Commentary Magazine


The Way the World Works, by Jude Wanniski

Taxes & Civilization

The Way the World Works.
by Jude Wanniski.
Basic Books. 319 pp. $12.95.

Jude Wanniski, until recently associate editor of the editorial page of the Wall Street Journal, announces at the start of this book that it was inspired by what he has “come to call the Laffer curve.” “Laffer” is Arthur B. Laffer, who teaches business and finance at the University of Southern California. Readers who have been permanently frightened by early mishaps in analytical geometry should be relieved to learn that Laffer’s “curve” is no more technical than an aphorism. It might be paraphrased thus: there are two ways in which a government can collect the same amount of taxes—one way is to set high tax rates, which should produce higher revenues but does not, because high tax rates discourage taxable economic activity; the other way is to set tax rates low, which should produce lower revenues but does not, because low tax rates encourage taxable economic activity.

Implicit in this formulation is the existence, somewhere, of an ideal tax rate, neither too high nor too low, but capable of encouraging the maximum taxable activity and yielding the greatest tax revenue with the least pain. But, alas, Professor Laffer himself cannot plot on his “curve” the coordinates of the optimum tax rate. Nor can he disclose to anyone—not even to the Chairman of the House Ways and Means Committee—whether the rates being charged an any given moment are below or above the ideal.

On the slender hypothesis that such a Laffer point exists, Wanniski, with the resourcefulness of a magician drawing an American flag from his empty fist, constructs a political program, sketches a new political economy based on the sociology of the American family, and presents a vivid explanation of events as complex and various as the Dark Ages, the 1929 crash, and the 19th-century prosperity of Britain.

Wanniski’s thesis is that the government “wedge” of taxes, regulation, and legal constraint compresses and diverts productive effort, blunts initiative, and causes depressions and wars. The “wedge” thus cripples the economy, and the gullible are led to propose new false cures to solve the problems the “wedge” itself has created.

This charge is about as old as the Industrial Revolution itself, but Wanniski makes it sound new. His timing also helps. He has published this book just when the economics of production once again have begun to claim public attention, after several decades in which economists fastened their attention on the problems of underconsumption. Wanniski’s discussions of the Laffer curve concentrate on the relationship between the level of tax rates and the productivity of the economy. Claiming that the right level of tax rates is the crucial stimulant of economic growth and strength, Wanniski admits that he too is unable to stipulate what the right rate is. He nevertheless offers a definition of “rightness” which opens the door to his discussion of history and politics.

The right tax rate, Wanniski tells us, is the rate the public will support in an election during which it has been given a proper choice. This answer eliminates columns of dreary statistics and graphs, and brings us to the essence of Wanniski’s political economy: the people know best, and Wanniski can tell us what they know and how they found it out. This proposition—which explains everything and nothing simultaneously—applies not only to nations in which the ballot lives; it applies to the whole world because the unschooled “global electorate” is as infallible as the university-trained Fabians of Bloomsbury. Even though the global electorate does not go to the polls, its members express themselves in the following ways: by emigration from countries whose policies ignore the Laffer curve; by allowing agricultural production to decline in countries which insufficiently reward the farmer; by assassination and bloody revolution in states whose policies make extreme measures necessary.

While the imputation of infallibility to the Many is scarcely more credible than imputing it to the One, Wanniski fashions out of this concept an effective device for asking the basic economic question: how is production possible? Why should anyone risk what he already owns in an untried enterprise? Why should anyone choose work over indolence? Or accept authority and direction, often from people he hates? And even welcome without much question the superior ingenuity of others?

These difficult psychological accommodations are needed to make production possible, and if it is to continue growing, the attitudes must persist far beyond the point at which the immediate needs of the producers themselves are satisfied. Wanniski’s answer to this problem is that people will continue to produce as long as they feel the system augments their contribution to it. They make this judgment on the basis of their understanding of complex economic concepts which they learned while they were growing up.

To explain economic expansion and the deadening effect of progressive tax rates, Wanniski relies on man’s natural grasp of marginal economics. Many economic writers believe that the lay public assumes that the marginal cost of the last unit produced is practically nothing, and that the entrepreneur derives an excessive reward for selling this unit at the same price as all the other units. Wanniski believes, to the contrary, that everyone instinctively understands that the cost of the marginal unit must include part of all the costs attributable to producing the units that preceded it in production.

Children, he tells us, learn the truth about marginal costs by observing parents in the act of losing their tempers, and by developing the art of wheedling and thus learning how to measure the effort needed to induce parents to opt for peace by giving candy. The child, he writes, comes to see that father loses his temper not because of a single childish outburst; the marginal cost—the last straw—is defined by all the other events that occurred previously to prepare the father to erupt. As children understand that what happened between Mom and Dad last night (or at work the previous day) is part of the cause of Dad’s outburst, so they understand that the cost on the margin of production cannot be measured in isolation from the train of costs encountered earlier.

Wanniski follows this demonstration with a note to the effect that economists and politicians promptly forget their own learning and (as he says elsewhere) apply progressive tax rates to income. In fact, however, the steep rates charged on marginal income offend the taxpayer’s understanding of the efforts necessary to produce it. This sense of injustice then stimulates large-scale evasion among those who recognize that their marginal income is what they had expected as a reward for the effort that produced the base income below the margin.

Wanniski culls additional evidence from history as proof of the ineffectiveness of high tax rates. He finds the historical process, like parent-child relations, less murky than it has heretofore appeared to others. The Roman empire flourished because Julius Caesar and Augustus installed lower tax rates, thus reducing the government “wedge”; the empire declined not because of Christianity but because of overtaxation. Napoleon’s contribution to European economic development was a reduction in the government “wedge” which he brought about by lowering taxes and rationalizing laws and customs. Harding was elected President because the electorate understood that in calling for a return to normalcy, he was advocating lower income taxes. The debates in Congress over the Smoot-Hawley tariff precipitated fluctuations in the New York Stock Exchange and led directly to Black Tuesday, October 29, 1929. High income-tax rates, steeply progressive, explain Puerto Rico’s poverty. Etc., etc.

One can be as skeptical of Wanniski’s history as of his sociology, but the effectiveness of his work does not depend either on the depth of his analysis or on the appeal of his single-cause explanations. His ability to persuade comes from the growing feeling that other economic analyses have not solved the problems of inflation, under-utilization of plant, and continuing structural unemployment. The monetarist theory that the government can control the economy simply by adjusting the money supply has been no more successful than the Keynesian reliance on budgetary deficits when necessary to stimulate the economy. In this atmosphere, the doctors of economics look more and more like astrologers, while advocates of a new turn seem more convincing every day.

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But, finally, in urging the propriety of tax cuts, Wanniski offers no protection against the risks his program entails. In the interim between tax reduction and economic revival (assuming his hunch is right), how shall the costs of government be covered? Wanniski makes the correct argument that inflation of incomes subject to progressive tax rates brings government a greatly augmented flow of revenue. But it is also true that government’s needs grow even faster. And are not these needs equally the expression of the will of the infallible electorate?

What Wanniski has missed is that the growth of government’s compass is at least as important a fact of modern political life as the resistance to higher taxes. This suggests that tax levels alone cannot account for the loss of productivity. In fact no single cause is responsible for a turn of events that probably reflects the attitudinal changes that follow the aging of a civilization. In the Britain and America of a hundred years ago, for example, public attitudes supported the steps necessary to favor economic development over the goals which are now being trumpeted by the elites: egalitarianism, anti-authoritarianism, conservation.

Thus Wanniski’s work leaves his reader with less than a full understanding of what has happened to the modern economy. But the reader has nevertheless been helped to glimpse the choices that must be made if public policy is to foster economic growth. Other writers on public policy, who try to combine the advocacy of material prosperity for the poor with the renunciation of the steps needed to achieve and maintain that prosperity, have not yet seen the problem as clearly as Wanniski. If the Laffer curve helped his understanding, there may be more to it than there seems to be.

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