Much talk these days swirls around the impending crisis over the national debt ceiling. That’s certainly true within the friendly (mostly) confines of America’s Web site. It’s too bad there’s no painless way around the debt crisis. It looks like the U.S. middle and upper class will have to pay more in taxes, and social, defense and all other fed spending must endure some cuts if we want to get serious about closing the deficit and preventing our great grandchildren from a hat-in-hand relationship with China.
But wouldn’t it be great if we could cut taxes and raise as much money, no wait, even more money, as we raised before?
It’s the self-financing tax cut, the golden chalice (fleece?) of American tax policy, and it’s the oft-repeated contention of some Conservatarian politicians. My father always told me if it seems too be good to be true, it probably is (it’s amazing how much smarter he gets as I get older) and sad to say I suspect that’s the case when it comes to launching an offensive on annual deficits by outflanking them with tax cuts.
The tax cuts=more federal revenue formula has evolved from a notion scribbled on a napkin to something close to an unshakable article of faith among a certain breed of American fiscal conservative. But it’s far from an easily demonstrable historical reality, though I doubt even a thorough debunking will do much to dissuade its enthusiastic repetition (probably the opposite will ensue). But as several posters at our venerable site have repeatedly thrown down this assertion as if it were an uncontested historical fact, I feel obliged to at least attempt to set the fiscal record straight on behalf of site visitors who have not whiled away their weekends poring over O.M.B. revenue records.
Famous one-time believers have turned harsh critics of the idea, most famously Reagan budget director David Stockman who still finds time to try to tear down the rhetorical battlement he helped construct. And here’s former domestic policy adviser to President Reagan Bruce Bartlett, one of the original supply-siders, writing in the New York Times in 2007: “[S]upply-side economics has become associated with an obsession for cutting taxes under any and all circumstances … The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues. For example, cutting the capital gains tax rate might induce an unlocking effect that would cause more gains to be realized, thus causing more taxes to be paid on such gains even at a lower rate.
“But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. … This is a simplification of what supply-side economics was all about, and it threatens to undermine the enormous gains that have been made in economic theory and policy over the last 30 years.”
Supporters of the less tax, more revenue thesis typically elevate the Kennedy, Reagan and Bush tax cuts as exemplars of the phenomenon. Trouble is, despite what the Heritage Foundation or Cato Institute might say, the numbers don’t hold up under scrutiny. In fact, many economists point out the tax cuts/revenue outcomes can only look remotely favorable if you ignore inflation, population growth, economic growth owing to other factors, the normal vicissitudes of the business cycle, etc. For instance, in inflation-adjusted dollars, Reagan’s 1981 tax cuts reduced federal revenue until late in his second term. Does that mean that the tax cuts finally did the trick or did something else that happen in those ensuing years to make the difference? A couple of variables that have to be considered is the nation’s population expansion over his two terms and the inescapable fact that in responding to dramatic revenue shortfall’s, Reagan’s administration raised taxes 11 times after his famous tax cuts started off his presidential watch. An increase in Social Security taxes also made a significant contribution to the improved revenue profile by the end of Reagan’s second term, hardly the unqualified outcome a supply-sider might hope for; finally in fiscal carousel fashion, Reagan’s (un)healthy appetite for deficit spending supercharged the economy and in a painfully roundabout manner delivered more revenue (and long-term debt). That Reagan debt-spending precedent also gets at one of the major flaws in the behavior of the supply-siders. Whether or not the theory of revenue-generation they espoused was completely bunk was pretty much beside the point as the vastness of their increased spending and other loosey-goosey fiscal habits, say, funding a war with off-budget supplemental spending requests, tended to overwhelm whatever good—or not—their tax philosophy was up to.
The Tax Policy Center had this unflattering assessment of the Bush tax cuts:
“The Bush tax cuts contributed, along with underlying economic conditions, to a historic decline in federal tax revenue. In 2000 total federal tax revenue was as high in proportion to the U.S. economy as it had ever been. By 2004 federal tax revenue in proportion to the economy had fallen to its lowest level in almost fifty years.” And more bad news on the effect of the Bush tax cuts is courtesy of the nonpartisan Congressional Budget Office, which in 2001 projected a $5.6 trillion surplus for the 2002-2011 time frame, but the U.S. ended up instead with a $6.2 trillion additional debt—a swing of $11.8 trillion from the January 2001 projections with substantial annual revenue shortfalls.
So two rounds of Bush tax cuts = less revenue = bigger deficit/debt, a clear-cut answer? Well, yes and no. Obviously those Bush years include the 9/11 terrorist attacks and the beginning of the war on terror, which naturally had an impact on the performance of the economy and tax revenue. But that’s part of the general problem with the tax cuts = more revenue formula. There are a lot of variables affecting revenue besides tax rates. Bill Clinton raised taxes in 1993, the economy boomed and federal revenue went up because of the higher rates and personal income. So does that mean that raising taxes helped the economy? (Some say yes.)
Have cuts in capital gains increased tax revenues? Yes, they have. But capital gains cuts often provoke a rush of tax settling stock sales as investors reckon the break may only be short-term. That leads to a revenue spike that does not last. Would a combination of lower taxes and closed loopholes produce more revenue? Now we’re getting to the interesting challenge for the years ahead. Advanced studies in human nature, like Arthur Laffer’s best conduced over drinks, suggest raising taxes encourages dodging and deters consumption. The trick is finding the taxable sweet spot, the point of optimal taxation, that will get the government the most before discouraging income growth and encouraging scamming. No one today is seriously arguing for a top rate like 90 percent (under Eisenhower) or 70 percent (under Kennedy-Carter); the current discussion centers around moving the top rate back to a Clintonian 39 percent.
And no one who has ever wrestled through tax season, even girded with Turbo Tax and an array of Internet resources, can argue that our excruciating tax code couldn’t use with a thorough house cleaning that, if done fairly and well, could—perhaps—mean lower tax rates and more revenue. But blanket cuts do not appear to automatically mean more dough. That’s just the way the federal pie chart crumbles.
Here’s more on this subject for those suffering from insomnia: