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Laffer on Taxes & McCain's Bold Stand on Iraq

The Journal Editorial Report

Paul Gigot: This week on "The Journal Editorial Report," hold on to your wallet. Congress has just lit a fuse for the biggest tax increase in history. We have the details as this year's filing deadline approaches. And, media darling no more. Sen. John McCain is under fire in the press for his staunch support for the war in Iraq. Will it sink his presidential hopes or pay off with the republican base? Our panel weighs in, after these headlines.

Gigot: Welcome to "The Journal Editorial Report." I'm Paul Gigot. The millions of Americans struggling this weekend to decipher their complicated tax forms may find is hard to look on the bright side when it comes to the American tax code. But earlier this week I spoke with renowned economist Arthur Laffer and asked him if we do, in fact, have a better system now than we did than in decades past.

Laffer: It's much better, Paul. We've dropped the highest rates quite dramatically and we've broadened the tax base. Even though we have a long way to go, it is a lot, lot better than it was back then--miles. Unrecognizably better.

Gigot: Better for incentives, business incentives, investor incentives? Is that what you mean, the economic growth part. Because it's certainly not less complicated.

Laffer: No, no, it's not less complicated, but the incentives are much better. You know, it's amazing. When Kennedy came into office, Paul, the highest federal marginal income tax rate was 91%. And that was on all income; I mean, it wasn't just unearned or whatever. just think of how high that is. I mean, Kennedy cut it from 91% to 70%, but now it's 35%. It probably should be a little bit lower, but it's well in the range of reasonableness.

Gigot: All right. Now take us up to the present. You were a big supporter of the Bush tax cuts, particularly the tax cuts of 2003--

Laffer: Yes, sir.

Gigot: --which brought the investment tax rates on capital gains and dividend down to 15%. Looking over the last four or five years, what's the record of those tax cuts? Did they work?

Laffer: Oh, yeah. They really worked. The thing that amazes me is, if you look at the deficit, I mean, you know, the president was in a very tough spot when he took office. Nine months after he came into office we had September 11. We already had a collapsing stock market a year before he took office. So all of the things were working against him. And he did the tax cuts and the strong defense, and you know, if you look at the economy today, there has never been a better economy on planet Earth than the U.S. today. The budget deficit's one of the smallest in the last 35 years. There are only five or six that are smaller as a share of GDP. The economy is roaring. The unemployment rate's 4.5%, very little inflation. It is a beautiful economy. I think Bush did a great job on the economy.

Gigot: But note, a lot of people disagree with that. And there's a big debate in Congress now with whether or whether or not those tax cuts, which expire in 2010, after 2010 should in fact be extended.

Laffer: I know.

Gigot: What would be the economic impact if they were not extended? Would there be a negative economic impact, and how soon would we begin to feel that? Would it have to wait until 2011, or would you feel the impact earlier?

Laffer: You know, if they did the whole thing, it would just be amazing to me. If they let them all expire, it would just be an amazingly huge tax increase. And it would have a horrendously negative effect on the economy. And that, I'll say just point blank. And the effects on the stock markets and on interest rates would occur before that--in fact perhaps quite substantially before that.

But, Paul, I honestly don't believe that's going to happen. I just can't imagine anyone making the case to let those tax cuts expire when you have such a small deficit, when you have such a great, strong, economy. I'd love to run against the guy that wants to let them expire.

Gigot: Well, the Democrats are already talking in Congress about doing something. They need to do something to ease the bite of the alternative minimum tax, which, as you know, hits more and more taxpayers every year--I think four million people in 2006, 20 million in 2007 if Congress doesn't act. What would your advice be to the Democrats who say we need $60 billion, $70 billion, $80 billion--money somewhere, to ease that AMT burden?

Laffer: Well, if they can find it in spending, I would go along with it. I mean, I think that would be a very good idea for them to do it in spending. But if they're going to try other tax increases to match this static number, this pay-go number, I really think that would be a huge mistake. I think they will be this thwarted in their expectation of revenues, because I don't think it'll pay off.

Gigot: But what should they do then? What would your advice be to them on the AMT?

Laffer: Just get rid of the AMT. Yeah, just get of the AMT with no offsets or spending cuts. But, you know, they've got that rule internally that they made for themselves, which is the pay-go rule--

Gigot: The pay-as-you-go, which says any tax cuts have to be offset by tax increases or entitlement spending cuts elsewhere.

Laffer: That's correct. That's exactly right. Now the entitlement spending cuts I think make sense. But if you're going to try to do a tax increase somewhere else, I think it makes no sense. It's counterproductive.

Gigot: All right, looking ahead from here, if were you to advise presidential candidates of either party what should be done as they go into the 2008 campaign, what's the single most important proposal that they could make, given the current tax code, to improve incentives and improve our economic performance?

Laffer: In the realistic area, I mean if you want to just be realistic, I'd say extending the tax cuts that Bush put in is probably the key issue going forward in a practical sense. Obviously I'd love to see us move to a flat tax, something along those lines. But as a practical matter, I think just letting the tax cuts continue, passing them, making them permanent's the right thing to do.

Gigot: That's would be your No. 1 priority? You don't think you need actually a flat tax to move ahead, even as all these other countries in Eastern Europe are moving towards lower rates and a flat tax? I mean, the rest of the world isn't standing by. And we're sitting here, saying we're fat and happy. I mean, how are we going to remain competitive with these other countries?

Laffer: I shouldn't smile so much because of that fat and happy, should I--just teasing. No. You know, we should match it. We should do the flat tax. I mean ,we started the revolution back in the late '70s and early 80's. And frankly, now these other countries are catching up and they're doing really well. Look what's going to happen in France. I mean, I saw in The Wall Street Journal your piece on that. I mean, there's a real chance the French will rediscover the word entrepreneur.

It's exciting what is going on in the rest of the word. And I would like to see the U.S. make the next step and become a leader again. I don't think that's in the cards in the next year or two, though, Paul. If we can get the tax cuts, making them permanent, I think that would be great, and then we should move on to a more serious structural reform.

Gigot: All right, Art Laffer, thanks very much for sharing those insights. Good to see you again.

Laffer: Thank you, Paul

Gigot: More tax talk when we come back, including why the Democrats' new pay-as-you-go budget rules may wind up costing you a bundle. Plus John McCain is betting it all on Iraq, pinning his presidential hopes on the success of the surge. Will it pay off? Our panel weighs in on those topics and the Duke Lacrosse case when "The Journal Editorial Report" continues.

Gigot: Welcome back. While the media has been focusing on the presidential horse race and the war in Iraq, Congress has been busy pulling a fast one on the American people. Both the House and Senate passed budget resolutions that would make a major tax hike all but inevitable.

Joining the panel this week, columnist Kim Strassel, editorial board member Jason Riley and, in San Diego, editorial board member Steve Moore.

Well, Steve, you've been saying that we weren't going to get a tax hike before 2008. What are the Democrats up to with these five year budget plans?

Moore: Well, the Democrats, Paul, really have put themselves in a box, because a few months ago they passed something called the pay-go budget rules, which say any tax cut has to be offset with a tax increase. Now we've got a situation where 26 million--26 million Americans are going to be confronted with the alternative minimum tax, the tax that was supposed to be for rich people, next year unless they change the rules. The problem is they can't change those rules unless they increase taxes majorly on other people. And that's the box they are in now.

Gigot: So what are they planning to do, Steve? Are they going to move ahead with a tax increase on somebody else, probably you or other people who have certain incomes?

Moore: Rich people like you, Paul. I mean, what they're talking about is taxing corporate CEOs, the top 1%. The problem they have is the problem that the soak-the-rich people always have. There's not enough revenue there. And that means the middle class is probably going to get hit with tax increases--the same people they say they're going to give relief to on the AMT.

Gigot: But Jason, the president and the Republicans aren't going let that kind of tax increase go away because it would mean--go through because it would mean a partial repeal of the Bush tax cuts of 2003, which they're not going to let. So if he vetoes it or they block it in the Senate, how do the Democrats get out of the box?

Riley: Well, they're going to certainly try and press the issue. And the reason they're going to do so, as Steve said, it's going to hit 26, 27 million people next year. And a disproportionate number of those people live in blue Democratic states--California, New Jersey, New York--where there are high taxes. So the Democrats have a real political problem here. And it won't be easy for them to solve because their solution, again, is not to cut spending, because they are Democrats, but it's to shift the tax burden elsewhere and to increase it on the wealthy Americans.

So what they want to do, the way they want to solve the problem, there's not much political payoff. They are trying to shield a number of Americans from being affected by the tax. But most of those Americans won't really appreciate it because they're not paying it now. But the people they raise the taxes on, in order to shield the others, will definitely feel the pinch and blame Democrats.

Strassel: Either that or tax time is about to become much more unpleasant. Because you either raise taxes or you cut spending. They don't--necessarily aren't going to be able to do either of those. So now they're trying to find ways to get more money out of the people that pay taxes. This tax gap idea, that you go after and find three, $400 million from just people who should be paying more to the IRS.

Gigot: But is there that kind of money there?

Strassel: No.

Gigot: We always hear this money exists, but it really means sending more IRS agents out at people or squeezing some people somehow.

Strassel: Putting new rules in effect that make the whole tax situation, the whole tax process, far more onerous. They've always been looking for this. They've never found it. It's a pot of gold.

Moore: Here's what is crazy about this debate, Paul. If you look at the tax situation right now, in the last three years, we've had $780 billion in increased tax revenues. So the tax system, with the tax cuts in place, have created record flows of tax revenues. And that's going to reverse course if we raise rates.

Gigot: There's another thing about the tax that I want to talk about, which is it progressivity. Because if--we have a chart here that we can show people. If you look at what the share of all income taxes that the top 1% of taxpayers pay, it's 35.6% of all taxes are paid by the top 1%. The bottom 50% only pay 3.4% of all taxes. So it really does show the tax code is already progressive, and I guess some people want to make it more progressive but how much money can you squeeze out of those folks, Steve?

Moore: Well, the most important point on that is the percentage of taxes that are paid by those richest 1% have actually gone up during the Bush presidency, not down. Where are those big tax cuts for the rich?

Gigot: All right. Well, what do you think about Republicans? How are they going to handle this? Is this is a chance for them, Kim, to reclaim what they hope will be their tax-cutting bona fides and block the Democrats?

Strassel: This is, yeah, especially the case if you look at the top Republican candidates out there running for president at the moment. Look down the road in all of these the issues that we just talked about. The tax cuts are going to expire. AMT is going to hit, and that would mean a big surplus. But if you're a Republican presidential candidate and you promise to keep the tax cuts in place and fix the AMT, you're not left with much. That means if you want to off further tax cuts to voters out there, you're going to have to come up with some really big thinking, some really big plans, on entitlement spending, on simplifying the tax code. and this is an opening for someone to really be bold and inspired.

Gigot: All right, we're going to have to watch and see if they follow your advice, Kim.

All right, when we come back, media darling no more. John McCain comes under attack for his staunch support for the war in Iraq. It may hurt him with the press, but will it help him with the Republican base?

Sen. John McCain: We who are willing to support this new strategy and give Gen. Petraeus the time and support he needs, have chosen a hard road. But it is the right road. It is necessary and just. Democrats who deny our soldiers the means to prevent an American defeat, have chosen another road. It may appear to be the easier course of action, but it is a much more reckless one. And it does them no credit, even if it gives them an advantage in the next election.

Gigot: Sen. John McCain in an address this week to cadets at the Virginia Military Institute. In the first of three major policy speeches, the Republican presidential hopeful trying to get his campaign back on track, vigorously defending the U.S. strategy in Iraq and further alienating his sometimes fair-weather friends in the media.

Kim, what does this week tell you about the John McCain strategy and his chances for being our next president?

Strassel: I think what you saw this week was remarkable and sort of impressive. I mean, this is a campaign that is struggling. It's having trouble raising money. It just went through big a shake-up of its top staff. It can't even keep up in the polls with people that haven't announced for president yet, like Fred Thompson. It's really having a hard time.

And yet that's normally a cue for a politician to put their head down. Instead, John McCain goes out and talks about the most politically unpopular subject there is in America at the moment. Now, that's not necessarily bad. I mean, this is a guy, if there is one thing people are impressed with him about--even the base, who've had their complaints over global warming, over taxes, over campaign finance--they do respect him as being a principled person. They do think he's an honest individual.

Gigot: So you think this is smart political strategy, in addition to being a principled stand on the war.

Strassel: I think this is John McCain, in addition to being principled, actually putting forward the thing that people are always often impressed with the most, which is his character.

Riley: Well, as a political strategy though, we'll have to see. I think the way that the media's love affair with him has ended should be a cautionary tale for Obama, among with other people--current media darling.

Gigot: Yes, we are fickle, aren't we, Jason?

Riley: But McCain has a problem in that he has supported the war effort, but not necessarily the tactics. And McCain is probably thinking, if I had been commander in chief, things would be going better in Iraq. And he's hoping voters would make that distinction. And the question is whether his political fate will be tied to the war effort, even if we're not fighting the war the way he's been calling for us to fight this war for what long time.

Gigot: Steve, why do you think John McCain is having such a hard time getting conservative voters' support?

Moore: I think it's all the reasons that Kim mentioned--that is, problem with taxes and campaign finance. But you know, you look at the field of Republican candidates and the one thing that I think the American people want, and especially Republican voters, is somebody who stands for something and somebody who doesn't flip-flop. This is the problem that Mitt Romney had had in his campaign.

And so I think we had it right in our editorial this week. This really was John McCain's finest hour. And the line that he used was so perfect when he said I'd rather lose this election and win the war. And that's something that's really going to resonate with Republican voters.

Riley: In a recent L.A. Times poll, 4 in 10 Republican primary voters say the war is their No. 1 issue. Yet in that same poll, McCain was trailing Giuliani by something like 17 points--Giuliani, who has no foreign-policy experience to speak of. And trailing people like Fred Thompson, like you said, who haven't even declared.

Gigot: But what does it tell you about McCain's failure to get voters, if he's being so stalwart on the war, as I agree he has been?

Strassel: Well, again, as Steve said, it goes back to some of his bigger problems. One thing that's interesting, though, is that McCain coming out here is actually having an effect on the GOP presidential field. I mean, you look at some of these guys--it's not like any of them have been real wishy-washy on the war. But they haven't been out and kind of firmly in the same camp as McCain has been. Since he's been out giving his speeches, you've heard a couple of them firm up just a little bit, Romney and Giuliani, be a little more forceful about how they'd handle the war. So he's having an effect in leading the field a little on this.

Gigot: Jason, quickly, on our friends in the media turning. It didn't help John McCain in 2000 that the media loved him. Could it help him this time that the media doesn't like him, particularly among Republican voters?

[laughter] Riley: It might. It might. I don't know, as a political strategy, if you want go out there and upset the media, thinking it'll help you in the polls. But it might.

Strassel: But he's got other things he's still got to fix.

Gigot: All right. Thank you. Well, we're going to have to go.

We have to take one more break. When we come back, our "Hits and Misses" of the week.

Gigot: Winners and losers, picks and pans, "Hits and Misses," it's our way to calling attention to the best and the worst of the week.

Item one, justice at Duke. North Carolina's attorney general drops all charges against three former lacrosse prayers. Kim?

Strassel: You know, I'd argue the most revealing statement that came out this week was from one of the young men who had been exonerated, who said, "Look people, we are just as innocent today as we were a year ago." And this is a case of a moralizing media, of an ambitious prosecutor, of a cowardly Duke University staff, taking what should have been an allegation that should have been treated with a great deal of suspicion, and instead turning it into this issue of race and wealth and hysteria. And not at all for the right reasons. This was all because they wanted to sell newspapers. It was because you wanted to fit in with something to do with political correctness or, in the case of Michael Nifong, the prosecutor, you were politically ambitious. But it was never about getting down to justice. So America should be happy this is done. But the misses are legion here for everyone in this.

Gigot: They sure are. OK, thanks, Kim.

Next, Republican presidential candidate Rudy Giuliani has a new Southern strategy. Jason?

Riley: Well, Rudy was in Alabama recently and was asked about flying the Confederate flag over statehouses. And he simply said, It's a state rights issue. I'm going to leave it at that. And I think Giuliani had an obligation to go a little further and talk about what this flag's history is and what it symbolizes for millions of Americans. And that is slavery and secession and Jim Crow and opposition to civil rights, and I think Rudy didn't go there because he is pandering to Southern voters. It's a little surprising for a former New York City mayor to start talking like George Allen and Trent Lott.

Gigot: OK, Jason. Finally, a frosty start to the baseball season as spring snow forces the cancellation of a record number of games. Steve?

Moore: Yeah, to paraphrase Mark Twain, the coldest winter I ever spent was springtime in Wrigley Field. You've had record numbers of games cancelled in Cleveland. They had a foot and a half of snow. In Cincinnati, the game-time temperature for the Cincinnati Reds game was lower than any Cincinnati Bengals game in the last five years. Now, what does this prove about global warming? Absolutely nothing. These are normal weather patterns.

But you know back in January, we had three or four days of record high temperatures. And the global warming crowd said This proves global warming. I think what we have to do is maybe have Al Gore get out of Hollywood and go to a baseball game in Cleveland or Cincinnati, and maybe just, well, chill out.

Gigot: All right, Steve. Enjoy sunny San Diego.

That's it for this week's edition of "The Journal Editorial Report." Thanks to Kim Strassel, Jason Riley and Steve Moore. I'm Paul Gigot. Thanks to all of you for watching. We hope to see you right here next week.

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