219. When Do Tax Cuts Pay For Themselves?

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1:02Hello and welcome to the Rest is Money with me, Robert Peston. And today it's me and the world famous economist, Dr. Arthur Laffer. Incredibly famous for, certainly in economics, you might regard it as the most famous curve of all time, the Laffer curve, which makes a very important point about the trade-offs between tax rates and growth. No one, I think even Art, would claim it's anything other than very controversial I'm sure because the shape of the curve is hotly debated. And the reason it's hotly debated is because economists profoundly disagree which kind of tax rates, when you put up taxes, you start to lose revenue.

1:48And indeed, when you cut taxes, what kind of tax cuts are going to generate revenue? So there's a ton of stuff we need to talk about. I mean, you're probably bored sick talking about it since presumably we all, you know, people like me are always talking to you about it. But I actually want to start by looking at a book that you've co-authored. It's called Prosperity Through Growth. So Britain, obviously, is a country that feels very growth challenged. We've had more or less economic stagnation since the financial crisis. And the prime minister, leaders of the major political parties are all obsessed with how we can get the growth rate up.

2:26Now, in this book, you write the introductory chapter in which you talk about the five grand kingdoms of macroeconomic policy that together determine a nation's economic destiny. And they're sort of, you know, these are not going to be categories that people are going to be surprised by. You talk about taxation, government spending, monetary policy, regulation and international trade. Right. And, you know, you make the important point that if you want to get an economy motoring again, you've got to get all of these areas of policy right. If you look at a country like the UK right now and you were looking at your so-called five kingdoms, which one would you start with?

3:10I would start with taxation, but that's because it's always been my favorite. You know, those doctors that get their names attached to horrible, vile diseases. And, you know, I'm sort of like that. I've got my name attached to basically taxation. And taxes in Britain are extremely important, especially since Gordon Brown really raised it from 40p to 50p. And then you've got the next administration, Cameron, coming in and doing the big analysis as to what happened to the economy. And that's when it really started the tailspin here in the UK. And we should remind people the top rate is back at 45p.

3:43That was brought down. Yes, it is. Went to Cameron down, back down to 45. Yes. Yeah. Yeah. So we should remind people of that. But if you look at the UK, because this is, you know, in the introduction, I said what's hotly debated is when tax cuts are income generating. And if you look at the UK, are there particular tax rates that you believe that if they were cut would in two, three years become net generators of tax? Yes, there are. And the income tax is one of them very clearly. So you think the top rate of 45 is too high, do you? I do. I do. And especially given what happened when Gordon Brown raised the rate from 40 to 50, you saw the deterioration of the economy.

4:32You saw the loss of revenues, people leaving the country, all of those things that are very common sense. And they did. And then Cameron came in and he lowered it back down, but he didn't take it back to the 40p that it was. He took it back only to 45p. And you've had a very sluggish period in the British economy since then. And it's very sad because, you know, Britain can do better. And when you talk about it being the controversies and opinions and all of that, we have huge amounts of evidence, Rob, as to how and where these taxes do hit. For example, my prior book, which is Taxes Have Consequences, I looked at the whole U.S.

5:08income tax from 1913 to the present. We have every single tax return. It's not estimation. It's not sampling. It's none of that. We know the last person in the top 1%. We know the top person in the bottom 99%. Now, they don't give us their names, but we have all of them. We have all of this information. We don't have to guess about this anymore. This is about facts, not how you feel. And we know that every time we've raised the highest marginal income tax rate in the U.S., the economy is underperformed. Tax revenues from the rich have gone down, not up, and the poor have been hammered. And every time we've lowered tax rates on the rich, the top 1%, the economy is outperformed.

5:46Tax revenues from the rich have gone up, and the poor have been benefited. Now, income inequality increases when you lower tax rates than the rich. That's true. But that's because the rich get richer faster than the poor get richer. But the poor do really well under very rapid growth periods. And that's really important to help the poor and make sure you provide opportunities for those who aren't blessed with the type of opportunities you and I are. I mean, look, as you will be aware, there are economists who dispute some of your findings. I mean, I think from memory, it is the case that when Cameron cut from 50 to 45p, I think there was an increment to tax revenues in the UK.

6:35Now, there will be some who say, nonetheless, it's not obvious that cutting from 45 back to the other higher rate we've got to 40 would generate revenue. But I suppose the question I would ask you, there are so many politicians who trade completely understandably because this is something that British people feel on the idea that the economy does not work fairly for everybody. Inequality is a big source of discontent among millions of voters. So, I mean, just out of interest, how would you go about, you know, even if you could absolutely beyond any reasonable doubt, prove that cutting taxes for those with the most wealth and the most income would ultimately lead to a faster growing economy that would benefit everybody.

7:29How do you sell that to people who are currently really struggling to pay their bills? Well, that's very true. And if you raise the rates on the rich, they'll struggle even further. You know, the problem is you've got an elephant in the living room there and everyone's trying to not look at it. They're all virtue signaling that how could dare you be one who doesn't raise taxes on the rich and doesn't put handouts to the poor. And, you know, if you do that policy for long, just factually, the economy will grow slower. These people will be worse off, not better off. And, you know, somewhere along the line here, Rob, we have to become factual.

8:04Now, with Reagan, we did it. We cut tax rates from 70 percent to 28 percent, which is pretty big. We cut the corporate rate from 46 to 34 percent. We went from 14 tax brackets to two tax brackets. And we created one of the greatest economies in U.S. history. With Donald Trump, we had the Tax Cuts and Jobs Act, the same response. Now, you can see what happened when the four stooges did it, Johnson, Nixon, Ford and Carter. When they raised tax, you can see how the economy went the opposite direction. You know, this is this should be about facts, not how you feel. But here I've got to really challenge you.

8:38because we do have to distinguish between rates of economic growth, which is one thing. And, you know, there's no question that under Trump and certainly, you know, in the latter period of Reagan, the American economy performs pretty well. But that is not the same thing as how much you raise in tax revenue because in both cases, the tax cuts, as I think you've accepted, were not self-financing. The tax cuts, certainly in the recorded period, led to falls in tax revenues. If I could be precise on it, tax revenues from the top 1 % under Reagan went way up. Now, the other tax revenues, remember that Reagan cut tax rates across the board.

9:17The cutting of the tax rates in the lowest income tax brackets did not raise revenues. That's very, very true. But the tax rates, rate cuts in the top 1 % raised a lot of revenue. Now, that's Marty Feldstein. All of their studies of the 86 Tax Act show that very, very clearly. And when you look at it in Britain, the same thing. You know, where those taxes come is really majorly important. But when you cut the lowest tax rate in the system by itself, you're going to lose revenues, period. You are. When you cut in the highest tax rate, that category, you're going to raise revenues because these people, they can shelter their income.

9:56They can hire lawyers, accountants, deferred income specialists, favor grabbers, lobbyists. I mean, they have the means to do that and they have the facilities, the ways to shelter their income. They can change the composition of their income, the location of their income, the timing of their income, the volume of their income. They can do all of this stuff that other normal people can't. And so, therefore, when you could look at the top rates, Rob, it's where you get the biggest kick, the Laffer curve extreme effect. Now, in the lowest rates, you get the normal range of the Laffer curve. You know, you get your lower rates, you get less revenues.

10:29But in the highest rates, you really get that kicker coming through. Those are facts. Now, how do you do it? That's the question you could look at facts. And when you look at what happens in these countries, the facts are that when you cut tax rates in the rich, you literally you collect more revenues, you collect a faster growth rate, and you also benefit the poor more. Now, that's what happens. Now, whether you can sell it to people who are feeling very guilty about being privileged themselves, I have no idea. But we've sold it a couple of times in the past. We sold it with Reagan. We sold it with Trump.

11:03We sold it with Thatcher. We cut the highest rate with Lady Thatcher from, you know, from 98 % or 97 % down to 40%. But nobody would say this is where the argument comes. I mean, look, nobody in their right minds would disagree that as tax rates approach 100%, which they did in Britain before Thatcher. Of course they did. Yes. That was a massive disincentive to entrepreneurialism. And there is absolutely no question that the kind of reforms that she put in place, reducing those top tax rates, were very good. You know, they were very good for the British economy and they ended up over the medium term helping, you know, the vast majority of British people.

11:43I mean, in a country like the UK, the reason why we're not going to get to that North Star while you and I are alive, for better or worse, is because in the short to medium term, even if you fundamentally believe that that is where you've got to get to for a much more powerful economy, the revenue loss in the short term as you move there is so great. particularly when in the country like the UK, you've got debt as a share of GDP of 100%. We might want to get there, but we would almost certainly die on the operating table before we got there. Not true. Not true. Okay, go on. Explain to me how we avoid dying on the, how we persuade investors not to pull the rug from us in the meantime.

12:30I got you. I got you. In the 86 Tax Act, we dropped the rate from 50 % to 28%, which sounds like a horrible drop in the US there. But we got rid of all the deductions, exemptions, exclusions, the loopholes, which paid for all of that. So the static revenue loss was zero. All we did was lower rates and get rid of all the deductions, exemptions, and exclusions. So we made it a much less gristy. There was no net revenue loss in that. And by doing the rates down and getting rid of all the deductions, we didn't have any static revenue loss and we spurred economic growth like mad. You know, there are lots of ways of skinning this cat.

13:08And it's not just reducing rates. It's reducing rates, but also getting rid of all the write-offs, all the lawyers, all the accountants, all the deferred income specialists, all of this garbage that's in the system. And do it a low-rate broad base so no one has any place to put their income except that it's taxable. And that's the way you do it. You know, there are lots of ways of building these systems to make them really, really, really work. And it's not just lowering rates by itself. It's lowering rates and getting rid of deductions. But look, I mean, the conditions in which you did that were not conditions where, you know, right now, as I said earlier, you know, the debts of the government are approximately equal to our national income, our GDP, right?

13:54In America, you've got, you know, the national debt in America is even significantly bigger than that as a share of national income. You've got investors in bonds, lenders to governments increasingly anxious about the capacity of governments to service their debts. And we did have an example in recent times of a British prime minister trying to cut taxes. as she said she was following what you wanted her to do initially you were quite you know you praised her but you know poor old liz truss she does her mini budget with quasi quateng bond markets massively turn against her she has to backtrack um i mean that surely that is an example um of you know essentially why even if you believe in the theory in today's world of high debts you know, highly indebted countries, it's just impossible to get where you want to get to.

14:54Well, you may be correct politically, but let me just say this about that. If I might, Liz Truss never put in a tax cut at all. She just proposed them. And before putting in anything, the whole thing collapsed. That's true. But what I'm suggesting is you're correct. You can't just cut taxes and have huge increases in deficits. I totally agree with you. But what you need to do is match the tax rate reductions with getting rid of all the exemptions, exclusions, deductions, write-offs, credits, all that nonsense of loopholes. Did you explain that to Liz Truss? Of course. I've explained it in every book, every article I've ever written.

15:28Almost all of the ways that the rich avoid paying taxes, we got rid of under Reagan. And we did it under Trump as well. Why didn't she listen? I have no idea. Maybe I don't speak English quite well enough. You're a brilliant communicator. Please don't put yourself down. Thank you very much, sir. You know, they didn't do it. And that's probably where I think Liz Truss lost. Now, Quasi was very clear on this stuff. I thought Quasi Quartong was just very clear. But, you know, to push this in one big thing and scare the living hell out of everyone in Britain was not probably the right way to go because she didn't even get to put in any one of her policies.

16:02None of them were ever implemented. She just got thrown out long before anything took effect. So, you know, you want to do it so successful. You know, if you're going to lose the battle, stop fighting. Back up to where you can make it work. So can I just say broadly, because she didn't talk frankly about removing some of the exemptions you talked about, but she did talk about in the media in the medium term cutting public spending. But in the short term, the problem was it looked like the deficit was going through the absolute roof. These were unfunded tax cuts. And that's why lenders to the UK got very panicky and just said, you know, this is too risky.

16:39Yes. And that's why I've never proposed it without being unfunded. What you need to do is make it fully funded by getting rid of the deductions, exemptions, exclusions, and getting a low rate broad based flat tax where the rich do pay their fair share as opposed to hiring all these lawyers. I mean, Warren Buffett in 2010, in his letter to the New York Times, he made$12.5 billion by the Hague-Simon definition of income and paid a little less than$7 million in taxes. Now, he paid 0.06 % of his total income in taxes because of all the deductions, unrealized capital gains, all of that other sort of stuff.

17:17You've got to get rid of that stuff when you lower rates. You're totally correct. No one wants to increase this outrageous debt. Clearly not. But you need the growth and you need the growth desperately because without the growth, there is no long term solution. Do you want to follow the path? Here you've got Britain, the founder of the Industrial Revolution, home of Adam Smith and David Ricardo, the leading world. And they are now the example of collapse, economic collapse. We need to bring Britain back by doing it logically, clearly, without big deficits. Now, I'm thrilled that you've mentioned Adam Smith and David Ricardo.

17:53Thank you. Because we're going to go over a quick break. But after the break, what I want to talk to you about is, you know, another one of your great kingdoms, as it were, that we need to generate growth, which is trade. And in particular, obviously, I mean, you've just heaped praise on Donald Trump for his tax policy. I mean, you are not quite so flattering of him, but let's get to the bottom of it when it comes to his tariff. policy because you are a believer in free trade. So in just a minute or two, let's get into the thorny area of Trump's tariffs. See you in a minute. This episode is brought to you by Wealthify.

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19:50Hello and welcome back to The Rest is Money with me, Robert Pest, and I'm thrilled that the distinguished economist Art Laffer is still with me. And I'm right in thinking that President Trump, when he was first in office, I think he didn't award you almost the greatest honor that can be awarded. So did you get the Congressional Medal of Freedom? Something like, is that right? No, Presidential Medal of Freedom. I didn't deserve it, by the way, Rob. I didn't deserve it, but I'm not giving it back. I love it. Okay, I don't think anybody expects you to give it back, and I'm sure you did deserve it.

20:23And this is just to demonstrate that, you know, historically, he's listened to you. You've felt that some of what he did, particularly on taxes, was the right way to go. But, you know, we just talked about, you know, our great intellectual heritage in the UK, economists like Ricardo and Adam Smith. You are very much an economist who recognizes that free trade is a generator of growth. Yes. And yet we have a president that you have been supporting who is undermining free trade with these massive and in many cases unpredictable tariffs. You must surely take the view that Trump's tariff policy is wholly inappropriate.

21:12Wrong. Damaging America. Damaging the world. Let me, if I can, address. You're completely correct about tariffs, quotas, non-tariff barriers. Restrictions on trade are killers. We built our country on free trade. We built it on the transfer of resources from Britain to the U.S. and Holland to the U.S. We built it with trade deficits that brought in the capital that combined with our natural resources, our labor. and we created the economic miracle. That is the U.S. We all know the Smoot-Hawley tariff of 1929, 1930 killed it. It led to the Great Depression, which led to World War II. It doesn't get any worse than that.

21:47I was in the Nixon White House when Nixon did the 10 % import surcharge, when he did the job development credit that excluded that. We're very clear. I was there also with Reagan when we did NAFTA, when Kennedy did the Kennedy round tariff, which led to great prosperity. You're completely correct on the facts. But where you are wrong, I think. Now, I'm not sure of this. So let me say it. Donald Trump uses trade in a different way than the U.S. has ever done. He uses it to negotiate. He told me personally that the U.S. is the freest trade large country, which is true in the world. And all these other countries have tariffs and quotas and non-tariff barriers against U.S.

22:27products, against other countries. And they don't understand that it's hurting them, too. They are mercantilists in the worst form, and all they care about is access to the U.S. market. So he tells me I'm going to threaten 50%, 100%, 200 % tariffs to bring them to the negotiation table to negotiate freer trade. If you look at what he did in his first term, Rob, in his first term, we had five trade deals. We had the USMCA, which lowered tariffs, didn't increase them. We had the Japan deal, which lowered tariffs and non-tariff barriers, did not increase them. We had the Korean deal, we had Brazil and we had Colombia, all of which were free or trade.

23:03We know that at the G7 meeting with in Ottawa, when he was going to meet with Kim Jong-un and he had to leave early, he told the other six, including your prime minister. He told the G6, he said, gentlemen, I've got to go to Singapore to meet with Kim Jong-un. No one likes nuclear war, but I am prepared right now to get rid of all U.S. tariffs, all U.S. quotas and all U.S. non-tariff barriers if you will do the same. And they all looked at the ceiling. They looked at their shoes, say, bye, Donald. See you later. You know, what he does is he uses these tools as a negotiation tool. And I believe you're going to see him use it to end wars in Ukraine.

23:42I think he's going to use it to end wars in Gaza. I think he's going to use it to subdue the hostilities of China. I think he's going to use it to bring tariffs down and free trade. He, after all, was the CEO of an international company and he imported two foreign wives, which means he really does believe in free trade. You know, I have a great respect of your economic analysis. I'm not sure that's the most profound point you've ever made. But anyway, but I have got to sort of basically challenge quite a lot of what you've said. I mean, first of all. Fair enough. First of all, look, I'm not sure I'm right.

24:14I'm not denying that in particular, in the case of, you know, depending on how you measure it, it's either the world's second biggest or biggest economy. In the case of China, right, there is no question that they used, you know, subsidies, currency manipulation, that their trading tactics were certainly, you know, by all historical standards, unfair. And I completely understand why, you know, essentially Trump or indeed any Western leader, you know, would be putting pressure on China because they, you know, engaged in essentially very unfair trading tactics. No question about any of that. And you could even argue in the case of a country like Germany over many years with its automotive industry, the weakness of the euro gave them a competitive advantage over quite a long period of time.

25:24But nonetheless, even against that backdrop of imperfect trade, which we had, there is still no question in my mind that the era of globalization, which undoubtedly has been brought to an end by Trump, what did represent way freer trade than this new era with Trump, where he is putting enormous tariffs on more or less everything, also in a very unpredictable way, which makes business planning extremely hard. And, you know, if I, if, if, you know, I could see any time soon where he would, in a sense, get these deals from other countries and we reverted to a freer trading world, I'd be tempted to agree with you.

26:15But what I see is broadly now a new, mercantilist, tip-for-tap world of recriminations on all sides. One of the things that is causing enormous anxiety around the world at the moment is Chinese retaliation, which is taken in the form of restricting supplies of absolutely, they call rare earth minerals, these absolutely essential ingredients for so many important industries. And, you know, there's panic in Europe, there's panic in America, that, you know, so many of our high tech producers from mobile phones through to cars are going to grind to a halt because they cannot get hold of these agreements.

26:58This is not a world of freer trade that is going to make people richer. And to be clear, You know, the person who who who has put way more than talked about sand in the wheels of capitalism. You know, this is sort of superglue in the world in the wheels of capitalism. And Donald Trump has put it there. So I just put you again. You know, I know you want to give him the benefit of the doubt. But at what point do you persuaded? Are you persuaded that actually he's doing the opposite of what somebody like you thinks is the right thing to do? Well, I tried to give you five examples in the first term that he reduced tariffs.