Economist Arthur Laffer, patron saint of tax cuts, is back, with an op-ed in the Wall Street Journal that he hopes will put the kibosh on future plans for government stimulus. Laffer, who had his heyday back in the Reagan years, is best known as the popularizer of the notion that raising tax rates beyond a certain level can actually reduce tax revenues by, among other things, discouraging entrepreneurship. The graphic representation of this idea, though not original to Laffer, came to be known as the Laffer Curve.
While he’s always had detractors, Laffer also had a lot of fervent fans back in the day. But his latest excursion into the public debate has drawn harsh criticism not only from liberal economists like Berkeley’s Brad DeLong but also from stimulus-hating, anti-Keynesian economists you might expect to agree with the Laffer line. The consensus? Laffer seems to have forgotten, or ignored, some pretty basic concepts in economics. In other words, Laffer is getting laughed off the economic stage.
In his WSJ piece, Laffer sets out a simple enough argument: In the current troubled world economy, he claims, the countries that have relied the most on fiscal stimulus — Estonia, Ireland, the Slovak Republic, and Finland — have done the worst. Why? Because, Laffer argues, the money for the stimulus has to come from somewhere, and therefore “every dollar of public-sector spending on stimulus simply wiped out a dollar of private investment and output, resulting in an overall decline in GDP.”
A rather elementary fact about fiscal stimulus, however, is that it doesn’t “wipe out” private spending in the present. Rather, it borrows money from the future. By relying on deficit spending, stimulus programs are designed to pump more money into the economy during downturns, when private spending and tax revenues are soft. The temporary deficits can be reduced, at least in theory, once the economy is back on its feet and tax revenues perk up.
But you don’t have to be a raging Keynesian to have trouble with Laffer’s argument. On his blog The Market Monetarist, Danske Bank Chief Analyst and self-described “right-wing economist” Lars Christensen suggests that Laffer has joined a number of other right-wing economists in the U.S. who “seem to have forgotten everything about economics — mostly as a result of an apparent hatred of President Obama.” Laffer, he argues, “is embarrassing himself” with his WSJ op-ed by pretending that Estonia, Ireland, the Slovak Republic, and Finland have been ruined by an excess of Keynesian zeal.
In fact, as Christiansen points out, Estonia, the Slovak Republic, and Finland are among “the most fiscally conservative countries in the EU,” while Ireland’s been spending its money on banking bailouts, not stimulus.
How did Laffer get things so backwards? Christensen suggests the following:
…maybe he never heard about cyclically adjusted government spending. It should be no surprise to anybody who just spent one hour reading an intermediate textbook on public finances that government spending tends to increase in cyclical downturns and tax revenues drop when the economy slumps.
On TheAtlantic.com, Matthew O’Brien takes this argument a step further, suggesting that Laffer may well have given us the “worst ever argument against government stimulus.” He writes:
It is trivially true that when GDP goes down, government spending as a share of GDP will go up. That’s how fractions work.
Laffer … wants to show that the most devastated countries were also the most profligate, but instead he’s simply showing that the most devastated countries were also the most devastated.
O’Brien adds several more years of data, and crunches the numbers in a more sensible way. By looking at the“percent change in public spending itself, rather than the change in public spending as a percent of GDP” he comes up with results that reveal the exact opposite of what Laffer is arguing. That is, O’Brien writes, “[t]he three countries that spent the least — Ireland, Greece, and Latvia — did the worst.” He adds, for good measure: “A silver bullet into the heart of Keynesianism, this is not.”
Laffer’s staunchest defender in all of this? The conservative weekly Human Events, which, like Laffer, had its glory days sometime during the Reagan Administration. In a blog post on the Human Events website, John Hayward writes that Laffer has dropped “an atomic bomb on Obamanomics.” More like a turkey.