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Arthur Laffer's piece in The Wall Street Journal is titled The Real 'Stimulus' Record. A closer reading of Laffer's data will convince you that he should have air quoted 'Real' instead of 'Stimulus'.

PhotobucketNow, when Arthur Laffer, The Wall Street Journal, and economic data converge during an election season, the perfect storm of bullshit is about to rain down. It epitomizes Mark Twain's three categories of lies - lies, damn lies, and statistics.

Laffer generated this table and declared, "Of the 34 Organization for Economic Cooperation and Development nations, those with the largest spending spurts from 2007 to 2009 saw the least growth in GDP rates before and after the stimulus."

Not knowing exactly how Laffer defined either data point, I pulled data from the International Monetary Fund to see if I could figure out his math. I wanted to confirm or refute the correlation he so boldly found.

After analyzing the data, I found there are a number of misleading things in both this op-ed article and the data presented in his table. Laffer cherry picks time references, produces data to fit his agenda instead of using data to draw a conclusion, misleads in his description of the data, and generally fails to meet academic standards concomitant with a PhD in economics.

I deconstruct the numbers below the fold... (don't be afraid, it's just math, I promise it will be OK)

PhotobucketLet's start with the data points Laffer presented in his table. First, we have "Changes in Government Spending as a % of GDP from 2007 to 2009." This defines the level of stimulus in Laffer's argument. My first inclination was this:

[(Government Spending in 2009) - (Government Spending in 2007)] / (GDP in 2007)
Boy, was I wrong! I was fixated on "Change in Spending" while Laffer wanted to utilize the shrinking denominator of GDP during a recession to fabricate dramatic jumps in government spending. The table on the left provides the data he used. His calculation was this:
(Government Spending in 2009) / (GDP in 2009) - (Government Spending in 2007) / (GDP in 2007)
This allows Laffer to leave you with this impression; the Slovak Republic increased government spending 7.5% and watched its GDP drop 18%.

It is entirely possible that share of government spending as a percentage of GDP can dramatically increase without any increase in actual government spending. That's the beauty of using a recession year (2009) as your base and compare it to an unsustainable year (2007) of asset bubble fueled GDP growth.

How misleading were Laffer's numbers? Laffer claimed Estonia, Finland, Ireland, and Slovak Republic had the largest stimulus programs. When you look at the incremental money these 4 nations spent in 2009 over over 2007 (as a percentage of 2007 GDP), they ranked 5th (Slovak Republic), 11th (Estonia), 19th (Finland), and 24th (Ireland) out of the 34.

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Laffer isn't really looking at stimulus spending - or at least what we'd call stimulus spending, namely spending more than expected the prior year. The reason the government share of spending as a percent of GDP went up was because GDP shrank, not because of some dramatic rise in government spending.

What Laffer captured is the devastation of the recession on these countries. Looking at their 2009 GDP relative to 2007 GDP, Estonia, Finland, and Ireland had the 3 largest contractions of the 34 nations. And what about the Slovak Republic? Its GDP was actually larger in 2009 than it was in 2007!

At this point, my head is spinning. How did Laffer turn a 0.5% gain in GDP turn into -18%?

Which leads me to Laffer's second set of data, "Change in real GDP growth from 2006-2007 to 2008-2009." Laffer cherry picks his time periods. GDP growth from 2006 to 2007 was fueled in part by an economically unsustainable asset bubble. GDP "growth" from 2008 to 2009 incorporates all of the recessionary misery of that asset bubble popping and very little of stimulus spending that really kicked in during 2010.

And his data point isn't very intuitive. Here is the math behind it:

[[(GDP in 2009) / (GDP in 2008) - 1] + [(GDP in 2008) / (GDP in 2007) - 1]] - [[(GDP in 2006) / (GDP in 2005) - 1] + [(GDP in 2007) / (GDP in 2006) - 1]]

Or simply look to the table on the right and add columns 4 and 5, then subtract columns 2 and 3. Finally tally is in column 6.

How meaningful were these specific time frames to Laffer's correlation? If Laffer's conclusion holds, that higher rates of government spending lead to lower rates of GDP growth, it should stand up to different time frames. Alas, Laffer's correlation only worked during a global recession. I looked at data for the same 34 OECD countries, maintained Laffer's spread in years for comparisons, and applied Laffer's funny math. While there is high correlation in the 2007 to 2009 spread (r=-0.694), it just doesn't hold up in other recent time frames. His correlation falls apart just moving it to the 2008-2010 spread (r=-0.228).
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Why go through the funky math when you just want to know if there is a relationship between growth in government spending and growth in GDP? Here's what the simple charts show.

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I could just as easily point to my graphs here and say, "Wow, stimulus really kicked in during 2010 and look at that GDP growth. It's got an r=0.793!" But I won't. Why? The strong correlation of government spending and GDP growth over the 2009-2011 period would point to government spending being all of GDP. It just ain't so and it's never gonna happen. Diminishing returns kick in, and we know from history that planned economies don't work (see, liberals aren't all socialist!). Plus, by shifting to different time periods, we can see that the correlation isn't as strong. And finally, for all of you who have been screaming it since the start of this post, correlation doesn't necessarily mean causation.

Government spending and GDP are highly correlated over time. In simple terms, government spending is a function of taxes, which are a function of income, which is a function of GDP. Generally, when GDP grows, tax revenues grow. When tax revenues grow, generally, government spending increases. You could argue that government spending typically is dependent upon GDP, not the other way around.

But, recessions cause a disruption in the relationship. Because of the social safety net, government spending is designed to grow during a recession even without additional stimulus spending. It's not a bug (as Laffer would have you believe), it's a feature. The safety net is designed to mitigate some of the pain caused by recession.

Any consumptive or productive spending the government can accelerate will help the economy by bringing future demand into the present. If you prefer zero-sum, the government trades future demand for the today's unrealized demand.

Did the stimulus work? Laffer says no - but he didn't exactly prove that now, did he? Ezra Klein's Wonkblog lists a whole lot of studies that say otherwise (and are much more rigorous than Laffer).

Originally posted to D Wreck on Thu Aug 09, 2012 at 06:20 PM PDT.

Also republished by ClassWarfare Newsletter: WallStreet VS Working Class Global Occupy movement and Community Spotlight.

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Comment Preferences

  •  Art Laffer: Paid Liar (14+ / 0-)

    Any time anything is found in the Opinion section of the Wall Street Journal, you can use history to conclude that it will be mostly false and might even manage to be contradicted by facts in news articles of that paper that same day. The Opinion section has been written by crazy liars for decades. Murdoch's purchase just upped the ante a little.

    Anyway, Krugman took a few moments off from his vacation to recommend David Glasner and Brad DeLong in their mockery of Laffer's most recent nonsense, and Glasner recommends Lars Christensen and Nick Rowe for those who enjoy piling on.

    As far as I can tell, Art Laffer has never believed any of the nonsense he spews.

    The GOP is the party of mammon. They mock what Jesus taught.

    by freelunch on Thu Aug 09, 2012 at 06:32:05 PM PDT

  •  Nice Charts (2+ / 0-)
    Recommended by:
    D Wreck, Gemina13

    Thanks. Forgot to comment earlier.

    The GOP is the party of mammon. They mock what Jesus taught.

    by freelunch on Thu Aug 09, 2012 at 06:40:24 PM PDT

  •  Last year (12+ / 0-)

    I had a discussion with a guy I know who claimed to be a student of economics.  When I told him I had an interest in it too he asked me if I had ever heard of Laffer. I said oh yeah, that's the guy with the famous curve that every reputable economist from every side has rediculed. I then asked him what he thought about Paul Krugman. This was the year Paul won the Nobel Prize. He'd never heard of him. I then asked him his views about the Chicago School of Economics vs Keynesian Economics. Blank stare.  The worst part is the guy is a teabagger and he votes. The best part is we live in Calif. and his vote doesn't matter.

  •  Laffer is and has always been a con man. (7+ / 0-)

    Nevertheless, thanks for shining more light on his B.S. Good diary.

  •  I'll always remember (8+ / 0-)

    this tweet from Nouriel Roubini @Nouriel. Sums it up nice.

    Laffer is a con man hack, high priest of voodoo economics @emcilveen: @Nouriel curious what your thoughts are on Laffer's rebuke of #buffet

    "In text, use only a single word space after all sentence punctuation." - Oxford Style Manual, Oxford University Press, 2003.

    by shaggies2009 on Thu Aug 09, 2012 at 11:05:56 PM PDT

  •  Excellent diary (5+ / 0-)

    It deserves to be published in the WSJ as a rebuttal.

  •  Great work. (5+ / 0-)

    I looked over Laffer's logic and came to similar results.

    One aspect that emerged for me is that Laffer never took into account that private growth cratered during a recession. That aspect alone will cause GDP to trend downwards. That never seemed to occur to him in his Laffer-able (sic) WSJ op-ed.

    I also saw that Laffer makes no distinction between fiscal policy stimulus and stimulus from The Fed. The Fed's bailouts added nothing to the federal deficit.

    Why do people pay any attention to this crackled husk of an economist? His credibility is completely shot.

  •  Thanks for shining some light into the (3+ / 0-)
    Recommended by:
    D Wreck, freelunch, basquebob

    dismal science of economics. If I didn't know better, I would think that Laffer and others are deliberately foisting preposterous theories on us with hopes that we'll simply run, screaming, into the night in confusion and despair. Your diary helps us say, "Hey, wait a minute, jackass... There's nothing wrong with us! We're just getting conned!"

    Some drink deeply from the river of knowledge. Others only gargle. -- Woody Allen

    by cassandracarolina on Fri Aug 10, 2012 at 06:48:57 AM PDT

  •  Laffer should be a joke by now, but he (4+ / 0-)

    serves the interests of the 1% and so he blathers on.

    "The object of persecution is persecution. The object of torture is torture. The object of power is power. Now do you begin to understand me?" ~Orwell, "1984"

    by Lily O Lady on Fri Aug 10, 2012 at 07:30:38 AM PDT

  •  That's an incredible take down of Laffer (1+ / 0-)
    Recommended by:
    D Wreck

    I'm personally a "conservative" who has long believed in some version of Laffer's famous "Laffer curve".  My layman's approach to the problem is that at 0 percent tax rate you obviously minimize tax revenue and at a 100 percent tax rate you destroy the economy and greatly reduce tax revenue.  Therefore, at some point between 0 and 100 percent you must have a rate that maximizes revenue.

    Now, progressives (at least the ones I came across) just laugh at the concept of the Laffer curve.  So it was nearly impossible to get them to debate the concept.  What I've come to believe but have yet to see a really analytical approach to the problem, is that, yes, the layman's version of the Laffer curve is generally true, but that we are significantly below the top marginal tax rates that would maximize revenue.  That, in a nutshell, is what Laffer's curve is meant to describe.

    I've seen Bartlett do a little bit on this but you seem to have the background and skills to address this issue.  So, if you don't mind, is the my layman's understanding of the Laffer curve generally correct and, if so, what do you think is the top marginal tax rate that we can incorporate into the tax code that will increase revenues without causing the economy to start to whither?

    FWIW, while I'm still a registered Republican I will not be voting for them for the foreseeable future due to, well, the incessant insanity being put on display.  TIA.

    We cannot solve our problems with the same thinking we used when we created them. Albert Einstein

    by theotherside on Fri Aug 10, 2012 at 08:16:58 AM PDT

    •  You are correct, but ... (2+ / 0-)
      Recommended by:
      D Wreck, IreGyre

      As you note, the tax rate in the United States is far below the revenue maximizing level, even if we don't know what the revenue maximizing level is. Why? Because we know that every tax cut has cut revenue for the country and has not affected growth to any greater degree than predicted by mainstream economics.

      Ideal tax policy varies by the location in the economic cycle and the type of spending that the government is doing. Long term, the worst spending is defense from an economic point of view. It is a dead waste aside from the jobs it pays for. Infrastructure development and rehabilitation is great for the economy long term. Single-payer health care would also improve the economy going forward because it would control costs, though companies like GE and Siemens and companies specializing in building new hospitals would be unhappy.

      The GOP is the party of mammon. They mock what Jesus taught.

      by freelunch on Fri Aug 10, 2012 at 08:50:21 AM PDT

      [ Parent ]

    •  The Laffer curve... (0+ / 0-)

      ... is best understood by its extremes. 0% taxes and 100% taxes are the same - they generate no tax revenue. It is the vast expanse between the extremes where the ideological battles occur. How does one define maximizing revenue? There are trade-offs between tax levels and GDP growth, so one must have a target for the social utility of government spending. What one wants to do with the money impacts how much or how little one is willing to constrain GDP.

      There is a way to mathematically prove the existence of the Laffer curve. Alan Blinder wrote "To establish the existence of a Laffer curve in theory, we do not need to know anything about either economics or the tax system. Rolle's Theorem will do." He also notes that this idea of targeting the tax rate that maximizes revenue dates back hundreds of years, not to Laffer's napkin doodle.

      I'd argue that rising inequality proves that we're below the tax rate that provides maximum social utility at a socially acceptable cost of GDP growth. I appreciate your faith in my ability to address the issue, but there is a rather large field of research around this. Wonkblog had a nice wrap-up of who thinks what. Tax experts say marginal rates of 60-70%. Political folks on the left concur, but folks on the right disagree. Appreciate Greg Mankiw hedging by saying 60% might work today, but comes at the cost of revenue tomorrow.

      •  Has anyone ever considered that it (1+ / 0-)
        Recommended by:
        D Wreck

        may not be unimodal?

        I'm an engineer so I have no idea what this would mean for economics, just curious since it is "proved" with Rolle's Theorem.

        Kiss my ass. This is a Holy Site...

        by jam on Fri Aug 10, 2012 at 09:50:25 AM PDT

        [ Parent ]

        •  That's where the complexity... (1+ / 0-)
          Recommended by:
          jam

          ... comes in. It can't be unimodal. We don't just tax one thing in one way. We tax many things by various methods and amounts. We would need to aggregated the revenue maximizing curves for each type of tax and adjusted for interactions among the taxing methods to get a useful model.

  •  The VOODOO (economics) that YOODOO (2+ / 0-)
    Recommended by:
    D Wreck, IreGyre

    ... how has this idiot not been Laffed off the public stage?

    Even Stockman says he is a total fraud and supply side economics and the laughing curve is total bullshit.

    Thanks for a great expose' on this fraud, and as an aside, gee the Walnut Journal sure does great Jurnalism.

  •  Excellent analysis (1+ / 0-)
    Recommended by:
    D Wreck

    While I [obviously] like political blogs, I dont often view them as authoritative compared to print media (though generally reputable ones, not political shills like WSJ editorials are nowdays).

    This diary shows otherwise.

  •  I didn't need much math to realize the article ... (2+ / 0-)
    Recommended by:
    D Wreck, IreGyre

    was a real "laffer". Just look at Israel and Switzerland, the 2 countries that cut government spending from 2007 to 2009. Their GDP growth is negative. If lower spending resulted in higher GDP, it would not be.

    Congress shall make no law abridging the right of the people peaceably to assemble.

    by edg on Fri Aug 10, 2012 at 03:27:13 PM PDT

  •  Thanks for the analysis (0+ / 0-)

    Good analysis.  I likewise posted one at http://usbudget.blogspot.com/... .  As I mentioned at the end of the analysis,  I believe that all publications should mandate that precise sources be given and, if possible, links be provided to background material that explains the author's calculations.  Then, others will be able to check the author's work, especially in the case where the publications chooses not to do so or does a poor job of doing so.

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