The Black Comedy of Arthur Laffer

The Black Comedy of Arthur Laffer

The idea behind the Laffer curve is a great satire of the hardworking self-image of the American managerial class.

Is there a clown of the imperial court more deserving of the accolades of this dark carnival phase of our national history than Arthur Laffer? This week President Trump awarded the economist the nation’s highest civilian honor, the Presidential Medal of Freedom, for his reputation as “the Father of Supply-Side Economics.” The prize is well deserved for a man whose career symbolizes the aspirational, anti-empirical turn in American macroeconomic management since the Reagan administration. He successfully peddled an intellectual dodge at the heart of the lay-conservative businessman’s economics in the United States—the idea that, left to their own devices, employers and the wealthy will invest in good jobs for all.

As an economist, Laffer made his name padding the memos of his superiors amid the intra-bureaucratic scrambles of the Nixon and Ford administrations. A central debate among economists during the three decades after the Second World War was whether government could reduce both unemployment and inflation without federal control of the pricing, production, and investment decisions of core industrial oligopolies, decisions which were jealously guarded by corporate executives as the essence of American freedom. By the beginning of the 1970s, many leading conservative economists—Herbert Stein, chairman of Nixon’s Council of Economic Advisers (CEA), and Arthur Burns, the chairman of the Federal Reserve—had come to agree with their liberal Keynesian counterparts that reducing inflation and maximizing employment could not be reconciled to private discretionary power over pricing by large corporate producers. Federal deficit spending could produce private-sector jobs, but it would empower workers to demand higher wages and to raise their consumption spending—a redistribution large employers and the wealthy would fight through raising prices and interest rates to protect their incomes. This created a political problem. Since conservatives could not consider bringing corporate executives under public oversight, they were confronted with the necessity of defending greater unemployment—an implacable taboo in a country with an organized working class.

Enter Arthur Laffer. He was initially brought into government during the Nixon administration by George P. Shultz, the first director of the newly established Office of Management and Budget, as the agency’s chief economist. There he defended Shultz’s unpopular and widely discredited policy position that holding back government expenditures in 1971 while expanding the money supply through lower interest rates could reverse the recession then underway without sparking inflation. Against the projections of the CEA and the Federal Reserve, Laffer showed how easy credit would lead to a $1.065 trillion gross national product and reduce the unemployment rate to 4.1 percent—without the rampant price increases that had occurred since the economic boom began with the Johnson tax cut of 1964. It was a vulgar monetarism that even Milton Friedman disclaimed. Herbert Stein bemoaned Laffer’s memo for promulgating “the best known GNP number in history.” Pundits described the argument that increases in the money supply could reliably predict increases in GNP as “Laffer’s Magical Money Machine.”

Shultz got his way. But when unemployment and inflation continued to rise with a presidential election on the way, the Nixon administration turned in panic to a last-ditch, unplanned intervention to secure its legitimacy. On August 15, 1971, Nixon declared a national emergency, announced a ninety-day price freeze, and signed an executive order establishing price and wage controls to prevent inflation as it accelerated government spending. The controls were widely celebrated. Even without the rationing that had facilitated controls during the Second World War, and with a scandalously inadequate administrative bureaucracy, they served their purpose: unemployment fell while inflation was restrained in 1972. They also put the administration, and Shultz in particular, in the awkward and undesired position of openly planning the national economy.

So it was not as a technician that Laffer made his career, but rather in the aftermath of the great inflation that followed the expiration of the controls regime that his style, as a movement man,  worked best. His reputation has always been that of the rough visualizer, the idea guy for the laity of a broadly defined businessman’s movement—an organic intellectual for the class of neoconservative Washington bureaucrats who took power amid the collapse, during the middle 1970s, of both the New Left in the streets and the New Deal order at the ballot box. It was over dinner with Donald Rumsfeld and Dick Cheney in 1974 that he articulated the idea that would launch his name into the history books: the “Laffer curve.”

As Nixon was pardoned for the Watergate burglary, as Cheney and Rumsfeld were released from their roles directing the Cost of Living Council—Rumsfeld to White House Chief of Staff to President Ford and Cheney to Deputy Chief of Staff to Rumsfeld—the problem of growing unemployment and accelerating inflation did not abate. How could the Republican administration help businessmen to employ people without raising prices, without regulating the private fiefdoms of corporate power, and without issuing new government debt?

Ford’s answer, unsatisfactory to all, was a one-year, 5 percent tax increase on corporate and personal incomes. Raising taxes would reduce spending. More important, it would raise revenue and close the budget deficit that was so widely understood—by both popular monetarists and academic Keynesians—to be the root cause of inflation. Laffer responded to Ford’s tax increase from the right with a simple idea that resolved the long-standing intellectual puzzle: what if they began to argue cutting taxes actually raised tax revenue? If that was the case, then taxes on businessmen could be lowered without contributing to the federal budget deficit. He sketched a graph on a cocktail napkin for Rumsfeld and Cheney in that Washington restaurant: economic activity, or spending, on one axis, and the tax rate on the other. Revenue increased as taxes were increased, but only to a certain point. Eventually, he argued, the burden of paying taxes surpassed the benefit of working or investing. After that point revenues would fall, no matter how much the government raised taxes. The liberals wanted growth through greater consumption. Laffer said it would come through increasing productivity, which current taxes were supposedly holding back. The problems that had irritated conservatives since the New Deal could be forgotten, if only enough of them could be persuaded to pretend and to promise, against all expertise.

Few renowned civil servants have finessed the art of hand-waving as consummately as this. As the Laffer curve gestated within the developing businessmen’s movement of the second half of the 1970s, it found incipient expression in Congressman Jack Kemp’s arguments that reducing income taxes would produce full employment. “The idea behind the ‘Laffer curve’ is no doubt as old as civilization,” Wall Street Journal opinion editor Jude Wanninski wrote in 1978. It began to seep into the mainstream with the Carter administration’s cut on capital gains taxes that year, before establishing itself as the basis, under Reagan, for the new post–social democratic American political economy. It also replaced the puzzle of reconciling full employment to private enterprise and price stability with a new political problematic: managing the national debt without raising taxes. Many of Laffer’s more professionally serious conservative colleagues foresaw this future with anxiety. “Laffer is no longer a very serious scholar,” University of Chicago antitrust economist George Stigler told Businessweek in 1978. “He is playing the role of a propagandist, and as such he is performing some service.” Alan Greenspan, who had served as chairman of President Ford’s Council of Economic Advisers, said he didn’t “know anyone who seriously believes his [Laffer’s] argument.”

Nevertheless, the routine worked. Under Reagan, Congress reduced the top marginal income tax rate from 70 percent to 50 percent to 28 percent. Federal deficit spending more than doubled between 1981 and 1983; the value of the federal debt rose from a third to over half of GDP by the end of Reagan’s two terms in office. Unemployment above 5 percent—politically intolerable between the 1950s and 1970s—became a new normal. To assuage bondholders, who may have feared the impending collapse of the value of their assets should the federal government prove unable to pay off its debts, George H.W. Bush and Bill Clinton raised top tax rates back to around 39 percent. But bondholders are a fickle class. As promises to cut taxes continued to win elections, Congress has repeatedly lowered the top rate and run up the federal deficit under George W. Bush and Donald Trump. Treasury bond prices have continued to rise.

The result has been a repeat pattern of Keynesian deficit spending on bare essentials of the welfare state—Social Security, Medicaid, and Medicare, for the most part—combined with the stimulus of military spending for constant armament and imperial interventions abroad. For freeing up corporate budgets from tax obligations, to be spent however businesspeople see fit, ostensibly altering incentives to work and invest, this form of top-heavy Keynesianism has been justified as a “supply-side” reform. But a demand-side stimulus of the upper class, in the form of freeing up funds for greater speculative purchasing, would be a more accurate description. Inequality is the byproduct: business revenues spent on upper management and stock and real-estate speculation, rather than on working-class incomes. In the words of historian Michael Bernstein, Laffer and the interpretation of the economy he helped to pioneer served “to provide a rationale for what became one of the most highly politicized and transparently unfair transformations in national policy in modern memory.”

But Laffer’s great contribution to American history is as dramatic as it is political. His quality as a court jester to Nixon and Reagan differs from Shakespearean theater only in his own obliviousness to the way his ideas skewer the kings he serves. The intellectual justification of the Laffer curve exposes a contradiction at the heart of the civic-minded defense of inequality today—that the power and wealth of the ruling class exists to benefit us all. To the contrary, the Laffer curve tells us, the wealthy won’t contribute to society unless it benefits them privately. The idea behind the Laffer curve is a great satire of the hardworking self-image of the American managerial class—the self-image of all of those for whom time is ostensibly so valuable that they can refuse to sell it. As an explanation for macroeconomic outcomes it offers the timeless and deep-seated laziness of wealth, stirred from inactivity only by the assurance of its own self-aggrandizement. Those who own wealth rule society, we know, but Laffer tells us they do so only in their own interest. For bringing that Calvin Coolidge catechism of the businessman’s government into the mainstream, and for persuading the wealthy to say it with a straight face, Laffer has performed one of the blackest comedies of twentieth century.

Andrew Elrod is writing a dissertation about wage and price controls as a form of corporatism.