On Economists, Tax Cuts and “Being Denmark”
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In 2003, then-President George Bush proposed massive tax cuts on dividend income and capital gains.
In response, 450 economists (including 11 Nobel Prize winners) signed a letter opposing the tax cuts.
The group argued that the tax cuts would increase both the deficit and inequality.
Shortly afterward, 250 economists wrote a letter of support for the Bush tax cuts.
They argued that it was “fiscally responsible and it will create more employment, economic growth and opportunities for all Americans."
Predictably, the Trump tax cuts have been similarly controversial, with supporters and detractors split along political party lines.
Taxation has always been a hot-button issue in the American psyche.
After all, the Boston Tea Party - led by the Sons of Liberty - helped launch the American Revolution.
Today it’s mostly economists who guide the serious discussions...
And the views of the right and the left could hardly be more different.
The “Right” Argument
When discussing taxes, free market economist Friedrich Hayek focused on efficiency and freedom.
Hayek argued that government spending is by its nature inefficient. So the less of it, the better.
Keeping more of your own money allows you the freedom to grow your wealth as you see fit.
President Reagan’s budget director David Stockman famously argued that tax cuts allow businesses to invest more. That investment, in turn, creates more jobs.
Thus, the idea of “trickle-down economics” was born.
Economist Arthur Laffer - a leading advisor to the Reagan administration - provided the most compelling rationale for cutting taxes.
Forty years ago, Laffer doodled the now famous “Laffer curve” on the back of a cloth napkin in a Washington, D.C., restaurant.
Put simply, Laffer argued that if the government cut taxes, total tax revenue would actually rise, not fall, because more people would be incentivized to work... and to work more.
Right-leaning politicians loved Laffer.
After all, he basically told them they could have their cake... and eat it, too.
The Response From “Left Field”
Stockman and Laffer’s logic drove mainstream economists of the left nuts.
To them, it was evident that cutting taxes resulted in less spending on public services, higher government borrowing and rising inequality.
Economists Paul Samuelson and Joseph Stiglitz argued that the free market is poor at providing public goods like roads, national security and police.
Having more money from income tax cuts, they said, is a false economy.
You may save money on your taxes, but if less spending on road repairs means more potholes, you'll end up spending more on car repairs.
The left also ridiculed the Laffer curve. They pointed to the continued explosion of government debt after each new Bush tax cut. They joked that Laffer’s famous doodle had the shape - and the substance - of a wishbone.
Finally, they made a moral argument.
Tax cuts benefit high-income earners disproportionally, increasing inequality.
And rising inequality would shake the very foundations of a stable society.
The View From the Bleachers
If you’ve made up your mind about tax cuts, nothing I write will change it.
However, let me share two perspectives...
First, the Laffer curve can work surprisingly well - but for reasons Laffer never expected.
When Russia first introduced a flat tax of 13% in 2001, tax revenues soared tenfold over the next decade.
It was a stunning confirmation of the Laffer curve.
(The Wall Street Journal even dubbed Russia’s success the “Putin curve.”)
The real reason for the success was best explained to me by a street-smart Russian entrepreneur.
He told me it cost him at least 10% to engage in the shenanigans needed to avoid paying taxes.
A flat tax of 13% was just low enough for him to pay willingly, to avoid the hassle of not paying.
Second, it’s a big world out there.
Shockingly, the citizens of some countries are okay with paying high taxes.
The left often idealizes the Nordic countries (Denmark, Finland, Norway and Sweden) where income and consumption (sales) tax rates are together far north of 50%.
High taxes allow the Nordic countries to afford generous welfare states.
Benefits include free education, free healthcare and guaranteed pension payments for retirees.
(Imagine your financial life if you didn’t have to save for college, buy expensive health insurance or worry about your retirement.)
As political scientist Francis Fukuyama once told me, the eternal question among many U.S. policymakers is “Why can’t we all be more like Denmark?”
Countries - including the United States - shouldn’t try to “be more like Denmark.”
Like individuals, countries should have the freedom to choose policies that are best for them.
In Russia, a 13% flat tax made a lot of sense for specific reasons.
And citizens in Nordic countries are willing to pay higher taxes because the government gives them cradle-to-grave security. This is as much a part of their cultural values as personal freedom is to ours.
In the U.S., lower taxes allow citizens to take on more personal responsibility.
And that’s very much in line with an American tradition that goes all the way back to the Boston Tea Party.
As a firm believer in personal liberty and choice, my own biases are evident.
However, here’s the irony...
The U.S. left idealizes the high-tax Nordic model and struggles with how to graft those values onto our society.
In contrast, the Nordic countries themselves don’t go out of their way to convince other nations to adopt their model.
The Nordics respect the freedom of nations to decide what’s best for them.
And that is what the freedom to chart your own course is all about.