Arthur Laffer: cuts succeeded where stimulus failed

High government spending increases unemployment and slows economic recovery

26 October 2013

 Nashville, TN

All the drama coming out of Washington in the last few weeks has obscured some seriously good news: federal government spending is falling. And not at a trickle: think the White Cliffs of Dover. Not since the economic boom following 1945 have Americans seen such a rapid decline in the government’s claim on the nation’s resources — falling by a welcome $94 billion over two years. You need to go back to the end of the Korean war to find a time when US government spending has actually declined over two years. If Republicans in the House stick to the sequester and future caps already built into current budget law, federal spending will stay at this low level for years to come.

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For liberals who thought that Barack Obama’s second term would mean a new multi-trillion-dollar Great Society spending binge, such as we saw from 2009 to 2011, all this is a cold shower of fiscal reality. For Keynesians who believe that government spending cuts are ‘austerity’, this is also miserable news: they expect the worst. But the signs are that this contraction in the size of government is a big plus for the American economy. It’s now happening much more quickly here than it is in Britain. Americans are moving faster towards fiscal sanity — and are already feeling the benefit.

It is clear, now, that a massive stimulus administered was an abject failure. It condemned America to the worst recovery in its history — including the 1930s. But when politicians make decisions while either panicked or drunk, the consequences are rarely edifying or attractive. US Treasury secretary Hank Paulson hyperventilating before Congress to pass his three-page stimulus bill granting him total authority to spend $700 billion to save the economy was a sight to behold. Why, he even insisted the need was so urgent that there was no time for hearings, reviews or oversight. And passed it was — with some $2.8 trillion additional stimulus funds over the coming few years. And what happened? American unemployment levels soared.

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The Keynesians warned that the post-Cold War spending cuts that occurred under President Clinton would cause economic contraction — instead we had an employment boom to match all booms. And this boom under Clinton was the direct result of the huge drop in government spending. As if that weren’t proof enough, Obama’s economists revved up their economic model to justify spending an additional $830 billion in stimulus, saying it would keep unemployment low. Without a stimulus, they said, joblessness would be 8 per cent. Instead of making things better, subsequent joblessness was higher than they predicted, peaking at 10 per cent. By their own assumptions, things were worse than they would have been without spending a cent of that ‘stimulus’ money.

As my former colleague Milton Friedman often said, ‘Government spending is taxation.’ Beyond the essential services government provides — such as roads, courts, schools, police and fire services, and the military — government spending doesn’t actually create resources. It just redistributes resources. For every beneficiary of government largesse, there’s someone who pays for that largesse. When the money the government takes from workers and producers is used to pay people and companies not to work — food stamps, unemployment insurance, bailouts, Obamacare health subsidies — it’s a double-whammy.

Those who receive payments for not working have now found an alternative source of income without working, which causes them to work less. This slows the economy, not to mention the waste of human talent. Those who are taxed more (in Britain, by a VAT increase) get to keep less of what they earned.

In my two studies last year, I demonstrated that Keynesian stimulus programmes failed in most developed countries around the world. Nations with the greatest stimulus spending had the deepest recessions — while those with the least stimulus spending performed the best. The bigger the spending stimulus, the slower the recovery. I also showed historically that spending has never been associated with faster growth of the US economy. The notion of a Keynesian spending multiplier is right out of an Aesop fable. And who ever heard of a poor person spending himself into prosperity? No one!

Critics say that I have it all wrong: they say that government spending goes up because unemployment is high — not the reverse. It is true that government spending does go up when the economy underperforms, but it is also true that economic underperformance is exacerbated by the increase in spending. In the 1970s, the more Congress spent, the higher unemployment rose, and it was not until government spending and taxes were cut in the early 1980s that unemployment started its long-term decline. The same is true for the ‘Go-Go’ 1960s when President Kennedy cut tax rates and government spending.

The last few years have delivered a powerful refutation of Keynesian economics because the American economy has performed better in an era of downsizing government than it did during the wild spending ride of 2008-11. Most economists in Washington predicted that sequester budget cuts of just over $50 billion would slow the economy — or even cause a double-dip recession. But the sequester has gone forward almost without a glitch.

Even Barack Obama is minded to boast about the returning fiscal sanity. ‘Our deficits are now falling at the fastest rate since the end of World War II,’ he said last month. ‘I want to repeat that. Our deficits are going down faster than any time since before I was born.’ He’s right — in spite of what his advisers told him (and everyone else), cutting the size of government is working in America. And this is the best news to come out of Washington in many years.

Arthur Laffer is known for the Laffer Curve, which shows the trade-off between tax rates and revenue, but he credits the idea to the 14th-century Muslim scholar Ibn Khaldun.

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Show comments
  • Paul1985

    Rubbish. Say’s Law (the formal name for the views in this article) has been refuted. I hope Krugman sees this article.

    • http://www.DNotice.org/ Dean Jackson

      Wikipedia explains the misconceptions surrounding Say’s Law:

      “Thus Say’s law, in its original concept, was not intrinsically linked nor logically reliant on the neutrality of money (as has been alleged by those who wish to disagree with the law[11]) because the key proposition of the Law is that no matter how much people save, production is still a possibility as it is the prerequisite for the attainment of any additional goods of consumption. Say’s law states that in a market economy, goods and services are produced for exchange with other goods and services – ’employment multipliers’ – therefore arise from production and not exchange alone-and in the process a sufficient level of real income is created to purchase the economy’s entire output due to the truism that the means of consumption are limited ex vi termini by the level of production. That is to say, (with regard exchange of produce within a division of labour) the total supply of goods and services in a market economy will equal the total demand derived from consumption during any given time period – in modern terms, “general gluts cannot exist”,[12] although there may be local imbalances, with gluts in one market balanced by shortages in others.” — http://en.wikipedia.org/wiki/Say's_law

      • mikewaller

        This would be all very fine and dandy if all national sub-components of a globalised economy were much of a muchness. Sadly they are not. What really spooked Western economies, albeit far too late, was the realisation that (a) we are up to our necks in debt; (b) our existing standards of living are unsustainable; (c) those from whom we have been happy to buy loads of pretty basic goodies at very low prices because of their very low wages, are now starting to show a disturbing capacity to move up into the higher-end goods which we had considered our preserve; and (d) the sheer number of new industrial workers being created in the new economies are going to create a global productive capacity greatly in excess of any plausible level of global demand.

        As all of this still applies, the happy self-stabilising model you propose is a pipe dream. For instance, much of the deferred spending would be invested elsewhere. Certainly Western governments will have to spend less because, increasingly, only the very stupid will be prepared to lend them any money. It is also true that in the US fracking gas, the acceptance by workers of significantly poorer condition and the stimulus packages are staving of the inevitable – but for how long?

        • http://www.DNotice.org/ Dean Jackson

          “For instance, much of the deferred spending would be invested elsewhere.”

          Investment goes where the rate of return is greatest. Western economies (and Japan) following low-interest rate policies sabotage investment, since the rate of return is negligible.

  • Paul1985

    When the author speaks of “who ever heard a poor person spend his way to prosperity” he surely knows that an individual is not a country? Typing this on the phone so hopefully someone else will point out the rest of the numerous fallacies on display here!

    • Liberty

      As Adam Smith said, what is good for the individual [balancing books, spending and investing wisely] is also good for the firm and a government. The myth that spending per se is good [even if it is borrowed] is perpetuated by governments because they tax everything so the more we spend the more they get. Add to that inflation and they get more income even without raising taxes because they get the same proportion of more money [of lower value but that isn’t their problem, it is ours].

      • Paul1985

        A country is not an individual because my spending is your income and your spending is my income, so if both of us cut spending both our incomes fall.

        • Liberty

          Not when the spending has been borrowed from Saudi Arabia, China, etc. at fat interests rates. Our spending is their income [interest]. You are thinking of the days when home spending was borrowed from home savers.

  • http://www.DNotice.org/ Dean Jackson

    Ladies and gentlemen, do you see what’s going on? The exact same inexplicable, and counter indicated, monetary policy is taking place with the Bank of England, the European Central Bank and the Bank of Japan, effectively preventing any investment-based recovery, and only investment-based projects are productive, increasing the wealth of the nation. What low-interest rates encourage is consumption spending, which is what we’re seeing with the buying and selling of stocks for the sake of selling and buying of stocks!

    Higher interest rates, however, decrease consumption and spur greater savings for investment because the lure for such increased savings–interest–is higher. The higher the market-based interest rate is, the greater the attraction for one to curtail one’s consumption, and place the monies that would have gone towards consumption into investments instead.

    Such investments then (1) lowers the prices of goods; and (2) creates new technologies that lower the price of doing business. This means that a real productive economy will see FALLING general prices, not year after year of rising prices thanks to central bank credit expansion.

    With central bank credit expansion, the money supply increases, leading to inevitable inflation. However, when market-based interest rates are maintained, where the central bank maintains credit neutrality, then people decrease consumption for greater investment, where now the prices of the consumption sector of the economy decreases, while prices of the investment sector of the economy increases proportionately, leading to both sectors’ price differentials cancelling each other out, producing no inflation. However, as the new cheaper goods come onto the market, thanks to greater investment, prices begin to fall, and fall further with the discovery of new technologies that decreases the price of business!

    The question then is: What entity co-opted Western political parties (who appoint central bank bureaucrats) to sabotage the economies of the West and why?

    Only one such political entity in recent history would have the (1) motive; (2) manpower; and (3) resources to pull off such a long-term strategy…Moscow and allies. Now you know why the West refused to verify the “collapses” of the East Bloc and USSR, when verification is critical to the survival to the West.

    Imagine it’s March 1944 and the Allies receive word from Berlin that Hitler and his inner circle are dead, cremated, and the Nazi government has collapsed. What do you think the reaction of the Allies would have been? To pack up the war, demobilize the armies? Ah, no. The Allies would have demanded that an occupation of Germany take place, where the Allies (1) could ensure that the Nazi government in Berlin had indeed fallen; and (2) prepare Germany, to the satisfaction of the Allies, to enter the pantheon of democratic nations. With that in mind…

    Take a look at these pictures out of Russia…




    Then for Russian Naval vessels, take a look at what’s still appended to the bows (enlarge picture)…


    Those pictures were taken in 2009, 2011 and 2001, respectively, not before the “collapse” of the USSR. As you can see, the Soviet era nationality emblem of the Communist Party…the Red Star… is still present. That political symbol of the Soviet government would have been immediately removed in early 1992 if the “collapse” of the USSR were genuine. As the legal emblem of the USSR and the Communist Party of the Soviet Union, the Red Star emblem can only be present if Communists are still in power in Russia and the other 14 republics that made up the USSR.

    Take a look at what’s still on Aeroflot aircraft…


    Note the Soviet emblem of the hammer & sickle stenciled on the aircraft’s fuselage!

    Now, for the main paper of the Russian Ministry of Defense…


    “Krasnaya Zvezda” is Russian (no kidding!) for “Red Star”, the official newspaper of Soviet and later Russian Ministry of Defense. The paper’s official designation is, “Central Organ of the Russian Ministry of Defense.” Note the four Soviet emblems next to the still existing Soviet era masthead, one of which pictures Lenin’s head!

    The fraudulent “collapse” of the USSR (and East Bloc) couldn’t have been pulled off until both political parties in the United States (and political parties elsewhere in the West) were co-opted by Moscow & Allies, which explains why verification of the “collapse” was never undertaken by the West, such verification being (1) a natural administrative procedure (since the USSR wasn’t occupied by Western military forces); and (2) necessary for the survival of the West. Recall President Reagan’s favorite phrase, “Trust, but verify”.

    Now you know why the hated Communist Red Star is still placed on the bows of NEW Russian Naval vessels (and the wings of Russian military aircraft), and why the “electorates” of the 15 republics that made up the USSR continue to “elect” for President Soviet era Communist Party Quislings. There have been 52 such Presidential “elections” since the “collapse” of the USSR, resulting in 40 Soviet era Communist Party member Quislings being elected. That’s 76.92%! If the “collapse” of the USSR were legitimate not one such Quisling would have been elected President. In fact, such persons would have been either arrested in the interests of national security or shunned by society. Remember, Communist Party members made up no more than 10% of the USSR, and it was they who for 74 years persecuted the remaining 90% of the population.

    In addition, the KGB agent Quislings that controlled the Russian Orthodox Church before the “collapse” of the USSR are to this day still in control. They were never identified and thrown out of that institution after the “collapse” of the USSR. The same is true for all other religious institutions in the other 14 republics of the USSR, including East Bloc nations, proving not only co-option of those religious institutions, but that the “collapses” of the East Bloc and USSR were disinformation operations.

    The next major disinformation operation under the LRP will be the fraudulent collapse of the Chinese Communist government. When that occurs, Taiwan will be stymied from not joining the mainland. This is why China is buying up gold all over the word. It is believed that China currently has 3,000 tons of gold. When it has 6,000 tons it will have the minimum gold reserves to replace the United States as the world’s reserve currency, that is after the fraudulent collapse of the Chinese Communist government.

    The “War on Terror” & Iraq War I and II:

    Regarding the “War on Terror”, Moscow and Beijing tasked America to conduct the operation to ensure that while the USSR was in a “liberalized” and therefore weakened state, such a war would (1) create enmity between Islam and the West; thereby (2) aborting any possibility for an alliance between Islam and the non-co-opted militaries of the West against their mutual and true enemy…World Communism; and (3) create the image that the United States is a rogue state, invading/attacking nations with impunity, thereby setting the stage for a future “democratic” China replacing United States preeminence on the world stage.

    Before the fraudulent collapse of the USSR in December 1991 Moscow tasked Washington, DC to ready the 1990 Gulf War with Iraq. Why? Because Moscow, after the “collapse”, was going to intentionally implode its economy to ensure foreign investments went to China instead. Russia could live on the relatively higher price that its oil exports (Russia is #2 behind Saudi Arabia in oil exports) would obtain thanks to the United States placing an embargo on Iraqi oil, thereby raising the world price of oil relative to the lower price the commodity would have fetched if the Iraq embargo hadn’t been in place. China has no such export market for oil, therefore would have to rely on foreign investments to build her military.

    Then by 2001 oil began getting too expensive due to India’s emergence on the economic scene, threatening China’s military buildup. To ensure China had the oil it needed, and at a lower relative price then what it would have been otherwise, and not exhaust Russian oil reserves, Moscow once again tasked Washington, DC to invade Iraq for the purpose of now opening up Iraq’s oil reserves once again to the world oil market. Hence the March 2003 Iraqi War, and why China is the major player that has benefited from Iraqi oil contracts.

    Notice that Washington, DC refuses to wage illegal wars against China, North Korea, Cuba, Vietnam, Laos and Burma, all nations that persecute their populations in one way or another. Only Muslim nations are invaded? Why would that be? Why is the United States funding the so-called “Arab Spring” movements, but not “Communist Spring” movements in China, North Korea, Cuba, Vietnam, Laos and Burma (Burma is also a Communist nation; in fact, the fake dissident Aung San Suu Kyi’s father founded the Burmese Communist Party in 1939, becoming its first General Secretary, which is why Aung San Suu Kyi keeps her silence as Burmese Muslims are being slaughtered. Didn’t know those facts, huh?)?

    For more on the “Long-Range Policy”, read KGB defector Major Anatoliy Golitsyn’s book, “New Lies for Old” (available at Internet Archive), the only Soviet era defector to still be under protective custody in the West.

    If anyone is interested in a list of “victors” names of those 52 “elections” that have taken place in the republics of the “former” USSR, let me know. I’ll post it. The list also includes the Soviet era Communist Party status of the “victor”.

  • Felix

    Laffer, hahahahaha, Lord spare us!

  • Roberto Machado

    We are counting chickens before they hatch. We in the UK are seeing hte creation of a new bubble and who will have the money to bail the banks out this time?

  • Karl219

    Until the QE subsidy to markets is tapered, It’s too early to make a call on austerity’s effectiveness. And weren’t there other significant events in the 1970s that had an impact on the US economy?

  • WilliamAshbless

    Hello Arthur,

    Have you discovered a single bit of empirical evidence for your Laffer Curve yet? Don’t worry about it conservatives aren’t convinced by evidence they’re comfortable with ignorant bliss.

  • allymax bruce

    Arthur, you’re an idiot; it was the Bush ‘sock-puppet’ president that ruined the economy of USA. Little did he, sock-puppet ‘W’, know, he was being advised, and ‘directed’, from Marxist evil collaborators; Bush senior(murdered John Lennon), Rumsfeld, and Cheney, that they were ‘authoring’ a Marxist empire!
    President Barak Obama came into ‘office’ off the Bush $13 Trillion Debt ‘crashed-economy, two illegal & wasteful wars, and a massive deletion of middle-to-working class investment/infrastucture; the Bush family have destroyed USA; President Obama has worked miracles to maintain its former glory. If anybody is going to bring back USA’s glory-days, and ‘American Dream’, it is the God-given President Obama; a Great Great man, and brilliant, honest President.
    Arthur, are you ‘working’ for the Marxists?

    • chan chan

      How could anyone be so stupid as to think The Lightgiver, The Magical Half- Black Man, could ever do anything wrong? It beggars belief, I agree…

  • Archibald_Bomwitz

    In 1945 government spending went down because World War II ended and there was no need for using government móney for weapons. The very same thing happened in the 1950’s after the Korean War. Apparently Mr. Laffer (Laughter ?) hasn’t noticed that the war in Iraq has ended for the USA as the troops have been pulled out and Afghanistan will follow in the near future. The biggest items in US government spending were these two wars! The major part of downsizing government consists in fact of downsizing military operations.

    • post_x_it

      “The biggest items in US government spending were these two wars!” Really? Do you have any sources for that claim?
      Here is the breakdown for 2007, the year of the Iraq surge: http://www.usgovernmentspending.com/breakdown_2007USrt_15rs5n. The defence budget only comes fourth after healthcare, pensions and education. And even then, the defence budget would not have been spent entirely on those two wars.

  • http://neitherangryorscared.blogspot.com/ Neitherangryorscared

    But the US recovery is stronger and faster than the UK’s. Had the UK carried on stimulating the recovery (as Obama did) instead of cutting it dead we’d be much further ahead on paying down the deficit than we are.

    Also as the spending is still above the ~21% of GDP that it was prior to the crash then you can’t say there’s a reduction. In fact until it gets back to Pre-Bush levels then it could be claimed as a Democrat stimulus.

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