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U.S. Tax Cuts — Foreigners to the Rescue

Are U.S. tax cuts actually to make foreign investors happy?

December 14, 2000

Are U.S. tax cuts actually to make foreign investors happy?

Remember Ronald Reagan and his “supply side” economics? Two decades later, the original architect of those ideas, Arthur Laffer, is still searching for more reasons to cut taxes. In his efforts to help out George W. Bush and his plans for tax reduction, Mr. Laffer argued in a recent editorial in the Wall Street Journal that “lowering income tax rates would inspire a continued surge in foreign capital investment in the United States.”

Mr. Laffer, of course, is known for one big idea — that cutting taxes will increase tax revenues. Within a few years of his initial sketch of a curve on a cocktail napkin in the 1970s, his ideas went all the way to driving the fiscal policy of the world’s largest economy. And then reality hit.

Mr. Laffer had pointed out that effort — the amount people work — might well be affected by taxes. A country with high tax rates could thus increase its tax collections by actually cutting taxes.

However, actual experience turned out to be different than the theory. Specifically, U.S. tax cuts in the early 1980s led to a decline, not a rise, in tax collections. [Click here for an explanation of the Laffer Curve.]

But that didn’t silence the proponents of supply side economics. They have always been less interested in the reasons for tax cuts than in just getting taxes lowered. Any argument, it seems, is grist for their mill. Hence the strangeness of the latest idea from Laffer and Co. — that tax cuts are necessary to keep foreigners happy so that they will keep investing in the United States.

Now savor this for a moment. Apparently, U.S. tax cut proposals are running out of steam on the domestic front. Thus, advocates of the idea have needed to resort to the world beyond U.S. borders.

It is a pretty novel concept in terms of economic theory to justify changes in fiscal policy at home with expectations of foreigners abroad. Moreover, we haven’t heard much clamoring from foreign investors that their future inclination to invest in the United States depended on further tax cuts. It seem to us that non-Americans have more confidence in the U.S. economy than even Ronald Reagan’s biggest boosters.

But despite his pseudo-internationalist bent, Mr. Laffer actually cares little for the rest of the world. He argues that cutting taxes would “translate directly into more jobs and higher productivity for US workers.”

But his argument is that the United States is competing directly with the rest of the world for capital — and that U.S. growth must come at the expense of jobs and productivity of workers in other countries. In effect, it might therefore appear that Mr. Laffer is quite willing to sacrifice the economies of other countries as long as the United States does a little better.

Let’s back up for a minute to see just how easily the rest of the world has been dismissed. It is remarkable in the first place that the world’s richest economy is so keen on attracting ever more capital from abroad.

Of course, this “giant sucking sound” helps balance the U.S. current account. But it still flouts economic theories far more basic than Mr. Laffer’s. U.S. workers already work with more capital than workers in most other countries.

Since US workers are so well equipped, the return on additional machines in the United States should be considerably lower than the return on those same machines in, say, Latin America (where workers have little capital). So it would make a lot more sense for capital to flow out of the United States and into Latin America.

From the point of view of world growth, then, foreigners hardly need more reason to invest in the United States. In fact, they probably need less. Beyond the question of where the capital should go, the huge investment flows into the United States have created the largest, and most disturbing, imbalance in the world economy today.

All of this, however, is really secondary to Mr. Laffer’s main point — cutting taxes. It is the holy grail for him, and it appears that the world economy only exists to supply him with additional reasons for a US tax cut.