No Laffer Matter Jude Wanniski March 26, 1997

Jude Wanniski letter, dated January 8, 1997,
to New York Review of Books, (Published in April 10, 1997 edition)

To the Editors:

Jason Epstein's commentary on "Conservative Mischief or "White Mischief," as the headline for some reason reads on the inside pages (October 17), pokes around in some interesting places. I found myself easily interested until I discovered that the Laffer Curve was "the most damaging of the intellectual 'hoaxes' fomented by conservatives like Irving Kristol and The Wall Street Journal" It is, Epstein asserts, "the crackpot theory that led Ronald Reagan to believe that huge tax cuts in federal taxes would lead to federal surpluses, when the actual outcome proved to be a cumulative deficit of $3.5 trillion."

It would take too long to explain the cross-currents of several separate policies that produced the $3.5 trillion deficit. It has been explained elsewhere. It is incorrect, though, to describe the Laffer Curve as an "intellectual hoax." It is simply the graphic of an axiom, an eternal truth — the law of diminishing returns. At the time it was put forth, the top marginal rate on interest and dividend income was 70%. This was certainly not the highest rate in the world at the time. It was 96% in the U.K. and 97V£% in India. The average top rate of income tax around the world was above 60%.

At present, there is no marginal income tax rate I know of in the world at 60%. Most are below 40%, including the United States, where it is at 38%. Democratic liberals who have sainted John Maynard Keynes for a great many good reasons, are silent when you bring up Keynes's argument that because of the law of diminishing returns, no tax rate should be higher than 25%. The concept behind the Laffer Curve is as old as civilization. There is nothing crackpot about it.

In my 1978 book, The Way the World Works, I named that curve after Arthur B. Laffer, who was the first economist to turn the ancient intellectual concept into a visual graphic. I'd spent the previous four years trying to persuade liberal Democrats that while it is imperative that the richest citizens bear the greatest burden of government, there comes a point in the rates where the rich avoid paying the higher taxes, and the burden falls on those who are not rich. When no Democrats showed interest, I changed my party affiliation and, with the help of Irving Kristol, Jack Kemp, and The Wall Street Journal, sold the idea to Ronald Reagan. That's the history.

Jude Wanniski
Morristown, New Jersey

Jason Epstein — published reply:

The Laffer Curve was a hoax because its allure and effect were not increased productivity but a tax cut for the rich. Thus the Laffer Curve illustrates another phenomenon as old as civilization — or even older: the tendency for wolves to dress like sheep.

*****

March 19, 1997

Jude Wanniski's response:

Ms. Barbara Epstein
Editor
New York Review of Books

Dear Ms. Epstein:

Thank you for printing my letter in your April 10 issue, in which I defend the Laffer Curve as an ancient axiom in graphic form. I do hope you read my letter and understood what I was driving at. Jason Epstein replied that even though the Laffer Curve may be axiomatic, it is still a hoax, because its "allure and effect were not increased production but a tax cut for the rich.111 truly hope you understand Epstein's sophistry.

If it is true that 2+2=4, should I be denounced for pointing it out in a context that undercuts Epstein's argument that it doesn't matter, because 2+2=4 benefits the rich? Please think this through carefully, and you will find reason to suspect that I really believe in what I wrote in my letter — that when tax rates get so high that they are avoided by the rich, the result is to throw the burden on the poor.

It is true that there were people who fastened on to my arguments because they saw an opportunity to see their own tax bills reduced. There were also those like David Stockman and Dick Darman who cynically saw a Trojan Horse inside the Laffer Curve. This was never the idea of those of us who developed the theorems and validated them by observing them work throughout history. That's why I pointed out in my letter to you that Keynes himself believed a marginal tax rate above 25% would be counterproductive.

My entry point on the planet came in 1936, in Minersville, Pa., as the son of a coal miner and a coal miner's daughter. I was not a silver spoon baby. I've spent the last six decades trying to figure out how to make the poor rich, not the rich richer. I've been trying to understand the way the world works and how it could be made to work better. At times, the solutions do not at first glance seem directly beneficial to the poor, but to help the rich inordinately. A second glance is required.

So it is with a cut in the capital gains tax, which seems to benefit the rich, but in fact showers most of its benefits on those who are not. This occurs because capital gains can only accrue to successful investments, while most investments fail. A rich man can get richer by investing in poor men, but only if the poor man succeeds. Five rich men investing in five poor men will generally produce losses for four rich men and gains for one, while each of the five poor men have earned their livelihoods while trying to succeed.

In case you might be interested in thinking this through, I send you a long piece I did a few years back on Karl Marx, one of my supply-side heroes. I invited him back to life, briefed him on what had happened since he died 120 or so years ago, and then asked him to look around and tell me what he saw. The Washington Post Outlook section ran an excerpt back then, but it has never been published in foil. You might pass it on to Jason Epstein if you think it worthwhile. He should also take seriously Deng Xiao-ping's admonition that it really does not matter whether the cat is black or white, as long as it catches mice.

Sincerely, as always,

Jude Wanniski