Et Tu, Laffer?

Subtitle: Arthur Laffer Makes Me Chuckle

A common mistake made by economists is assuming that economic policies have the same effect under all economic conditions. But it’s not true. It is a general principle that water will turn to ice if the temperature is reduced. But that general principle does not hold true if the temperature is reduced from 95 degrees to 40 degrees. Only when the temperature declines to 32 degrees or below will any ice form.

Similarly, the effectiveness of fiscal and monetary policy varies depending on current economic conditions. Policies to curb inflation are helpful during periods of high inflation, but during periods of deflation they could be harmful. Tax cuts generally result in increase net after tax income, but during periods of losses, there is no effect.

One would think that Arthur Laffer, an educated economist who has practiced the craft for decades, would get it. Instead he fails to consider the current economic conditions while advocating policies. Laffer writes a column http://tinyurl.com/2auuu6g in the Wall Street Journal advocating that unemployment insurance benefits cause higher unemployment.

Under healthy economic conditions, it’s a sound theory. Higher unemployment benefits make unemployment more attractive thereby increasing the incentive to remain unemployed and decreasing the incentive to look for a new job. Laffer imagines unemployment benefits of $150,000 per year and correctly guesses that the unemployment rate would be higher if such a generous unemployment benefit were offered.

Laffer offers a chart that shows the correlation between increased unemployment benefits and unemployment. A glance at the chart shows that the more unemployment benefits are paid, the higher the unemployment rate rises. Laffer uses this to prove that high unemployment benefit payments cause unemployment.


And this is what is most annoying. He wants his audience to conclude that unemployment benefits cause unemployment. Of course, a closer look at his chart shows that the unemployment rate actually rose BEFORE unemployment benefits rose. How can an increase in unemployment benefits in 1975 cause unemployment to rise in 1974? It’s clear from Laffer’s chart and from just plain common sense that high unemployment is the cause and high unemployment benefit payments are the effect. For Laffer to suggest otherwise tells me that he is being dishonest.

Another policy about which he is clueless is stimulus. He believes that if the government spends money on stimulus, such as unemployment benefits, then the money must come out of the pocket of some other productive participant in the economy. This assumption also holds true under normal circumstances. In order to pay Peter, the government must tax Paul. It makes sense.

But it’s not always true. Currently, financial institutions are hoarding trillions of dollars that are not being invested in the economy. This normally causes deflation. However, the Federal Reserve is operating an anti-deflation policy. Bonds issues to pay for the Federal deficit are being bought up by the Fed. The money for the stimulus is not being taken out of anyone’s pocket.

We’re all familiar with the Laffer Curve. Lower taxes leave more money for businesses and productive individuals to invest and create an incentive for businesses. That’s sound economic theory. I’ve always had a lot of respect for Laffer. But this column is pathetic, and his use of deceit and his display of ignorance with respect to economics causes me to question his integrity as well as his competence.