Of all the misunderstandings that plague public policy making in our country today, none is as important as the question of whether cutting tax rates raises tax revenues.
Having written about this frequently, including columns on March 14 and 21, I won’t replow the ground of how broadly economists dismiss this idea and why economic data show it did not happen in the past.
But all who believe in self-financing tax cuts should consider the views of two prominent Reagan administration officials who helped initiate the “supply-side revolution” 30 years ago and who are campaigning against the tax cut fallacy today.
David Stockman was the Director of Management and Budget for Ronald Reagan’s first administration. He believed deeply in the supply-side prescription for lower tax rates and smaller government.
But in a New York Times opinion piece July 31, he blasted Republican Senate Minority Leader Mitch McConnell for his insistence on sparing the wealthy from tax increases and said fiscal doctrine “as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance.” He went on to assert that, “This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts.”
Bruce Bartlett had impeccable supply-side credentials, serving as an aide to Rep. Ron Paul, R-Texas, and helping the late Rep. Jack Kemp, R-N.Y., draft the Kemp-Roth tax reform bill that was the framework for the 1981 Reagan tax changes. He held a variety of positions in the Reagan White House and with conservative think tanks and was a mid-level Treasury official under George H.W. Bush.
The borrow-and-spend policies of Bush’s son horrified Bartlett, however, leading him to write a 2006 book: “Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy,” followed in 2009 by “The New American Economy: The Failure of Reaganomics and a New Way Forward” in which he blasts the fiscal stance of post-Bush Republicans.
Some will dismiss the two as RINOs (Republicans In Name Only) or even socialists. But thoughtful Republicans who care about their party’s long-term future, as well as our nation’s, need to weigh these men’s concerns. Why are two Reagan veterans now so disgusted by the core fiscal positions of their own party and, by extension, of the “tea party”?
The answer is that true supply-side economics was much more nuanced than current doctrine. The movement defined itself in opposing then-prevailing Keynesian policies of micromanaging the economy by manipulating overall national demand. It generally favored lower taxes, less regulation and smaller government. But it never argued that all tax cuts pay for themselves or that taxes should never be raised.
The Laffer curve plotted tax revenues against tax rates from zero to 100 percent. This curve argued that if marginal tax rates were very high, cuts in those rates could increase revenues. And it specifically was high marginal rates on high-income people that were crucial, since high-income people were more likely to save and invest any tax cut, rather than consume it as lower-income households would.
This expected increase in savings was the key link that would funnel tax cuts into more factories and equipment fostering greater economic growth. It was of utmost importance that tax cuts funnel directly to a higher national savings rate. Seeing it flow to higher consumption would be Keynesianism.
But while the Laffer curve asserted that cutting high marginal rates could increase revenues, it demonstrated just as strongly that once tax rates dropped below some point, further rate reductions would cut revenues at an increasing rate. Laffer and other original supply-siders never argued that all tax cuts would pay for themselves, only those involving high marginal rates on high-income taxpayers.
In any event, the Reagan tax cuts did not foster greater savings and investment, even among the rich. For whatever reason, household and national savings rates began to fall from usual levels in the mid-1980s and fell to near zero within the last decade. But increased savings were the key variable to making the theory work.
Income taxes paid by the rich did rise because the wealthiest 20 percent of the population garnered nearly all the increase in national income in the past three decades. But it was consumption rather than savings that boomed among those who benefited most from the tax cuts.
What the original supply-siders also know is that while Reagan always promoted lower taxes, he was a pragmatic politician who would sign tax increases when necessary.
In an article written for National Review in 2003, Bartlett details how Reagan signed bills for major increases in payroll taxes for Social Security and unemployment together with those on motor fuels and cigarettes. And, in the face of burgeoning deficits and pressure from fiscal conservatives in his own party as well as Democrats, he reversed some of his own income tax cuts. All in all, according to the 1990 federal budget cited by Bartlett, tax increases signed by Reagan amounted to 2.6 percent of GDP, or more than $350 billion of annual revenue in 2010 dollars.
Whatever the outcome of Tuesday’s elections, the reflections of these two men who invested so much of their careers creating conservative tax policy should give us pause as we move forward.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.