too. Many politicians are always worried about someone saying something nasty about them (laughter).

Proposition 13 was the best thing that ever happened to California, and it went on to prove that my prior analysis was indeed correct.

California housing prices went way above the national average, doubling the national average. We had the fastest growing state in the nation by miles from 1970 to 1990 and dropped our unemployment rate to below the national average. We increased the size of California by Massachusetts’ economy over the period. It was just the most wonderful period of prosperity.

After Proposition 13 passed, this movement spread to other areas. We got Proposition 2.5 in the state of Massachusetts and there was a tax reform in the state of Delaware. California’s tax cut movement impacted many states and led to a large-scale tax reform. There wouldn’t have been the 1980 Reagan administration without Proposition 13.