Covid Daydreaming

Like for many of you, the last few months has forced a pause in the ordinary business of life. Recent weeks have seen stage 4 restrictions bite in greater Melbourne where I live. Unable to attend cafes, theatres, pubs or visit family and friends, I am spending a lot of time staring out of my study window. This has had its advantages. Apart from spending time with my lovely wife and getting around to dealing with the backlog of household tasks, I have been able to progress several writing projects. But as the weeks drag on I find my mind wandering. Odd thoughts come uninvited. This morning, for no obvious reason, I started thinking about one of the more bizarre events in the mid-distant past.

In 1974 an unknown economics professor was having lunch with two members of the Nixon/Ford administration – Dick Cheney and Donald Rumsfeld. Struggling to get his points across – so legend has it – Arthur Laffer started sketching on his paper napkin. He was trying to tell his companions how the US government could reboot the lagging US economy by reducing taxes. This, of course, is music to a politician’s ears, and the ears of their advisers. It also seemed to be straight out of the Keynesian playbook; when the economy falters, prime the pump. In fact, Laffer was only suggesting what appeared to be a partial Keynesian boost. The theory underlying his prescription was very different to Keynes’s. Laffer was claiming that current taxes had risen past their ‘optimum’ level, that they were stifling entrepreneurial zeal among investors and dulling the workers’ incentive to work. Reducing the tax burden on both would galvanise the supply side of the economy, encouraging firms to take more risks and increase investment in the expectation of keeping more of the profits generated, while inducing workers to give up ‘leisure’ to work more hours.

But, his companions might have replied, wouldn’t cutting taxes drive the budget further into deficit? Isn’t public debt a sin? No, it won’t. Look. This is where the famous napkin makes its appearance.

The two points on the x-axis are obvious. If the tax rate is zero, then the total tax raised will be zero. At the other extreme, if the rate is 100%, then no one would work or invest; why bother if all and any income generated is taken away? Logically, some revenue will be raised at tax rates between zero and 100%, the amount varying depending on how workers and firms react. Overall, there must be some rate that maximises revenue to the government; denoted by ‘?’ in the graph above.  As the tax rate climbs from zero, incentives are strong and economic activity increases, boosting the government’s coffers. But past point ‘?’ incentives cool and activity falls off reducing taxes flowing to government. Workers ‘choose’ more leisure and entrepreneurs become more conservative, shelving riskier projects to bet only on sure things. What Laffer was suggesting was that America was well past the top of the curve and that cutting current taxes would more than pay for themselves as the economy boomed.

You can see why this would appeal to conservatives of all stripes. In the late 70s Democrat President Carter flirted with the theory. But it really came into its own during the Reagan years. Supply-side economics (less politely, Voodoo economics) enjoyed a brief but heady career during the 1980s. Unfortunately, history wasn’t kind to the theory, although the man himself went from strength to strength, eventually picking up the Hayek Award and in 2019 being granted the US Medal of Freedom, the country’s highest civilian award, by Donald Trump. This year Laffer has been advising Trump on how to ‘open the US economy for business’. It goes to show; always have a pen and paper napkin about your person.

Of course, the actual history of US fiscal performance since Laffer’s lunch ran directly counter to what his simple graphic predicted. Whenever tax rates fell, the budget deficit rose and vice versa. This is not so very surprising. The world is more complex than can be represented on a napkin. Many factors operating together determined the actual course of American economic history and budget outcomes over the past forty years. But the famous curve served its purpose; governments of all persuasions all over the western world were empowered to cut taxes to the delight of the top 1%. We now live in a deeply unequal world where the richest 10% own more wealth than the bottom 90%, in the US, more than twice as much. The famous napkin also resonated the deeply entrenched anti-government ideology of the American Right. Cutting taxes delivered welcome benefits to the rich but its main purpose was to squeeze government expenditure, a case of ‘starving the beast’, in Milton Friedman’s words. Small government was the mantra of the libertarian wing and alt-right; in the words of one warrior – the aim was to shrink the government to a size that it could be ‘drowned in a bathtub’.

Humour me a little longer and take a gander at the other graph below.

Here there are three Laffer curves, one skewed left and one skewed right, of the symmetrical version. The red ‘conservative’ relationship suggests that disincentives cut early into the picture and government revenue and the budget is at risk unless tax rates are kept low. The blue ‘radical’ line suggests, conversely, that rates can be jacked up to quite high levels – say, to fund generous minimum incomes and public services without driving the budget into the red. Which relationship holds depends on the economic and social theory you choose. And, of course, in the real world the relationship may be rugged rather than smooth, discontinuous and subject to change over time, making Laffer’s lunch light bulb moment irrelevant for public policy. In fact, supply side economics has passed into history to join other economic heresies. However, its ideological clout as a simple summary of trickle-down economics remains as a malign blot on the current landscape.

So why talk about it? Well, in part it tickles my fancy and passes the time. But in musing over this oddity I found myself thinking about how the napkin could be wielded to explore other areas of current public concern – namely, the issue de jour of inequality and what to do about it. Following the work of Thomas Piketty and other economists like Anthony Atkinson and James Galbraith, inequality has zoomed back into the eyeline of economists and left-leaning activists.

Rename the x-axis above ‘degree of economic inequality’ and the y-axis ‘social sustainability’. The latter is a complex aggregate of things like health, education, housing, income, sociability, environmental security and all factors that go to make up a decent life. At the origin, absolute equality (a Gini coefficient of zero), let us assume society is unsustainable – I know not necessarily so, but let it slide. At the point where all wealth is owned by the top 0.01% (Gini of 1) society is also unsustainable. At levels of inequality in between society coheres to some extent.

This time the curves take on a reverse meaning; I’m immodestly calling them variants of ‘the Berry curve’. The blue line is now the conservatives’ trajectory. High inequality is conducive to sustainable societies before finally, at five minutes to midnight, sparking popular revolt and collapse. The red line suggests a more radical world in which societies start to fall apart at much lower levels of inequality. Since the real world has been becoming regressively more unequal over the era of neoliberal globalisation, it’s safe to assume that we are well over the hump and on our way to social and ecological collapse. We can gain more sustainable lives in future by ratcheting back inequality. Just how to do this and the policies and timing required to reverse the current trajectory are the subject of a book I am writing during this period of forced navel-gazing. I am waiting – nervously – for the outcome of the US presidential election in a couple of months before sending the manuscript off to the publishers.

I’ll let you know when I do. Stay safe.