Less is More

Dr Arthur Laffer recently toured Australia as a guest of the Australian Chamber of Commerce and Industry. He is a well-known economist and was an economics advisor to President Ronald Reagan.

In his speech to the IPA, Laffer discussed, among many other topics, the impact of taxes and particularly the relationship between income tax and the subsequent revenue it generates.

It isn’t always the case that more taxes means more revenue. ‘It’s true’, he explains, ‘that when you lower the taxes on the bottom 95 per cent of income earners, you will get less revenue. It’s also true that increasing taxes on the bottom 95 per cent will generate more revenue’.

Increasing taxes, however, on the high-income earners so they pay ‘their fair share’—a battle-cry often heard when governments have run up massive debts—has an entirely different result. To explain this, Laffer recounted the history of income taxes in America and took his lessons from the past.

At the turn of the twentieth century, there were no federal income taxes in the USA. In order to fund America’s participation in the First World War, President Woodrow Wilson imposed an income tax on high earners, raising it from 0 to 7 per cent. As is to be expected, tax revenues increased. By the end of the war, the federal government had raised income taxes on the top earners from 7 to 77 per cent.

The result: absolutely no corresponding increases in government tax revenues from that same tax bracket. Higher taxes did not result in higher revenues.

Calvin Coolidge ran for President in 1924 promising to cut taxes. He won in a landslide. Coolidge actually did lower taxes on high-income earners, reducing the rate from 77 to 25 per cent. And what followed was the boom of the 1920s. Laffer’s conclusion was that lowering the tax rate on the highest bracket to less than a third of what it had been before, resulted in an increase in tax revenues (from that same bracket) as a share of GDP.

It’s a pattern that has since repeated itself many times in the US. The Kennedy, Reagan and Clinton presidencies all saw reductions in the tax burden on high-income earners, and they resulted in increased tax revenues as a share of GDP. Kennedy’s tax reforms gave rise to the ‘go-go’ ‘60s. Reagan’s ‘revolution’ kick-started the longest peace-time economic expansion of the USA, and that growth continued through both the Bush senior and Clinton presidencies.

The key wasn’t just in cutting taxes on high-income earners (and reducing a slew of other taxes as well). Often the cuts were accompanied by reductions in government spending. Milton Friedman explained this best: government spending is taxation. When the government must provide a service, it requires funds. The more services a government provides, the more it must spend, and the larger its taxes will be.

So when Treasurer Joe Hockey released the federal government’s Tax White Paper in March this year, many thought it would present a comprehensive review of the federal tax system that would put everything on the table. This was welcome. After all, Liberal candidates campaigned on the slogan ‘Our Plan: Lower Taxes’.

Instead, what turned up on the table were new taxes. In particular, the government plans to adjust anti-avoidance laws to target those multinationals shifting their profits to lower-taxing jurisdictions—‘tax minimisation’. But in actuality, this represents a change in corporate tax law, which will only increase the corporate tax burden. And then there was the so-called Netflix tax, imposing a GST on digital downloads like books, music, videos and so on, to counter the ‘lost’ GST on online sales from sellers outside Australia. But as Mikayla Novak has pointed out, this is simply a new tax for Australian consumers.

It is troubling that the federal government cannot make the case to lower taxes or to cut government spending.

Many of the articles in this edition of the IPA Review explore the issues of tax and regulation. Darcy Allen and Patrick Hannaford explore the economic legacy of Ronald Reagan. There is also a short excerpt from Dr Laffer’s brilliant presentation, ‘Lessons from the Reagan Revolution: the case for lower taxes.’ Dr Peter Hendy, MP for Eden-Monaro, outlines why the relationship between the state and federal government must be at the heart of any discussion regarding tax reform. Christian Kerr argues that the coalition must work on creating the conditions that will allow for growth.

Perhaps it’s time to take a lesson from Dr Laffer, who outlined five key points to promote economic growth: ‘a low-rate, broad-based, flat tax, spending restraint, sound money, free trade, minimal regulations, then get the hell out of the way!’