F*ck the Laffer Curve – Individual Vs. Social Consumption

In Budget Politics, California, Democratic Governance, Economic Planning, Economics, Full Employment, History and Politics, Inequality, Liberalism, New Deal, Political Ideology, Politics, Politics of Policy, Progressivism, Public Policy, Public Sector, Public Works, Social Democracy, Social Policy, Taxes, Welfare State, WPA on September 13, 2010 at 2:57 pm

Introduction:

The power of ideas to define the range of the possible and the acceptable can be seen in the fact that, despite nearly four years of budget austerity at the state level, California appears to be trying once again to cut itself out of a recession, or the fact that despite a stimulus that has appreciably worked, an incredibly modest proposal for public works and tax cuts is unlikely to pass Congress.

Among other things, this should point to the legacy of nigh-on forty years of anti-government rhetoric at the highest level of government. One angle into seeing the effects of this legacy is to look at the way that taxes are publicly discussed as either a net loss to the taxpayer (or outright theft by movement conservatives), and the government itself as a kind of black hole into which taxes disappear. The progressive alternative to this rhetoric that has yet to be comprehensively advocated for on the national stage is to emphasize that taxes pay for things, and that they are ultimately a question of individual versus social consumption.

Theory:

On the conservative side, their most influential thought construct that negatively describes taxation is the (in)famous Laffer Curve. This theory, popularized by Arthur Laffer on a cocktail napkin in a drinks meeting with Dick Cheney and Donald Rumsfeld (which gives a nice Gothic ambiance to the story), is that the amount of revenue collected at different rates of taxation can be described as a curve – at a 0% rate, no revenue is raised; and at 100%, no revenue is raised either because workers have no incentive to work or evade their taxes massively.

This theory has been incredibly influential, to the extent that even liberal commentators like Ezra Klein or Matthew Yglesias argue with conservatives about where the U.S is on the curve and where the curve actually bends (i.e, whether the U.S can actually increase revenues by raising taxes) – rather than arguing over whether the Laffer Curve exists in reality. On the conservative side of things, the thrust of the Laffer Curve has been political – offering the potential for a “Two Santas” mode of budgeting that has allowed Republicans to woo the electorate with tax cuts without offering unpopular spending cuts, as well as to portray Democratic efforts to balance the budget through raising taxes as counter-productively. In addition to the immediate partisan implications, the Laffer Curve has been able to define the tax debate in such a way that taxes are seen as distorting the economy away from a pattern that is a priori assumed to be the most efficient and optimal pattern possible. In other words, any effort to expand the state will be ultimately inefficient and self-defeating.

A progressive counter to this theory would be to ask – what about government spending, or in other words, social consumption? Because what the Laffer Curve leaves out, and this is endemic of conservative thought, is what taxes pay for. Keep in mind that the premise of the Laffer Curve is that revenues decline because people stop working when taxes eat up their income. However, if we think of taxes as financing the collective or social consumption of goods – what scholars sometimes call the “social wage;” think things like Social Security and other forms of government-provided income – then a decrease in after-tax wage income might be matched by an increase in the social wage, such that real income doesn’t change at all and eliminating any disincentive effect. Indeed, when we think about the actual distribution of income, taxes, and public benefits, for many people the change in income might actually be positive.

In other words, the Laffer Curve doesn’t necessarily bend at all. Instead, as we move from left to right on the X axis, tax revenue might increase or hold steady, and the only thing that shifts is the distribution of income between the individual consumption of consumer goods from wage income (i.e, the “market wage”) to the social consumption of collective goods ( i.e, the “social wage”).

Enter the “Baxter Cycle”:

This argument would not be unusual if Progressives had not lost so much of our historical memory of periods in which our thinking about the economy and the state were less restricted by the last forty years of anti-government rhetoric. Back in 1935, smack-dab in the middle of the New Deal, the Federal Emergency Relief Administration hired a man called Louis Baxter, an economic analyst, to produce a model of what the American economy would look like if the government included a system of “employment assurance” (i.e, job insurance).

Lewis Baxter of the ESA devised a graphical chart (essentially, a primitive PowerPoint presentation)  that displayed the American economy as a figure-eight, with public and private economies as two halves of a whole, inherently linked by flows of taxation, interest, government spending, investment, and above all, purchasing power. By adjusting a slide that denoted the size of the Federal budget, the reader can see that increasing Federal outlays on jobs programs expands purchasing power and increases production. The added purchasing power is spent in the consumer economy, and swells the incomes of retailers, wholesalers, producers, and the people who work for them through the multiplier effect. Through the additional consumption, growth, and the consequent rise in incomes, tax revenues grow, completing the cycle,  as long as “universal useful employment based on assured jobs in public service” could be assured.

National Balance Sheet

Baxter argued that this new component of the economy changed the overall structure dramatically.

“Government activities constitute, in effect, an auxiliary industry,” Baxter argued, “which might always utilize advantageously the entire labor surplus.” By focusing on government as a net producer of capital, with its own rates of return on investment and labor, Baxter argued that the old idea of government spending as a chill on private economic activity (and thus a barrier to economic recovery) was missing the big picture. In one hypothetical recession, Baxter argued, “Decreased private activities have released 1,200,000 workers…but under this plan, expanding public activities would promptly take on 1,200,000 extra men.” Thus, government-created jobs would maintain “the required equation between total workers and total available jobs. There would be no labor surplus to start the “vicious cycle” of a depression.” Thus, direct job creation would be the solution to cyclical economic crisis, stepping in to alleviate the effects of decline the moment they occurred.

Moreover, Baxter argued that jobs programs offered two further advantages. First, jobs programs provided the prospect of recovery through growth by putting potential labor to use. “The point to be emphasized here,” Baxter wrote, “is that allowing an over-supply of human productive energy to go to waste in idleness, which might be utilized to create general benefits, deflates the entire price and investment structure.” By putting labor power to work, jobs programs would push the economy to its maximum level of production, reduce the downward push on wages caused by mass unemployment and decreasing demand, and restore an imbalance in the distribution of capital between consumers and investors by shifting tax revenue taken from the rich towards wages for the poor. Second, these programs represented a movement towards the socialization of work and an affirmation of the importance of being a worker, a productive member of society, part of the workplace. By expanding government into the role of employer and producer, employment assurance blurred the distinction between the private and public sectors. The public industry “differs from the others only with reference to the nature of its products and the methods of marketing them,” Baxter argued. In the conclusion of his report, he emphasized the sameness of government and industry, how government would become a model of moral capitalism, such that the basic economic structures Americans were used to seeing would change without seeming to change; with public employment , “total income remains constant. The average personal income remains constant. The sole change is that the average producer is buying less individually and more cooperatively (emphasis mine).”

Why Does This Matter?

So why should we care about a seventy-five year old economic theory? Because the Baxter Cycle offers a mirror image to the Laffer Curve. First, it argues that there is no inherent practical limit to the size and scope of government built into the “natural laws” of the economy. As long as the government organizes itself so that the different flows of spending balance out, the government can adjust itself upwards and downwards to whatever mix, whatever kind of political economy that the people desire without lowering growth or income. All that changes is the organization and distribution of consumption. Second, it argues that there is no necessary trade-off between equality and efficiency. By showing how the huge dead-weight loss of unemployed labor – both in terms of lost consumption and lost production – has to be included as an “opportunity cost” inherent in the laissez-faire model, the Baxter Cycle shows that government efforts to provide equal protection against unemployment can actually raise production and produce a more prosperous, more secure, and more just outcome.

And ultimately, this is why conservatives want to believe in an economic law that limits the size of government and proclaims the futility of expansion – because a government that can alter that balance between individual and social consumption threatens the assumed inevitability of the free market. And a theory that suggests to the contrary that the people have the ability to change how consumption is organized for the better is quite powerful weaponry in the rhetorical battle over taxation and government.

  1. A jobs insurance program sounds way more appealing to me than the current unemployment (income) insurance.

    Interestingly, government jobs seem to be slowly privatized rather than private jobs becoming public services. I think a large reason for this is that it is easier to not renew, modify or terminate a contract than it is for a public official to fire people. This is because government has a civic and social role to perform in addition to an economic role. This is the basis to the argument that republicans make that money spent in the public sector is less efficient than money spent in the private sector.

    That being said, what makes a government jobs program better than stimulus spending? The third ( and fourth) option of doing nothing (and austerity) you claim can result in a depression cycle and I will totally agree with that.

    The Laffer curve was unfortunately and appropriately named. It claims two points where y=0 and assumes assumes a nice curve between them. That “t%” is clearly a magic bullet and will never be in the same place twice. Also as I mentioned before, government’s only role is not maximizing revenue (although a balanced budget should be a priority).

    • Yeah, privatization is becoming a larger phenomenon. But I don’t think it’s actually an efficiency thing – the evidence on privatization and efficiency is really, really weak. It’s more an ideological and monetary thing – there’s a lot of money to be made from privatization.

      A government jobs program is better at creating jobs than a general stimulus, because it creates jobs both in the primary phase (when the money is spent on wages) and in the secondary phase (when the wages are then spent, creating a multiplier effect), whereas a general stimulus creates jobs generally only through the multiplier effect. It’s probably the case that general stimulus is better at boosting GDP growth than a jobs program, the question is which is needed more right now. GDP growth has basically recovered, although it could be stronger – unemployment hasn’t.

      So in general, I would advocate doing both – you want a program that helps the struggling employed and struggling unemployed alike. But if the immediate concern is jobs, then it’s the more effective tool.

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