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Scott Morrison and the Laffer napkin

Jul 10, 2019 • 14m07s

Scott Morrison’s tax cuts are based on an American theory of economics trialled in the 1970s, but the evidence since suggests it does not work.

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Scott Morrison and the Laffer napkin

32 • Jul 10, 2019

Scott Morrison and the Laffer napkin

[Theme music]

ELIZABETH:

From Schwartz Media. I’m Elizabeth Kulas. This is 7am.

Scott Morrison’s tax cuts are based on an American theory of economics first trialled in the 1970s. But evidence gathered since then suggests trickle down economics doesn’t work. Mike Seccombe on why the Coalition perseveres with its reforms.

[Theme ends]

Archival tape — Unidentified woman 1:

“Let's move on to the Government's tax cuts now. Good result for millions of Aussies.”

Archival tape — Unidentified newsreader:

“The $158 billion dollar package was shored up after Labor backflipped and voted in favor of the plan.”

Archival tape — Scott Morrison:

“This is a win tonight not for the government not for the Liberal and National parties. This is a win for those hard working Australians quietly going about their lives.”

ELIZABETH:

Mike, Morrison's tax package has passed the Parliament; tell me what's in that package?

MIKE:

Well the essence of it is that it flattens out the tax scales so instead of having four marginal rates there will only be three and they will be set at 19 per cent, 30 per cent and 45 per cent. And the most important change once it's finally all in place is that that middle rate, 30 per cent, will cover everyone earning from $45,000 up to $200,000.

ELIZABETH:

Mike Seccombe is the national correspondent for The Saturday Paper.

MIKE:

And the number of people paying the top marginal rate will go down to just 6 per cent of the population on their calculation. So, 94 per cent of taxpayers will pay no more than 30 per cent of their earnings in income tax.

ELIZABETH:

By the year, what, 2024 or something like that when it, when it closes out.

MIKE:

By 2024 is when it when it closes out. Yes, when the final tranche of the tax cuts comes in.

Labor made a show of objecting to the third stage but when push came to shove in the Senate they voted with the government to get it through.

ELIZABETH:

And Mike where does the logic for this kind of tax reform begin, where does it originate?

MIKE:

Well we can be pretty precise about that. It began in 1974 at the Two Continents restaurant of the Hotel Washington, where there was a conservative economists named Arthur Laffer and he met with two what were then just rising stars, Dick Cheney and Donald Rumsfeld.

Archival tape — Unidentified male:

“In 1974. We came to the Hotel Washington to the two continents restaurant that's where we sat down and talked about tax policy.”

MIKE:

At the time that had happened the US was in recession and so they were they were looking for economic ideas...

Archival tape — Unidentified male:

“...and Art drew the Laffer curve.”

MIKE:

And on a serviette Laffer sketched out something that became famous as the “Laffer Curve.”

ELIZABETH:

And what the heck is a Laffer Curve?

MIKE:

Well the fundamental premise of the Laffer curve is pretty simple and that is that if you have a tax rate of zero the government gets no money, but if you have a tax rate of 100 per cent the government gets no money either because no one bothers to work. So somewhere between zero and 100 they say there is an optimal point where the government gets its maximized return, and working people also get the maximized return for their labors. And so Laffer’s suggestion was that if you actually cut the tax rates the government could stimulate economic activity and ultimately get higher revenue on the premise that the whole economy would work harder and faster and there would be a boom in jobs and growth.

ELIZABETH:

So Mike this theory does have other names though because the Laffer Curve is kind of an economic wonk term in comparison to some of the others, is that right?

MIKE:

Yeah yeah. Some of the others are “supply side economics” which you hear around a little bit or “Reaganomics” which is because it was Reagan who was president at the time. Even more well-known his trickle-down economics. And there was a famous phrase by George Bush senior, who called it voodoo economics.

ELIZABETH:

Did the idea catch on?

MIKE:

Well yes it did, because some among certain people of conservative bent certain economists, politicians and particularly of course business leaders and wealthy individuals thought the idea of lowering taxes was a wonderful idea. So Laffer went on and became an economic adviser to President Reagan, who implemented his prescription and progressively cut taxes. He cut the marginal income tax rate from 70 per cent all the way down to 28 per cent. In Britain, Margaret Thatcher also became a devotee of this theory. She spread the philosophy further that tax cuts spur growth. And it came to Australia in a small way but we didn't have a right wing government at the time, so it was much more muted but nonetheless ever since then, there has been a sort of global push particularly in the anglosphere to cut taxes on the basis that that will encourage economic investment and growth.

ELIZABETH:

And in a nutshell it's the idea basically is give the wealthy more and everybody will benefit; that that'll flow down to all parts of the economy to all people.

MIKE:

Yes hence the trickle down bit. I might add that the famous economist J.K. Galbraith had a great quote to the effect that conservatives were engaged in one of mankind's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness. And you might say that the Laffer Curve provided just that justification. It allowed people to believe that if the wealthy got more everyone would benefit.

ELIZABETH:

And in a way that is also the premise of the Morrison tax cuts package we've just witnessed?

MIKE:

Yes. As it was the premise of the business tax cuts that this Government's put through. That that would also encourage economic activity. But yes it's it's absolutely the premise on which their tax decisions are being made.

ELIZABETH:

We’ll be right back

[Theme music]

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ELIZABETH:

Mike Seccombe, you've described trickle-down economics as the underpinning of this Morrison tax package that passed late last week. The theory was developed by the American economist Arthur Laffer. Is he still influential?

MIKE:

He's still going around the world spruiking his economic vision and is still well-received in some circles. Back in 2015, which was the year Scott Morrison became Treasurer, the Australian Chamber of Commerce and Industry brought Laffer out to Australia to help with their campaign for lower business taxes. And they took him down to Canberra and he did the rounds there. He met with various key government figures including the then assistant treasurer Kelly O'Dwyer and including also a group of Liberal free marketeers called the modest members. And among those people, then Assistant Treasurer, now Treasurer Josh Frydenberg had a picture taken of himself grinning as he stood there with Laffer.

ELIZABETH:

And so he's coming out to do speeches and all kinds of think tanks and other economic institutes.

MIKE:

He went to the Institute of Public Affairs which of course is very influential in policy formulation for the conservative side of politics. And he also turned up at Gerard Henderson’s Sydney Institute which is another of the right wing think tanks.On his way through. He appeared on RN Breakfast with Fran Kelly.

Archival tape — Arthur Laffer:

”Well we had multiple national economy of all time. It was the best single recovery in US history. I mean to be honest with you “

MIKE:

Now it's true America was in recession and came out of recession. But as Kelly pointed out to him, that was a very rosy view of Reaganomics.

Archival tape — Fran Kelly:

I mean critics say the biggest impact of those Reagan tax cuts was to double the US budget deficit 255 billion dollars and triple government debt to more than two trillion dollars.

MIKE:

So in short as the tax revenue fell day they had to resort to borrowing more money...

Archival tape — Arthur Laffer:

“You know we did do that we did a lot of spending, especially defence spending, but all taxes are bad Fran and some are worse than others.”

MIKE:

It's become the popular wisdom then that big government is bad. Reagan famously said that government wasn't the answer, it was the problem.

ELIZABETH:

And the Laffer curve has become kind of policy orthodoxy since the 70s. Does it actually work?

MIKE:

In a word no. One of the big flaws with it is that instead of maximizing revenue as we’ve said, it reduces government revenue. And so we have to either fund it with debt or we have to make government smaller or we can decrease the level of services that's offered to the populace. And it tends to be the case that government debt has gone up, even as some services have declined.

ELIZABETH:

And what about the ability for these income tax cuts to stimulate growth. Can they kind of make up for lost ground there?

MIKE:

Well that's one of the interesting questions here. Back in 2012 the US Congressional Research Service, which is a nonpartisan body which does research to advise lawmakers, set out to establish whether there had been any association between lowering tax rates and increasing economic growth, and it found no correlation whatsoever.

They went back for 65 years and found that there was no clear relationship between reduction in tax and economic growth. In fact, economic growth had been stronger when taxes were higher. The other thing that that report found, which was probably even more damning for the whole supply side theory, was that, and I'm quoting here, the top tax reductions appear to be associated with the increasing concentration of income at the top of the income distribution. So in other words, the tax cuts not only didn't encourage growth but they promoted inequality at the same time.

ELIZABETH:

Mike if we move on to Australia, what are we seeing here?

MIKE:

Well, in Australia it has to be said because we have not embraced this theory to quite the same degree, iInequality has not grown to the same degree. Nonetheless it's a huge issue and it's a rapidly growing one in Australia. And according to analysis from the Australian Council of Social Service, between the year 2000 and 2008 it grew more rapidly here than in all but two other developed countries. So we were a little late to the party. But at this point inequality is growing extremely rapidly in Australia. In terms of wealth distribution the top 20 per cent of the population have about 70 times, 7, 0 times, more wealth than the bottom 20 per cent. And the bottom 40 per cent of households own just five per cent of all wealth. So, it’s enormously skewed towards the top.

ELIZABETH:

I mean obviously there are massive impacts, with deepening inequality on social cohesion. But how does inequality work for the economy, even if we just look at it as an economic argument?

MIKE:

In the long term, it slows economic growth. And there have now been a wealth of other studies on this, on this basis, showing that in fact societies where wealth and income are more equally distributed actually perform better in overall economic terms because everyone has skin in the game and so things go along rather better than they do when things are dramatically skewed to the rich.

ELIZABETH:

And so that all being said, what are the likely outcomes of these Morrison tax cuts on, you know, the next decade or two of Australian economic growth?

MIKE:

Well we can expect for a start that there will be much less revenue for government and greater inequality. The Grattan Institute did an analysis of this and found that at least $40 billion a year would need to be cut from government spending by 2030, as a result of these cuts, which bodes ill for all kinds of government services provided to people health education et cetera. The Coalition counter argument is that it won't have to cut services because it will encourage the growth of jobs and as a result of that they will have to be much less spending on welfare, so the other argument other, part of the argument, is that because we're going into economic surplus, budget surplus the Government will have to pay less interest on its debt. But that seems to be a very heroic assumption according to most economic analysts.

ELIZABETH:

And so, you know, that being said that there seems to be a quite a bit of wishful thinking going on in the way these numbers are being shifted and projected forward. Why are these cuts being handed on?

[Music starts]

MIKE:

There's a couple of possibilities I suppose. One is that the government still really believes, despite all evidence to the contrary, that trickle-down economics will actually make us all better off. The other possibility is that it is governing for the rich and deliberately seeking to give them a bigger share of wealth at the expense of the rest of the population.

ELIZABETH:

And it all came from a cocktail napkin.

MIKE:

It all came from a cocktail napkin. And the non wealthy people in Australia are going to pay the consequences long into the future, I suggest.

ELIZABETH:

Mike, thank you so much.

MIKE:

No worries at all.

[Music ends]

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[Theme music]

ELIZABETH:

Elsewhere in the news:

Hong Kong's chief executive, Carrie Lam, announced yesterday that the controversial extradition bill introduced in mid June was dead. The proposed law had led to mass protests, including the storming of legislative buildings earlier this month. There were concerns that earlier suspensions of the bill were temporary, with protestors repeatedly calling for it to be fully withdrawn. Lam told a press conference on Tuesday, quote: "I reiterate, there is no such plan, the bill is dead" and she stated that there was no difference between this and a withdrawal.

This is 7am. I’m Elizabeth Kulas. See you Thursday.

[Theme ends]

Scott Morrison’s tax cuts are based on an American theory of economics trialled in the 1970s. But the evidence since suggests trickle-down economics does not work. Mike Seccombe on why the Coalition perseveres with its reforms.

Guest: National correspondent for The Saturday Paper Mike Seccombe.

Background reading:

Reagan "voodoo" at the budget's heart in The Saturday Paper
The Saturday Paper
The Monthly

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7am is hosted by Elizabeth Kulas. The show is produced by Emile Klein, Ruby Schwartz and Atticus Bastow with Michelle Macklem. Our editor is Erik Jensen. Our theme music is by Ned Beckley and Josh Hogan of Equate Studio.

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32: Scott Morrison and the Laffer napkin