Tuesday, July 20, 2010

Voodoo Economics

¡Hola! Everybody...
I wrote the following some time ago and thought it needed some dusting off.

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-=[ Of Laffer Curves, Cults & Crackpots]=-

What we might call, by way of eminence, the Dismal Science.

-- Thomas Carlyle (1795–1881) Scottish philosopher on economics

One day, spurred by a comment left on my blog, I called my friend who works on Wall St. My friend is a staunch conservative who majored in economics. His wife, bless her soul, doesn’t like me too much and thinks I should be excommunicated for my sexual views. LOL!

Anyway, I’m not very bright when it comes to economics and finances, I believe my ex-wife is correct in her observation that I should never be allowed to handle my own finances, let alone talk about them. Whenever I have a question on economics, I always call my Wall St. friend. Lately he hasn’t been returning my calls, but I was able to reach him yesterday and he agreed to talk to me on condition that I would never tell his wife we met and if I didn’t interrupt him with my “radical” views. I agreed and even offered to buy him lunch considering the market is right now more radical (anarchy!) than I could ever dream of being. LOL

We met at a popular eatery near Wall St and when we sat down, I immediately blurted out, “Laffer Curve! Tell me about it!” That prompted a hush over the mid afternoon crowd -- nervous glances from others in the restaurant. My friend begged me to lower my voice, “Eddie, things are pretty much volatile around here these days, please don’t start a stampede.”

I promised to be quiet and he began to tell me about this mysterious, all-knowing talisman -- the Laffer Curve.

Now, keep in kind my friend, though a conservative, believes supply-side economics to be the biggest con ever perpetrated on the American people. He’s an “old school” republican: republicans that concerned themselves mostly about such things as deficits, inflation, and excessive spending; republicans who didn’t care much about cutting taxes and were quite willing (like Eisenhower and Ford) to raise taxes in order to balance the budget.

I laugh and and my friend assures me that such men existed, but that they have become an endangered species (extinct?) as the GOP has essentially been hijacked by a cult.

All sects have their founding myths, my friend assured me, and the cult in question can trace its roots to a Holy Trio (like in Christianity!) that met in Washington, DC in late 1974. That trio consisted of Arthur Laffer, an economic consultant, Jude Wanniski, a high-strung Wall St. Journal editorial writer, and, yes, Dick Cheney, who was then Ford’s chief of staff.

Wanniski had no formal training in economics, but he had taken Laffer as his mentor. His choice of tutelage was curious. Laffer had been an economics professor at the University of Chicago since 1967. In 1970, a colleague brought him to Washington to serve as a staffer in the Office of Management and Budget (OMB). There he quickly distinguished himself by making a wildly unconventional calculation about the size of the 1971 Gross Domestic Product. President Nixon, ever the craven opportunist, jumped on Laffer’s number because it was far more optimistic than other estimates and suggested an economic boom under his watch. It was discovered that Laffer had used only four variables to arrive at his figure. My friend tells me that most economists used hundreds if not thousands of variables -- inputs.

When his calculations turned out to be horribly wrong, he became the laughingstock of Washington. He left government in disgrace facing the disdain of his academic colleagues. Still, he stayed in touch with Wanniski, the two having met in Washington, and continued to tutor him in economics.

At this point, I gave my friend a patented Eddie ::blank stare::

My friend shrugged as if to say that no one can ever understand the underpinnings of human motivation.

In 1972, Wanniski had an epiphany that led him to believe Laffer was a brilliant economist who had developed a blinding new insight that would turn the economic establishment on its head. Wanniski and Laffer believed that it was possible to simultaneously expand the economy and hold down inflation by cutting taxes, especially taxes for the wealthy. Respectable economists -- even conservative ones -- considered this laughable. Nevertheless, Wanniski was convinced of its truth. He promoted the doctrine through his high perch on the respected (and uber -conservative) Wall St. Journal Editorial page and in articles in the equally conservative Public Interest (published by the Godfather of the NeoConservative Movement, Irving Kristol). Both were highly influential media outlets.

Still, Wanniski’s new doctrine, later to be called supply-side economics, failed to catch on beyond a few loyal devotees.

Then came that fateful Holy Night. Wanniski and Laffer were working hard with little success to explain the new theory to Cheney. At this point, Laffer pulled out a cocktail napkin and drew a parabola-shaped curve on it. The premise of the curve was simple. If the government sets a tax rate of zero, there’s no revenue. And if the government sets the tax rate of 100 percent, the government will also receive zero tax revenue, since there will be no incentive for anyone to earn any income. Between these two points -- zero taxes and zero revenue, 100 percent taxes and zero revenue -- Laffer drew an arc (“The Laffer Curve”). The arc suggested that at higher levels of taxation, reducing the rate would produce more revenue for the government.

At this point, Cheney could have raised several questions. First, he could have noted that the Laffer Curve was not... ummm ... correct? Yes, a zero tax rate would obviously produce zero revenue, but the assumption that a 100 percent tax rate would produce zero revenue was categorically false. I mean, c’mon, I tell my friend, Cheney had to be familiar with communist Soviet Union, with its 100 percent tax rate.

My friend sighed, patiently trudging on. While he assures me he’s no socialist, the soviet revenue scheme may not have been the model of efficiency, but it still managed to collect enough revenue to maintain an enormous military, enslave half of Europe, fund ambitious projects like Sputnik, and so on. Second, Cheney could’ve pointed out that even if the Laffer Curve was correct in theory, there was no evidence that the U.S. income tax was on the downward slope of the curve. My confused look prompted my friend to explain: there was no proof that rates were then high enough that tax cuts would produce higher revenue.

But Cheney didn’t do any of these things. Perhaps, in looking back, like most conservatives, he likes theories that confirm his ideological stances. You can almost picture Donald Rumsfeld drawing a Laffer Curve showing that only a small number of troops would be needed to occupy Iraq.

I digress, but whatever the case, Cheney saw the light and became an immediate convert. For Cheney, the Laffer Curve provided an easy to understand frame for the messianic power of tax cuts. The significance of that Holy Night wasn’t that Cheney was converted, it was the creation of a powerful symbol with which to spread the gospel of supply-side economics. The mantra was irresistible:

Lower taxes! Higher revenues!

The Laffer Curve swept through the republican ranks like wildfire. Kristol would write later, in almost theological terms, of the conversion of Ronald Reagan. And in that way, the totally untested and utterly ideological notion that cutting taxes for the rich is always a good idea came to life. Call it an economic Immaculate Conception.

That is how what Bush the Elder rightfully called “Voodoo Economics” came to being and it would go on to dominate U.S. economic policy for the next 30 years.

So, my friends, the next time one of the goober zombies start blurting crap about the Laffer Curve, or how tax breaks for the rich is a good idea, please know it was something that was literally pulled out of a failed economics professor’s hairy anus.

There’s more to this story, but this is already too long, but I love stories -- especially myths. More to come...




  1. Huh? Listen, if you want a fair, objectionable, balanced understanding of the Laffer Curve, just look at this video series. It explains both where it works, where its weak, and where it doesn't work.

    You are wrong. Conservatives are wrong. You are right. Conservatives are right. Both sides exaggerate the curve.

    Part I:

    http://www.youtube.com/v/Mw7LtVwDCbs&feature" type="application/x-shockwave-flash" width="170" height="140

  2. This is not the first time someone has pointed out these videos to me. AFAIC, they are worthless. There is NOTHING in the acdemic literature -- peer-reviewed literature -- that suggest Laffer knows what he's talking about. IN FACT, as i noted in the post here, Laffer was, well, laughed out of town for his less than rigorous research methods.


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