In re: Sen. Mitch McConnell’s recent remarks on tax cuts, Kevin D. Williamson wrote an excellent piece that summarized what we know about the impact of tax cuts on revenues:
There is considerable debate among economists and federal legume-quantifiers about how large supply-side revenue effects are. The Congressional Budget Office did a study in 2005 of the effects of a theoretical 10 percent cut in income-tax rates. It ran a couple of different versions of the study, under different sets of economic assumptions. The conclusion the CBO came to was that the growth effects of such a tax cut could be expected to offset between 1 percent and 22 percent of the revenue loss in the first five years. In the second five years, the CBO calculated, feedback effects of tax-rate reductions might actually add 5 percent to the revenue loss — or offset as much as 32 percent of it. That’s a big deal, and something that conservative budget engineers should keep in mind. But the question of whether the CBO accounts for tax cuts at 100 cents on the dollar, 99 cents on the dollar, or 68 cents on the dollar is hardly the stuff that a broad-based political movement is going to put at the center of its campaigns. Federal spending, on the other hand, is a national crisis.
When the Senate Minority Leader says that
“That there’s no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue, because of the vibrancy of these tax cuts in the economy. So I think what Senator Kyl was expressing was the view of virtually every Republican on that subject.”
one wonders what exactly he means. His statement runs directly counter to the Kevin’s able summary of the debate so far. If cutting taxes always led to revenue increases, there would be little reason to, for example, limit compensation in the public sector. I assume that Sen. McConnell recognizes that there is some point at which tax cuts will lead to decreased revenues. But that’s not clear from his statement.
And this kind of thinking inclines us to increase spending to new heights. Why? If the public is convinced that we can afford high levels of spending by cutting taxes and contributing to the vibrancy of the economy, the case for restraining the growth of public spending collapses. While a large majority of voters can be persuaded that we need to cut wasteful spending because it has to be paid for through higher taxes, a large majority of voters can’t be persuaded that we need to cut wasteful spending because we don’t like social workers or public school teachers or free roads and much else besides.
There is a deep illogic here, and it does more damage to conservative efforts to create a more efficient and sustainable public sector than Sen. McConnell seems to appreciate.
While reduction of excess spending inherently is a fiduciary good, history has shown that such spending (so long as it is not truly bank-breaking) can, indeed, be compensated for through tax cuts.
This is a lesson derived from both Reagan and Bush 43 (not to mention Kennedy) - neither gained much traction in attempts to restrain spending, yet the economy boomed and tax revenues were ample due, if the claim is correct, to reductions in the marginal tax rates.
Clearly, the ideal world is reduced tax rates coupled with restrained spending. Absent one, though, the better choice seems to be tax reduction.
Reply to this commentLinkReport AbuseSeems to me a slightly different lesson can be learned from the '90s. Although there were some tax cuts following a couple of rounds of tax increases, the most striking factor was the restraint of government spending. Some economists say that government spending restraint or reduction, more than tax cuts, can stimulate the economy.
Of course, other factors were at work in the '90s, so it's a little hard to tell for sure. It is clear, to me anyway, that in a recession, a combination of spending restraint and (permanent) tax cuts will turn the economy around every time.
Reply to this commentLinkReport AbuseMessrs. Salam and Williamson are asking the wrong question about marginal federal income tax rates. They are focused on maximizing revenue collected by the federal government through imposition of its income tax. Whereas, they should be focused on maximizing the economic welfare of the American people. After all, we are a nation that has a government; not the other way around.
Unless marginal federal income tax rates on ordinary income are at very high levels, such as 70% or 92%, a reduction in those rates will always result in reduced income tax receipts for the federal government in the short run. (The Laffer Curve was written during the Ford Administration when the federal government imposed a 78% marginal income tax rate on top earners.) The cuts in marginal rates in the 1920's, 1964, and 1981 all generated higher income tax receipts to the federal government because the federal income tax rates had previously been so high that they were greatly retarding economic growth. Whereas, our present tax system merely shaves a percentage point or two off of GDP growth each year. A tax cut in our present environment will not increase federal revenues but it will cause the economy to grow more quickly which will put many people back to work. This maximizes the welfare of the American people but does not maximize the income tax receipts of the federal government. However, the federal government still benefits because there will be less outlays for people who are in economic need and the newly re-employed will pay employment taxes and a little income tax.
Reply to this commentLinkReport AbuseSalam is right to question McConnell. The "Bush Tax Cuts" were cuts in income, estate, and investment taxes. Is a 10% cut in the income tax rates the same as a 10% cut in investment taxes? Probably not, because the dollar returned in income tax cuts is usually just spent, and doesn't necessarily go towards multiplying itself. The invested dollar, on the other hand, is directed towards multiplying itself as much as possible. This capital finds the workers and products which will most likely grow the fastest and feeds that growth.
This is the essence of supply-side economics: wages and salaries grow by connecting capital and labor more efficiently. As a result, we can say that investment taxes can pay for themselves in higher income tax receipts, whereas cuts in income tax rates from 40 to 35% are not as likely to do so. Unless McConnell and his brethren and sistren can figure out the difference they will always be confused and open to attack.
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