Arthur Laffer warns about tax hikes. He's half right.
Arthur Laffer helped build the intellectual case for the Reagan tax cuts. Now he warns that tax hikes will kill the recovery.
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Everyone knows that tax rates are going up, at least for rich people, once the Bush tax cuts expire at the end of this year. So Mr. Laffer has weighed in with a provocative article in the Wall Street Journal, headlined: "Tax hikes and the 2011 economic collapse."
"It has always amazed me how tax cuts don't work until they take effect," he wrote in his June 6 op-ed. "Mr. Obama's experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011."
Laffer has long experience in this area. His theories in the 1970s helped build the Republican political argument for the Reagan tax cuts in the 1980s. The economy took off after that.
The problem with his argument is that he only tells the short-term story. Laffer relates how Americans and corporations will shift as much income as possible from 2011 to 2010. Thus, tax revenues will be lower next year than they would be otherwise.
That's all true. But America's economy is not going to crash because government revenues go up or down in a single year. The real policy question is what the long-term effect of the tax hikes will be.
No question they'll have a negative impact on growth. But that effect will be far smaller than the short-term effect – maybe one-third the size, say economists who have studied previous tax hikes. (See the Monitor's story on the research.)
That's not insignificant. But the developed world is embarking on an austerity drive and starting to bring budgets back into line. Governments can only do this in one of three ways: cutting spending, raising taxes, or both.
One can be an ideologue about this and push for either option one or two exclusively. Given the size of those deficits, however, option three is going to look far more appealing to most governments, including the United States.