TAX NEWS - JUNE 2010

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Laffer Curve and virtual tax cut

Art Laffer posted an op-ed in the WSJ yesterday explaining that the deferring of taxes increases to Jan. 1, 2011, will cause companies to push profits into 2010, making 2010 appearing very good and making 2011 appear awful, perhaps even creating an economic collapse in 2011. Laffer may have missed a few twists.

One has to take Laffer seriously, and when I went on Kudlow's show last night to debate Laffer on his idea I had to think a lot about the premise. In general, I agree with Laffer's long standing concept called "The Laffer Curve" that essentially states at a tax rate of 0% and a tax rate of 100%, the government generates no revenues. At 0%, because they collect nothing. At 100%, because nobody has incentive to work. When taxes were cut in the early 80s, for instance, the economy boomed. The exact same thing is happening now, Laffer argues, but in reverse.

I made several points on the show last night, including one about The Virtual Tax Cut.

Right now, the surge in corporate profits we are seeing has not been created by tax cuts but by the enormous "tax cut" of high unemployment. Companies are making more goods than ever with less people. In other words, productivity is skyrocketing. This has the same effect as an enormous tax cut because corporations get to keep more of every dollar made. Interestingly, another curve develops: At 0% unemployment, corporations will make nothing because the labor market will be so tight that labor costs will reach to infinity, and at 100% unemployment, corporations will make nothing because nobody will be there. There's a point of equilibrium where the labor market begins to tighten but corporations still have sufficient profits. We aren't at that point, but still at a point where companies are making enormous profits without having to pay the full labor costs (maybe call this "The Altucher Curve")

Eventually companies have to hire more with their profits. The people they hire then become spending consumers, buying houses, cars, etc. This creates a cycle until equilibrium is reached at about 5% unemployment, where history has generally shown the employment levels to be at a point where there is neither inflation or deflation of wages.

Assuming that taxes go up as planned (and let's not forget there's an election in between), we are still only going to the level, give or take, where we were in the 90s. There was a nice boom then.

When will equilibrium of employment be reached? We are at roughly 10% unemployment now. My guess is we go down 1% per year. Giving us about 4-5 years before 5% unemployment is reached again. Until then we do not have to worry about the biggest cause of inflation, which is wage inflation.

Are higher taxes good? Of course not. They will certainly slow down the economy. But not enough to derail it.

Some companies, by the way, are doing massive hiring right now, according to career builder. They could be interesting buys in any recovery. They include Cardinal Health (CAH), with 500 openings. Charles Schwab (SCH) has 103 openings, Dollar General (DG) 150 openings and Geico, owned by Buffett's Berkshire Hathaway (BRKA), 200 openings.
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