Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler. We talk about the world of money and investing here and what’s going on in the world today that affects money, investing, financial planning, and quality of life.
Investing and Economics
I am absolutely thrilled today to have as my guest Dr. Art Laffer. You’ve probably heard of him. I’m guessing a lot of my listeners are very familiar with his work. He is the Legendary founder of Supply Side Economics.
He was the economic advisor to President Ronald Reagan and Prime Minister Margaret Thatcher. He was also awarded the Presidential Middle of Freedom by President Donald Trump in 2019.
Dr. Art Laffer: If you tax people who work and you pay people who don’t work. What do you think’s going to happen? A lot of people are not going to work. These are the examples I want to come across. Economics is all about incentives.
Incentives change the world.
PW: That’s why I thought it was so fascinating, because it made sense to me. That’s why I loved economics as a major.
One of the things I want to bring up is your book, Taxes Have Consequences. I really enjoyed it because as I was looking at it, I wondered how you came up with the idea. You get into a little bit of the history of The Wealth of Nations, for example, Adam Smith, and how if you reduce taxes you can increase output and a little bit of that. But that was pretty audacious at that time to say, “Hey, if we reduce taxes, we can actually increase revenue.”
AL: It’s not obvious. Everyone understands it in microeconomics. You can way over-tax a product and have so low sales that you make no money. You can underprice a product because you have it so cheap, and everything like that, that even if you sell a lot of them, they still go bankrupt because they don’t make any money per unit.
There’s a perfect price in there for a businessman to sell his product to maximize revenues. And those revenues or profits, let me say profits, because the profits of the life of the product and how long you keep it at that price matters.
The competition matters, the size of the product, all of these things matter. And same thing as a macro-level, but they’d never used it in the macro, Paul. That’s what really got to me in the 1970s when I lectured on this stuff. Everyone understood it in microeconomics, but no one understood it in macroeconomics. It hadn’t been used that way for eons.
Tax Cuts
PW: So is that why when you were dealing with state economics, you know, you talked a lot about that with Rex Sinquefield, you had been talking a little bit about the different entities around the country, different states around the country, and different localities, and when they raised taxes, it actually slowed down economic growth in those areas.
AL: Again, just to use the example I use with my students, if you have two locations, A and B, if you have raised taxes in B, and you lower them in A, producers, and manufacturers, and people are going to move from B to A.
I mean, it ain’t rocket surgery. Everyone understands. You can change the location of income, taxes by states, cities, whatever. You can change the volume of income, the Laffer Curve and all that. You can change the composition of income.
If you tax certain items more than other items, people will shift from getting capital gains or getting ordinary. They could do all those shifts. And lastly, you can change the timing of income.
Tax cuts don’t work until the moment they go into effect.
Let me give you a beautiful example of that. Reagan signed a tax bill in 1981, but the tax cuts were phased in. The tax cuts actually began on January 1st, 1983 because we had a 1.25% cut in 1981, a 10% cut in 1982, and a 20% cut on January 1st, 1983. Now if you know that they’re going to defer taxes and that taxes are going to be a lot lower in the future, what do you do?
PW: I’m going to wait and take the income later.
AL: You postpone your income and accelerate your costs. Which is exactly what happened in 1981. In 1982, we had a deep recession, whatever, purely and simply because people deferred their income to January 1st, 1983. On January 1st, 1983, not January 3rd, not December 26th, the economy went boom right through the ceiling. It’s amazing to me how tax cuts don’t work until they take effect.
Taxing the Wealthy
PW: You made an interesting point in your book that fascinated me that the wealthy, 20% of their income typically went to taxes, regardless of what the tax regime was. That was fascinating.
AL: It’s even worse than that. If you go through it, 20% of their income goes to taxes. That’s true. But their reported income is way below what the real income is because of taxes.
PW: They’re hiding it. And that’s what we’re talking about.
AL: They’re not hiding it.
The wealthy know how to use the tax laws legally and correctly to their advantage.
I did a piece on Warren Buffet, and I love Warren Buffet, and what he does is perfectly legal. I admire him.
But in 2010, he reported income taxes of, I think it was a little less than $7 million. He said he paid less in taxes as a share of his income than anyone else in his office of 22 people. I think it was 17.4%. So I took his income taxes of $7 million and divided it by 0.174. I came up with this taxable income of $40 million.
Then I took the deductions there, and I got his adjusted gross income of $62 million, but divided by 0.7. And then I looked at his real income by Haig-Simon definition, which is how much did he spend, how much did he give away, and what was his increase in wealth? That’s his income for that year.
He gave away something like $3 billion. All right, well that’s the Bill and Melinda Gates Foundation. He has two sons who have foundations, a daughter with a foundation, and a wife with a foundation. So he has all these foundations he gives to. He may give to others as well.
Then I looked at the increase in his wealth, and all of his wealth is in Berkshire Hathaway, so therefore you could find out what it was from Forbes at the beginning of the year to the end of the year. His wealth increased that year by $10 billion, from $40 to $50 billion.
If you look at it like that, he actually had income of about $13 billion and paid less than $7 million in taxes. Now that comes out to an effective tax rate of 0.0006. Six-100ths of 1% of his income and taxes, all legal, all perfectly fine, all brilliant, wonderful. Because of taxes, he’s able to do all these things.
Tax Sheltering
Now, if we had a low rate, broad based, flat tax with no deductions, exemptions, exclusions, omissions, or anything, and just that at a very low rate, we’d collect a lot more money from him. He’d report all of his income fair and square.
And then you look at all the reported income of what it would be and what happens to sheltering when you raise tax rates, people shelter the living hell out of it.
When you raise tax rates on the rich, the rich earn less, but what they do earn, they shelter like mad.
Then you get the economy underperforming, you get the poor damaged badly, and you get tax revenues going down.
PW: And I thought it was fascinating. You talked a little bit about how when the tax rates were so high, 60% even off to the 90% range, how the tax laws were not necessarily enforced during that period of time.
AL: Well, they hire great people in the IRS. The IRS is a wonderful institute, really a substantive institution like the OMB.
PW: And the closest you came to that was under Reagan because you had those two tax rates we got to, 15% and 28%.
AL: We went from 11 tax brackets to 2.
PW: Now a question for you, when it comes to companies actually avoiding taxes and things that they can do, I remember Buffet had this whole thing about two companies lending money, and when they repatriate, they don’t have to repatriate the money and bring it back to the United States and pay taxes.
So that’s one of the ways they avoid things. Now you also talk a little bit in the book about companies setting up shop overseas. Are there a lot of places where they can set up shop still and be able to avoid taxes, and are other countries so similar to our tax rates that there are not a lot of places to hide anymore?
Politicians and Policies
AL: Let me put it this way, prior to the Trump tax cut, which was spectacular, he dropped the highest rate from 35% to 21%. He did all this other stuff, lowered the income tax cut, tax-exempt passed through corporations, and got rid of the ACA bandaid, and all of these other wonderful things.
Before that, companies had divisions abroad that withheld the taxes over there. Trump also gave a very preferential tax rate to repatriating funds, which they repatriated huge amounts of funds. They did it just before the end of 2017, so there was a huge surge of income in the last couple of weeks of 2017 from repatriated funds.
It was this that really pushed us way over the top. We increased revenues from the Trump tax cut by a huge amount. I don’t know what the recent numbers are on foreign-held profits, non-repatriated funds, but Trump really brought them all back.
PW: And I know you’re going to have an opinion on this because you had said something, we had been talking at one point in time, you talked about how frustrating it was for you talking to politicians and saying, “Hey, here’s what we ought to be doing, but you’re not doing this. Why are you not doing this?”
One of the things that I thought was you look at the media, and you have so many politicians so scared of what the media is going to report on them that they’re not willing to say anything about tax cuts or anything like that. I look back at deregulation of the media, when it used to be you’d have hundreds of different media outlets, and then all of a sudden they got bought out.
AL: Let me, if I can. I don’t think you’re right on that.
Politicians do not bear the consequences of their own actions.
PW: So you think it’s just on the politicians. It has nothing to do with being fearful of the media?
AL: Well, they don’t. You know, it’s loads of fun spending other people’s money. “Oh, let’s buy this. Let’s buy that..” So when you look at them and ask them to do good policy, what’s in it for them? Nothing.
Politicians on Commission
It’s like the movie with Jimmy Stewart going to Washington. He goes in there with the soul of human kindness in his heart. He brings down the inflation rate, he brings down interest rates, he brings up the stock market, he brings down the unemployment rate.
The enemies of America are thrown offshore, and everything. He does all these wonderful things. Orphanages are emptied as the people got adopted, and the trees blossomed, they bore fruit, the animals multiplied. It was wonderful.
What happened to Jimmy Stewart’s salary? Nothing. Now imagine his evil twin comes in and does everything wrong. Inflation goes up, unemployment goes up, the interest rates go up, the enemies of America are coming forward, all the children die, the trees are barren.
What happens to that guy’s salary? Nothing. The problem is these guys don’t have a stake in the policies they make. Now you, and I, and everyone else on earth who has a brain knows that if you are in a position of immense political power, you’re going to get rich.
Now the question is how are you going to get rich? My view has always been I don’t mind politicians getting rich at all. I do not, as long as I do too.
PW: It reminds me so much of Animal Farm.
AL: Well, it is like Animal Farm. They will do all the stuff, and they’ll be crooks and all that stuff because that’s the way they get rich. And no one, no politicians has ever died poor.
How can we align their incentives with ours?
Now, my view is we should put politicians on commission.
Let me give you an example. If the economy grows to 3%, you get your pay fair and square. Boom. If it grows to 4%, double your pay. If it grows to 5%, triple your pay. However, 2%, eh, no pay this year. 1%, you owe us the money that you would’ve normally gotten paid.
All of a sudden, they have a stake in the game. They could become very rich by creating great prosperity by begetting goodness. I mean, you can do it as unexercised stock options or whatever you want. Take the S&P 500 the day you take office.
PW: It works for the private sector, sure.
Economics in Other Places
AL: I mean, there are just lots of ways of doing this. And the question is I want to make it so that they get rich by making us rich, which is the right way to do it rather than doing it the way they do it now by stealing and corrupting or passing laws that allow them to exempt themselves.
PW: That’s an economist speaking.
One of the things that we do in economics all the time is, we look out a sample for things, get out of just the United States. If these things may work in the United States, there’s something special with the United States. We’ve got a different type of workforce, a different type of education system, but do taxes actually have the same effect that they have over in other countries? And what did you find when you looked over other countries?
AL: It is amazing that they do. When Thatcher came in, and I’m going to exaggerate a little bit here, but the highest marginal income tax rate was 98%.
PW: That’s insane.
AL: People would borrow suits instead of buying them, would lease the suits because they could deduct the lease. At first, I think what she did was she substituted product taxes for income taxes, all right? What they call external and internal taxation.
Outside of the U.S. tax policies can work differently and sometimes better.
She did that. It had no effect. It was not a good bill in 1980, and she was in trouble. Then along came the Falklands, which saved her, but then she did the great one. She taught the highest marginal income tax rate in Britain from, I say, 98% down to 40%. Britain experienced a huge boom like nothing before. It was just amazing. Then, of course, she left office.
Then of course, along came Tony Blair and Gordon Brown who raised the highest marginal tax rate from 40% to 50%. The economy went to hell in a handbasket.
Chile, the same thing happened when we went in there. We went in there with Pinochet and he was after Allende. Pinoche put in a fixed exchange rate, lowered taxes, privatized. We sold something like 10,000 companies that had been nationalized there. Chile had its best performing economy for 30 plus years in South America.
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