Arthur Laffer’s theory helped guide the Reagan revolution

The economic theory that helped launch the Reagan revolution, the Laffer Curve, has proved itself again in the wake of President Bush’s tax cuts, according to a new Congressional Budget Office report.

The theory by economist Arthur Laffer counters the argument that America “can’t afford” tax cuts because they drain resources from the government, says Wall Street Journal editorial board member Stephen Moore in a column.

Laffer asserted that lowering the tax rate on production, work, investment and risk-taking will help stimulate these activities, thereby generating more tax revenue for the government rather than less.

According to Beltway legend, Laffer sketched out his famous curve on a napkin at a dinner meeting in 1974 attended by policy makers, including Dick Cheney and Donald Rumsfeld.

“The theory is really one of the simplest concepts in economics,” Moore writes. “Yet its logic continues to elude the class-warfare lobby, whose disbelief is unburdened by the multiple real-life examples that validate its conclusions.”

In the 1980s, Reagan’s slashing of the highest personal income tax rate from 70 percent to 28 percent was followed by an economic boom in which federal tax receipts doubled, from $517 billion to $1,032 billion.

Now, Bush’s cuts — highlighted by a drop in tax rates on dividends and capital gains — have been followed by a $187 billion rise in federal tax revenues in the first eight months of this fiscal year.

That represents a 15.4 percent gain in federal tax receipts over 2004. Also, individual and corporate income tax receipts are up 30 percent in the two years since the tax cut.

The Bush economic plan reduced tax rates on dividends from 39.6 percent to 15 percent and on capital gains from 20 percent to 15 percent.

Moore says the sharp cuts in the double tax on capital investment were intended to reverse the 2000-01 stock market crash, which had liquidated some $6 trillion in American household wealth. The cuts also aimed to inspire a revival in business capital investment, which had collapsed during the recession.

“The tax cuts were narrowly enacted despite the usual indignant primal screams from the greed and envy lobby about ‘tax cuts for the super rich,'” Moore says.

He also emphasizes that despite the dire predictions that states and localities would be victims of the Bush tax cut, the Laffer Curve effect has created a revenue windfall.

State tax receipts already have climbed 7.5 percent this year. New York City, which long has suffered from debt, suddenly has a surplus of more than $3 billion.

Moore points out, however, that the news isn’t all good for advocates of smaller government. Federal expenditures are up $110 billion, or 7.2 percent.

Nevertheless, the numbers indicate the budget deficit will be at least $60 billion lower than last year, and states and cities, including California, will enjoy net surpluses of at least $50 billion.

Moore also sees a broad-based investment boom as lower capital gains and dividends taxes are capitalized into higher stock values.

That, in part, he says, explains why the Dow is up 24 percent since May 2003 while the Nasdaq has risen 39 percent, adding roughly $3 trillion to the wealth holdings of American households, according to Dan Clifton of the American Shareholder Association.

The severe slump in capital spending in 2001 and 2002 has turned around, Moore says, marked by a rise in capital purchases of 22 percent since 2003.

“Because higher wages and new job creation are highly dependent on business capital investment, the mislabeled ‘Bush tax cut for the rich’ has in reality enormously benefited middle-income workers,” Moore says.

But he points out that because of budget rules in Congress, the capital gains and dividend tax cuts are set to expire in 2008.

“Until now, the Democrats in Congress have in unison sanctimoniously charged that the government can’t afford the price tag of making the tax cut permanent,” Moore writes. “But, of course, all this new fiscal evidence points to precisely the opposite conclusion: that we can’t afford not to make the tax cuts permanent.”

Note: Read our discussion guidelines before commenting.