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Economist assesses nation’s fiscal issues

Boy, has this country made a mess of its fiscal house.

That’s the message Arthur Laffer, an economic adviser to former President Reagan and the oft-credited father of supply-side economics, delivered Thursday to a crowd of local businesspeople.

In a speech to attendees of the Nevada Development Authority’s annual luncheon inside Bellagio, Laffer discussed the genesis of today’s credit crunch, and he told the crowd the nation’s fiscal problems won’t end as long as the federal government keeps ginning up stimulus plans and talking up tax boosts.

First, about that credit crisis. It was born of an imbalance between two factors: the demand for money, or people’s desire to stay liquid for possible purchases, and the country’s money base, or currency in circulation combined with banks’ reserves. That imbalance developed in 2007, when economic growth pushed up demand for money even as the Federal Reserve kept the money base low to curb inflation.

“The Fed did not allow the money base to expand, and we had a panic in the liquid markets,” Laffer said. “What caused this was financial panic, pure and simple.”

Meanwhile, to help consumers and companies through the liquidity crisis, the government passed a passel of bailout and stimulus packages aimed at everybody from middle-income shoppers to mortgage guarantors. Throw in a $300 billion drop in tax collections courtesy of the economic slowdown, and it all adds up to $3 trillion, or 20 percent of the country’s $15 trillion GDP.

But faulty logic underpins those rescue plans, Laffer said.

Take that $150 billion springtime rebate that sent each low- to middle-income American a check for up to $600 to boost consumer spending. The problem with the stimulus, said Laffer, was that it wasn’t based on work effort. In fact, people earning more than $75,000 a year received little or no stimulus at all.

“When the government writes a check for something other than work effort, that check doesn’t come from the tooth fairy,” Laffer said. “The government distributes. It doesn’t create.”

So while the middle class enjoyed money to burn, affluent Americans who pay most of the country’s taxes had less money to spend. Net effect on the economy? Nothing.

“It’s true that people who received the stimulus bought goods they otherwise would not have bought, and that, in turn, employed people who had to produce those goods,” Laffer said. “A multiplier effect cascades through the economy. But people who had that increased tax liability spent less, which disemployed some people. That also has a multiplier effect that cascades through the economy.”

It’s an arc that repeats with every revenue shift, so any bailout or stimulus plan will always impose a net economic effect of zero.

“Whenever the government gives someone money, they are reducing someone else’s income dollar for dollar,” Laffer said.

Tack on 30 percent for the administrative cost of federal redistribution, and a stimulus that sends $100 billion to consumers requires $130 billion in government spending, he added.

“When you bail someone out, you’re putting someone else in trouble and paying a toll along the way,” he said. “A stimulus will pay people who are losers. It will pay people for not working. It will pay people for taking risks.”

Nor will raising taxes on the country’s richest 5 percent, as President-elect Barack Obama has said he’ll do, bolster the country’s finances, Laffer said.

In 1981, when the marginal income tax rate was double today’s rate, the top 1 percent of U.S. earners paid 17.5 percent of America’s income taxes, and the revenue they forked over equaled 1.5 percent of GDP. Today, the richest 1 percent pays more than 40 percent of all income taxes, with taxes as a share of GDP coming in at 3.2 percent. That’s because when taxes fall considerably, hiring attorneys and accountants to hunt for loopholes and shelters doesn’t make economic sense. It’s easier and cheaper to pay the tax, Laffer said.

The rich can tweak the location, timing and composition of their income, Laffer said. Take Obama booster Warren Buffett. His wealth sits almost exclusively in unrealized capital gains in the stock market, and he pays no taxes on those assets as long as he doesn’t sell them. Nor will he pay taxes if his money goes to charity upon his death.

“If you raise taxes on the top 1 percent, you’ll collect less revenue because they will find ways around the tax, believe me,” Laffer said. “There’s no way you can raise tax revenue just by raising taxes on the rich.” Nevada’s tax structure, with its lack of personal and corporate income taxes, won plaudits from Laffer. The state ranks No. 10 in an economic competitiveness index he publishes with the American Legislative Exchange Council.

Laffer said the Silver State’s leaders seem to understand that businesses can relocate, and business owners often opt for lower-cost business climates.

“Nevada is doing a beautiful job,” he said. “If you stick to your guns, you’ll come out (of the downturn) better off than the rest of the country.”

Sticking to those guns won’t be easy, though, because tax increases enjoy broad political traction.

“A bad model is embedded in the body republic,” Laffer said. “Both Democrats and Republicans flock to it, because nobody understands double-entry bookkeeping. You can’t bail somebody out without hurting someone else.”

Contact reporter Jennifer Robison at jrobison@reviewjournal.com or 702-380-4512.

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