Where the twain does not meet: Dr. Laffer vs. Dr. Hepner

A full room of legislators, lobbyists, academics and activists of all stripes witnessed a debate over income taxes between two economists at the Oklahoma History Center on Wednesday (May 9). Sparks flew at times. While the tone was generally civil, the two men did not persuade each other on key points.

University of Central Oklahoma Professor Mickey Hepner defended the state’s income tax status quo, while Professor Arthur Laffer made the case for income tax cuts, pressing anew for the proposal he helped craft that would phase out the income tax levy over a decade or more. 

Hepner said maintaining or increasing state government spending is critical to the state’s quality of life, while Laffer argued Oklahoma can go to the next level in economic success by joining the ranks of states that are inviting to income producers.
 
In an interesting twist in their discussion, the two agreed Oklahoma has weathered the Recession well and that the state economy is undeniably on an upward track, especially in comparison to most other states. They parted company sharply on what should come next for the Sooner State.
 
Hepner said he has “serious concerns about the model used” in Laffer econometric study making the case for an income tax phaseout, while nonetheless characterizing it as a sophisticated system. He said tax cuts should follow (as in some past cycles) good revenue years, not be the basis for projecting future good tax revenues. He asserted, “The Oklahoma economy is doing better than most states that don’t have an income tax.” He contended “we are thumping Texas” and “bumping Texas metrics.”
 
He passionately contended a tax reduction or phase out “won’t generate the benefits proponents are claiming.” He contended the state’s options then “will be to raise the sales tax or property tax, or to cut spending.” He observed that in that case, a property tax hike would be unlikely, and that sales taxes are already high.
 
Hepner’s thesis, stated in several different ways, is that the state’s needs for education, roads, prisons and other government projects outweigh any benefits that might come from cutting taxes. He observed that there are “undeniably” benefits from lower taxes, but that “cutting government spending would create harm, undeniably.” Arguing from his premises, he concluded the state will better progress with retaining the structure of existing government spending and taxation.
 
He concluded one of the exchange’s opening segments by saying, “My fear is that is that if this plan doesn’t generate the benefits that proponents project, it will harm Oklahoma’s quality of life.”
 
Dr. Laffer placed himself squarely in the tradition of the late Nobel economist Milton Friedman, his colleague of many years at the University of Chicago. Laffer referenced his work on the intersection of economic theory with the real world of policy-making, including involvement in the historic Proposition 13 property tax reductions that helped trigger an economic surge in California. He reflected, as Larry Gatlin has said, “This is not rocket surgery.” Laffer continued, “Government spending is taxation.”
 
He observed that Oklahoma taxation and spending have risen, relative to personal income. His fundamental analysis: “All taxes are bad, but some are worse than others. “
 
He pointed to both his work for the Oklahoma Council of Public Affairs, and books (including “Eureka”) to note that while it is not possible to predict exactly how a set of tax changes will play out in every state, it is “common sense” to observe that zero or low income tax states are, over time, outperforming high income tax states. He stressed that of the 11 states that have introduced a state income tax in the modern era, “all have lost ground/declined as a short of national GDP.
 
"The zero/lower income tax states do better.”
 
He noted that the often-acclaimed income taxes early in the presidency of John F. Kennedy “led to a boom” – followed by the economic follies of “the four stooges” – Presidents Johnson, Nixon, Ford and Carter. Laffer argues from evidence that just as JFK’s tax cuts provoked economic growth, Ronald Reagan’s two decades later led to another boom. His thesis for the state of Oklahoma, and for its problems of poverty: “You’ve got a chance to make Oklahoma better. When you talk about poor people, the best form of welfare is a good paying job.”
 
Treasurer Ken Miller served as moderator of the History Center event, jointly sponsored by the State Chamber, OCPA, and the Oklahoma Policy Institute.
 
Miller observed the state is low (37th) in overall state and local tax burden, but seventh highest in sales taxes – yet 47th lowest in property taxes. Then there are personal and corporate income taxes. He asked each economist how they would structure government revenue sources to maximize growth and fairness.
 
Hepner said the system should be designed to raise money with the lowest possible cost. He said it is important to “keep in mind income tax and property tax are deductible. … If you rely more on deductible taxes, you reduce federal tax liability.” Relying more on those, and less on sales taxes, is a better tradeoff, he asserted.
 
Laffer repeated his belief that allowing a phase out permits “ten years to identify problems,” leaving time for correctives or moderation. He reflected, “Taxes don’t redistribute income, they redistribute people. If you want to make the state attractive to people, lower taxes.” While agreeing with one of Hepner’s contentions, that good education should be a government objective, he said a more critical factor is to make the state “a better place to live.”
 
Briefly the discussion turned to the tradeoffs of a national sales tax versus national income taxes. Laffer said, “if that were the choice,” he would support a sales tax rather than income levies. Hepner strongly argued against that tradeoff.
 
Miller asked the pair to consider evidence from Rich States/ Poor States, published by the American Legislative Exchange Council (ALEC). He pointed to what he considered mixed evidence on the difference in performance of no-income tax states like New Hampshire and Tennessee, versus a state like New York that has recently performed well, economically. He also noted that Oklahoma has outperformed some of the no-income tax states.
 
Laffer observed that Oklahoma is among the states that have been cutting taxes, and that Tennessee, for example, has not been as aggressive in some respects in creating a tax-friendly environment – although certainly “friendlier” than his former home of California. Hepner noted that distribution among the income tax vs. no-income tax states was not consistent. In competitiveness rankings, distribution of economic vibrancy was mixed.

The pair seemed to agree that a number of economic and taxation factors matter, not just “all one thing.”

The men did not agree on anticipated or projected “dynamic” effects on jobs growth that Laffer anticipates will occur (and, he notes, historically has occurred) in the wake of income tax reductions.
 
Laffer said “I hope you do it. Get rid of all deductions and exemptions. Go to a lower rate” of income taxation. He stressed his view that “the income tax protects the wealthy, and prohibits the poor from becoming successful.” His point was that taxes change behavior. He observed, “The dream in America has always been to make the poor rich, not to make the rich poor.”

Dr. Hepner argued that an income tax phase out would not be prudent, that the state would be forced, as he contended repeatedly, to “raise taxes or cut spending.”
 
Among the sharpest disagreements was over that “dynamic” effect of tax reduction. Hepner was dismissive of this analysis, and said taxes were needed to finance improvements in government functions in core areas. Laffer said the object should be creation of economic vibrancy, not maintenance of government – that new economic activity will, in turn, be taxed and broaden the base.
 
The two men also clashed on the importance of teacher pay in government education systems. Hepner said the state could not expect to attract or retain quality teachers without higher pay; Laffer countered with his contention that teacher pay is not the crucial factor in teacher, or student, performance.
 
Miller noted that Oklahoma news reports provide evidence that the more aggressive tax reduction/elimination plans “have not gained traction for various reasons ranging from natural gas prices to lack of interest in reducing spending or incentives.”He asked if multi-year reductions and/or growth triggers should be part of a tax cut plan.
 
In some of their final arguments, the pair clashed over what the result of income tax reduction would be. Hepner repeated his contention would lead the state either to “cut services or raise [other] taxes.” Laffer argued that some taxes are worse than others, and that an income tax phaseout would make the system simpler, and “then you have certain expenses that are gone.”
 
Hepner's argument was that the Legislature should adopt a “pay as you go” approach on all tax or spending questions. Laffer endorsed triggers as a moderating mechanism that would, in good revenue years, still allow progress to reduce taxes and “start on the way to prosperity.”