30 January 2015

A call to all politicians: cutting taxes is good for you and your constituents


Last November the U.S. had its general elections. The party of tax cuts and a pro-growth agenda – the Republicans this time – was able to command the largest majority in the Peoples’ House since the 71st Congress was in session from 1929 to 1930. Republicans were also able to wrest control of the Senate by flipping some 9 seats in the U.S. Senate. And that may not be the end of it. Two senators who have caucused with the Obama Democrats may actually switch parties and now caucus with Republicans.

The first challenge to tax-increasing Democrats is in the works as I write. The new House and Senate are working to authorize the Keystone XL pipeline connecting oil fields with refineries from well inside Canada to the U.S. Gulf Coast. President Obama said he would veto the pipeline – despite the House already having voted to approve the pipeline 10 separate times – setting the tone that he and the anti-growth members of the Democratic Party will continue along the same path they have been forging for six years.

But the authorization of the Keystone pipeline is merely a beginning of this historic struggle between growth and redistribution. In the weeks and months ahead, we will witness both houses of Congress moving to repeal Obamacare. The President will veto, and the veto will be upheld, but such confrontation will only serve to weaken the Democrats’ hold on power. November 2016 isn’t all that far away after all. And there will be many, many more heroic confrontations between the forces of growth and the legions of redistribution. And to be honest, I’ve never seen growth policies lose when directly opposed by redistribution. The electorate knows better. The only time growth loses is when politicians don’t give the voters a choice. And that time has long since passed in the U.S.

The depth and breadth of the electorate’s understanding of basic economics, however, is demonstrated by the recent U.S. state and local elections. After November’s election, Republicans have 31 of the 50 states’ governorships, and they control more legislative seats than at any time since there have been 50 states. Of the 99 state legislative bodies (Nebraska has a unicameral legislature), Republicans control 69, picking up 9 new state legislative chambers just last year, and they came damn close to picking up two more.

The Republicans also did extraordinarily well in races for lieutenant governorships and attorneys general. Tax-cutting governors are everywhere, and since 2000, three states have adopted right-to-work laws and Wisconsin has done so in all but name. Several states are on the cusp of ridding themselves of forced union labor. What has become clearer each of the past six years is that politicians at the state and local level have been listening to their constituents and are enacting pro-growth policies left and right, which is in direct contrast to what President Obama and the Democrats have been doing at the national level. And now, with Republican control of both houses, the pro-growth team will begin undoing the damage done over the past six years. Policies that seek to redistribute income and wealth – rather than policies that foster economic growth – are losers for politicians and the electorate.

Electoral success for pro-growth political candidates is certainly no uniquely American phenomenon. After all, economic growth is much more than new stock market highs and a falling unemployment rate. Economic growth is the foundation on which nations are made great, and rising incomes, employment and profits that result from good economic policies are panacea to many more problems faced by nations and their politicians such as welfare dependency, race relations, gender and age discrimination, labour relations, immigration policies and much, much more. And a policy prescription of low-rate flat taxes, sound monetary policy, free trade, spending restraint and minimal regulations are the ways to achieve this growth.

Politicians around the world have seen enormous benefits from adopting pro-growth policies and rejecting redistribution. One of my favorite examples of a politician who embraced these ideals was my friend Margaret Thatcher, whom I had the distinct pleasure of advising on economic policies during the 1980s. Britain’s transformation during Lady Thatcher’s tenure was astounding. When she took office, Britain’s top rate of income tax was 83%. Rates these high are what led The Rolling Stones to move to France to record Exile on Main St. – they knew they would never be able to pay their back-taxes if new income was taxed away at such high rates. These days, it’s hard to imagine anyone moving to France to avoid high tax rates.

By the time Lady Thatcher left office, the top rate of income tax in the UK was 40%. To put that tax rate cut into perspective, one can look at the change in incentives to those earning incomes large enough to pay the top rate of tax. Remember, we don’t work to make pre-tax returns; we work to get what we can after tax. At an 83% top tax rate, the after-tax return on labour for earners in the top bracket was 17p for each additional pound earned. After Lady Thatcher’s tax rate cuts, the after-tax return for that same additional pound earned was 60p. Simple arithmetic – (60p-17p) ÷ 17p = 253% – shows that this is a 253% increase in the incentives to earn an additional pound. If that kind of tax rate cut doesn’t get people off their couches and back to work, I don’t know what will!

Lady Thatcher’s economic policies set Britain on a growth path that it hadn’t traveled in ages, and the electorate responded very favorably to her and her ideas. She became the longest-serving UK Prime Minister of the 20th Century, and the final 40p top rate of tax she achieved was not touched until Gordon Brown’s administration raised the top rate to 50p, which resulted in less than half as many UK citizens reporting £1 million or larger incomes as the year before the tax rate increase. Lady Thatcher’s income tax reforms were so successful, in fact, that Tony Blair pledged never to change them during his time in office.

The recipe to electoral success is simple and it works the world ‘round: put in place sound economic policies that increase the incentives to work, save and produce, and the ensuing economic success will all but guarantee your political longevity. Growth is the answer.

Arthur Laffer was a member of Reagan's Economic Policy Advisory Board, and is the economist behind the famous Laffer curve, which illustrates that a low tax rate can yield greater tax revenues than a high one. He is coauthor, along with Stephen Moore, Rex Sinquefield and Travis Brown, of "An Inquiry into the Nature and Causes of the Wealth of States" (Wiley 2014).