Building an Economy that Works for Everyone

Cue the Laffer track when reading latest Wall Street Journal column on Initiative 1098

A new assault on economic wisdom written by Arthur Laffer claims taxing the wealthy will stymie personal income and tax revenue — but it’s a textbook example of using selective data to support a predetermined conclusion.

Arthur Laffer is the originator of the “Laffer curve”, a theoretical premise that as tax rates decline, tax receipts will grow because the decline in tax rates will generate greater economic activity. This notion was used perhaps most famously by Ronald Reagan to promote his administration’s economic policies. But of course, quite the opposite happened when Laffer’s premise was put into practice.

When Reagan cut taxes in 1981, the economy went into a tailspin and tax receipts fell. Individual tax and corporate receipts, in constant dollars, did not reach the level they had been in 1981 until 1987, even accounting for population and productivity growth. By comparison, the Clinton tax increases on the wealthy in 1993 were followed not only by multi-year economic growth, but also by an increase in federal tax collections — so much so that the government was running a surplus at the end of the century.

The same pattern of declining tax receipts and stagnant economic activity followed after the Bush tax cuts in 2001 and 2003. Total income was $2.74 trillion less during the eight Bush years than if incomes had stayed at 2000 levels. Average taxpayer income was down $3,512, or 5.7 percent in 2008, compared with 2000. Had incomes stayed at 2000 levels, the average taxpayer would have earned almost $21,000 more over those eight years — almost $50 per week.

Given the actual history of tax increases and cuts, and revenue growth and decline, it’s no exaggeration to say the Laffer Curve has been thoroughly debunked. It is amazing that Arthur Laffer is still considered a reliable and predictive economist — though it helps to have a platform like the Wall Street Journal.

Laffer sums up his ideology with this statement: “(T)hose states with the highest tax rates, and those states that have introduced state income taxes, have seen standards of living (personal income per capita) substantially underperform compared to their no-tax counterparts.” Okay, so let’s compare, starting with those states Laffer highlights in his column.

They are Connecticut, New Jersey, Ohio, Rhode Island, Pennsylvania, Maine, Illinois, Nebraska, Michigan, Indiana, and West Virginia. It is an odd collection of states, those which have adopted an income tax in the last fifty years!

The first thing to note is that most of the states Laffer calls out — Ohio, Rhode Island, Pennsylvania, Maine, Illinois, Nebraska, Michigan, Indiana, and West Virginia — have something thing else in common besides an income tax:  a manufacturing sector in long-term decline that has also been hammered by the nationwide recession. In fact, manufacturing jobs make up more than 10% of the total payroll in those states – a fact Laffer rather conveniently overlooks.

Laffer also fails to recognize that two of the states he mentions — Connecticut and New Jersey — have quite high average personal incomes relative to the rest of the country. Connecticut has best per capita income in the country, topping $54,000. That’s $19,000 more than in our own state. New Jersey is not far behind, at over $50,000. It doesn’t seem that an income tax significantly dampened the standard of living there.

Nor has it in other states with an income tax. In fact, accounting for state population size, the average per capita income of those states with the highest effective tax rates of 6.5% or greater on the top one percent of taxpayers — California, New Jersey, and New York — is $45,000. The average income of the seven states without an income tax — Alaska, Nevada, Florida, Wyoming, South Dakota, Texas, and Washington — is $38,000.

So the top tax states generate $7,000 more in personal income than the no-income-tax states. That’s 18% more personal income. That’s nothing to sneeze at, or to bury with false data.

How about the rich people — where do they live? Proportionally, there are almost twice the number of rich people in Connecticut and New Jersey than in our state. And that is not because of the weather! These states’ effective income tax rates on the top one percent are 4.9% and 6.5%. Ours is zero now, and will be 4% with Initiative 1098 in place.

In fact, millionaires tend to favor the states with the highest per capita state and local tax revenues. According to Phoenix Marketing International’s most recent report, the states with the highest concentrations of millionaires in 2010 were Hawaii, Maryland, New Jersey, Connecticut, and Massachusetts. Effective state income taxes for the top one percent of taxpayers in these states are 5%, 5.8%, 6.5%, 4.9%, and 4.2% — all higher than I-1098’s effective tax rate of 4%. And all five of these states are among the top ten states for highest per capita state and local tax revenues.

Perhaps millionaires might – all things being equal – like to pay lower taxes; but it seems they’d rather not to give up the great schools, high-quality public amenities like museums and parks, and sound infrastructure that our taxes make possible.

UPDATE: Sightline’s able analysts also take on Laffer’s column – it’s worth a read: Wall Street Journal Flunks Math. Again.

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