Broad-based tax cuts work best for the economy and for the GOP.
Republican candidates for president are almost united in their desire to cut income and estate taxes. The supply-side economic theory holds that increasing financial incentives for high-income and high-wealth individuals will make them more productive — stimulating economic growth and thereby increasing tax revenue (if not for the entire amount of tax cuts, then for a large part of it). This is the essence of the fiscal side of Republican economic policy since the 1980s. For many Republican officeholders, cutting marginal tax rates has replaced balancing the federal budget as the appropriate macroeconomic goal.
But what if the empirical analysis underlying the supply-side position is faulty? There is, in truth, little to suggest that, on a long-term basis, reducing top income-tax rates increases economic growth. Between 1948 and 1980 in the United States, when the top marginal rates were high, national economic growth averaged 3.7 percent per year. By way of contrast, between 1981 and 2009, when top rates were low, annual economic growth averaged 2.8 percent. Though the two eras were very different in many ways that might account for the slower growth in recent decades (even before the Great Recession), a robust positive correlation between higher economic growth and lower top income-tax and estate-tax rates over time cannot be shown; in fact, the correlation is in the opposite direction.
To be sure, much of the reason for cutting taxes, at least initially, was to “starve the beast.” Though many economists, led by Arthur Laffer, believed (and believe) that cutting top rates would lead to greater economic growth, other economists — in particular, Milton Friedman — thought that reducing tax revenue would result in less government spending. These two positions are not necessarily in conflict, but their foci are different.
Ronald Reagan was an indifferent supply-sider. His analysis, if not his terminology, was semi-Keynesian, at least with respect to the first round of tax cuts that passed during his administration in 1981. Tax rates were reduced for all taxpayers, not just those with high incomes. In fact, tax rates were in important respects reduced to a greater extent for those with less income than for those with more. The top marginal income-tax rate was reduced by 20 percentage points (from 70 to 50 percent), while the marginal rates for other taxpayers were reduced 25 percentage points. Moreover, this was at a time when income was not as concentrated as it is now, and income-tax cuts made more of a difference to most taxpayers.
Reagan said of the 1981 tax reductions that “tax reform didn’t create a windfall for the rich at the expense of the poor; instead, it was the other way around.” As a result of these tax cuts, “more than eighty percent of Americans paid the lowest tax rate . . . or no tax at all.” He also characterized his 1981 tax reform as “reducing federal income tax rates from top to bottom” and said that it “applied to people in all tax brackets.” Though there is plenty in Reagan’s speeches and writings about the incentive effects of tax cuts in spurring economic growth, he also saw tax cuts operating in a basically Keynesian manner — when “you reduce tax rates and allow people to spend or save more of what they earn, they’ll be more industrious; they’ll have more incentive to work hard, and money they earn will add fuel to the great economic machine that energizes our national progress,” he wrote.
Rather than lowering personal-income-tax and estate-tax rates, there is a strong argument for reducing payroll taxes. The vast bulk of Americans pay more in Social Security and Medicare taxes than they do in personal income taxes. Indeed, the bottom 99 percent of Americans pay, in aggregate, about as much in Social Security taxes as in personal income taxes, and the bottom 95 percent of Americans pay more in Social Security and Medicare taxes than in income taxes.
In order to boost the economy, tax cuts for wage-earning Americans are required — not just tax cuts on the passive, investment, and dividend income of those with high incomes. Tax cuts for high-income individuals fuel the stock market and other investments; that is where the rich disproportionately spend their money. By way of contrast, tax cuts for wage-earning Americans fuel the economy. Wage-earning Americans spend all, or almost all, of their income. Wage-earning Americans below the 95th percentile — which includes the families of almost all children in the United States — save little.
Many Republicans support higher marginal income-tax rates on those with the highest incomes, while favoring lower taxes and less government spending overall.
Social Security tax cuts, especially for workers with children, will have a more beneficial effect on the economy than reducing personal-income-tax rates, as proposed by several candidates, for those with the highest incomes to 28 percent — the lowest top marginal income-tax rate enacted during the second round of tax-rate cuts in the Reagan administration in 1987 (a rate supported, incidentally, by many Democrats, including Dick Gephardt and Bill Bradley). It bears noting that the rate of economic growth slowed after the second round of Reagan income-tax-rate cuts.
Opinion polling by Gallup and others shows that many Republicans support higher marginal income-tax rates on those with the highest incomes, while favoring lower taxes and less government spending overall. The “reformocon” movement in the GOP advocates wage subsidies to increase the value and rewards of work to lower-income Americans. Cutting Social Security taxes for working Americans would function as a wage subsidy.
From an electoral perspective, among the most sought-after demographic groups is working-class Americans. They would receive almost nothing from the tax cuts proposed by Republican candidates for president. Cutting Social Security taxes, however, would substantially increase the disposable income of lower-income working Americans. That would be politically popular, begin to address equity concerns, and be a forward- rather than backward-looking policy. Moreover, it would lead to more economic growth and thereby stronger families.
How much would it cost? To give every full-time working American with an income below $30,000 per year a Social Security tax cut of $1,000 would cost about $35 billion annually. That’s a pretty small price tag when most current tax cut plans are measured over time in the trillions.