Laffer Proved Right....Again

Much to the chagrin of Democrats, it seems that yet again Arthur Laffer was right.

Many out there may not remember Arthur Laffer or the graph he created that bears his name – the Laffer Curve.

Basically, Laffer created a graph that shows the relationship between tax rates and tax revenue. Ste the taxes too high or too low and the amount of tax revenue the government collects falls off. The trick is to figure out exactly where the along the curve tax rates happen to be and to adjust them accordingly to maximize the revenue.

When President Bush pushed through the tax cuts in 2003, he believed that the tax rates were on the wrong part of the curve, which meant that the government was taking too much out of the economy and, consequently, discouraging investment and the growth of the economy investment spurs.

Many of the congressional Democrats thought that taxes were too low and the only ones who would benefit from tax cuts would be the rich. It turns out they were wrong.

esterday's political flurry over the falling budget deficit shows that even Washington can't avoid the obvious forever: to wit, the gusher of revenues flowing into the Treasury in the wake of the 2003 tax cuts. The trend has been obvious for more than a year...but now it's so large that Republicans are trying to take credit while Democrats explain it away.

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The real news, and where the policy credit belongs, is with the 2003 tax cuts. They've succeeded even beyond Art Laffer's dreams, if that's possible. In the nine quarters preceding that cut on dividend and capital gains rates and in marginal income-tax rates, economic growth averaged an annual 1.1%. In the 12 quarters--three full years--since the tax cut passed, growth has averaged a remarkable 4%. Monetary policy has also fueled this expansion, but the tax cuts were perfectly targeted to improve the incentives to take risks among businesses shell-shocked by the dot-com collapse, 9/11 and Sarbanes-Oxley.

This growth in turn has produced a record flood of tax revenues, just as the most ebullient supply-siders predicted. In the first nine months of fiscal 2006, tax revenues have climbed by $206 billion, or nearly 13%. As the Congressional Budget Office recently noted, "That increase represents the second-highest rate of growth for that nine-month period in the past 25 years"--exceeded only by the year before. For all of fiscal 2005, revenues rose by $274 billion, or 15%. We should add that CBO itself failed to anticipate this revenue boom. Maybe its economists should rethink their models.

It appears that some of the states in the US could learn from this lesson. One in particular needs to look at both its spending and tax policies: New Jersey.

Both the New Jersey legislature and the governor, John Corzine, have forgotten that ever increasing state spending and taxation does nothing more than discourage businesses and investment in those businesses. Residents have gotten tired of the ever increasing tax burden and are leaving, voting with their feet. Unless New Jersey can get its insatiable lust for spending other people's money under control, its economy is going to fold like a cheap suitcase in the rain.

All New Jersey has to do is look at the history of Massachusetts during the 70's and early 80's to see what fate awaits them. Back then unemployment was high, even higher than the rest of the country, which was in the throes of a deep recession at the time. Businesses were closing up shop and moving, many of them to the bordering states of New Hampshire and Vermont, where the tax burdens were a fraction of that in Taxachusetts. Other businesses just folded up, closing their doors for good. Whether it was because of the recession, the ever increasing state tax burden, or both, is still debated. In either case, the state was on the verge of economic ruin. It was then that the Powers-That-Be woke up and started the realize that they were a major contributing factor of the economic problems. The people also woke up and voted to take control away from the legislature and the special interests by passing two controversial ballot questions. The first, Question 2, also called “Prop 2 1/2”, cut property taxes to 2.5% of the assessed values. The second, Question 3, removed fiscal autonomy from the school systems. (It used to be that the school systems told the towns and cities how much money they wanted and the communities had to deliver. The idea was that the schools would then be adequately funded. However, what it became was a license to steal. Some towns were driven to the edge of bankruptcy because of fiscal autonomy.)

If New Jersey wants to solve their fiscal problems, best that they get around to looking at the examples of Massachusetts and the US Government, both good and bad.