An Anti-Growth Tax Cut

By Kevin D. Williamson

Thursday, September 21, 2017

Republicans want to cut taxes by $1.5 trillion — while the government already is running a deficit — and they propose to offset those cuts with wishful thinking.

In control of both houses of Congress with a nominally Republican president in the White House, they are pursuing the dead opposite of the immigration policy touted by Donald Trump on the campaign trail, and considering something close to the opposite of their longstanding promises on health care. They are embarrassed by their inability to execute any proposal of great consequence, and have retreated into that great Republican safe space: tax cuts, the more irresponsible the better.

Congressional Republicans argue that they can in good conscience pass these tax cuts without any corresponding spending cuts or other countervailing measures on the theory that the tax cuts will produce economic growth, and that this economic growth will be so substantial that it will entirely offset the revenue theoretically lost to the tax cuts. There is very little evidence to support this theory, but Republicans remain fond of it.

Taxes are not especially high just at the moment. Federal revenue amounted to 17.6 percent of GDP in 2016; by way of comparison, consider that in the balanced-budget year of 2000, federal revenue was 19.7 percent of GDP — and 2.1 percentage points is a heck of a lot in an economy the size of ours.

Taxes were 18.7 percent of GDP in 1981, when the Reagan tax cuts were passed. The free-lunch theory of taxation holds that strategic, pro-growth tax cuts allow the government to increase its revenue by taking a smaller share of a larger GDP. But that isn’t what happened after the Reagan tax cuts: In constant dollars, federal revenue shrank, and by 1983 revenue was in real terms $153 billion lower than it had been. There was a recession, and revenue in constant dollars declined along with revenue as a share of GDP. It would not make sense to blame the tax cuts for that recession — nor would it make sense to credit them for all the growth that came after. By the end of the Reagan years, tax revenue as a share of GDP was right back around where it was at the end of the Carter years — and right about where it is now. The deficit as a share of GDP doubled between 1981 and 1985, then declined — and began to climb again in 1990. As usual, the main variable was spending.

In economic terms, there are two things going on with those revenue and deficit numbers. One is the structural issue, i.e., tax policy, spending, etc. The other is the cyclical issue, i.e., the ups and down in the economy. Both structural and cyclical factors have an effect on growth, revenue, and deficits — and they both have an effect on each other, too. Disaggregating those is a complicated business, one that does not necessarily provide any clear answers. But if you want to stick with the naïve supply-siders’ story, then you have to credit essentially all of the economic growth following their favorite tax cuts (Reagan’s in the 1980s, Kennedy’s in the 1960s) to tax policy in order to arrive at the conclusion that these tax cuts not only paid for themselves but actually added to federal revenue. Given the fact that the economy is growing right now, that is not a very plausible story.

It also is not the story that the designers of the Reagan-era tax cuts told themselves. Bruce Bartlett may have become an insufferable crank in his dotage, but there is no reason to doubt that he knows his own mind. Bartlett, one of the architects of the 1981 tax plan, did in fact have the Kennedy-era cuts in mind, and did expect there to be offsetting growth effects. But he and the other designers of the 1981 tax bill expected those growth effects to amount to only about one-third of the lost revenue, which was what studies at the time had found to be the case with the Kennedy cuts.

“Contrary to common belief,” Bartlett writes, “neither Jack Kemp nor William Roth nor Ronald Reagan ever said that there would be no revenue loss associated with an across-the-board cut in tax rates. We just thought it wouldn’t lose as much revenue as predicted by the standard revenue forecasting models, which were based on Keynesian principles. Furthermore, our belief that we might get back a third of the revenue loss was always a long-run proposition. Even the most rabid supply-sider knew we would lose $1 of revenue for $1 of tax cut in the short term, because it took time for incentives to work and for people to change their behavior.”

The Kennedy tax cuts saw the top individual income-tax rate reduced from 91 percent to 70 percent, and the Reagan cuts saw it reduced from 70 percent to 50 percent. The current top rate is 39.6 percent, which kicks in at $470,700 for a married couple. President Trump’s preferred policy would reduce the top rate to 35 percent, while congressional Republicans have aimed at 33 percent, along with modest reductions in other brackets and, possibly, a large reduction in the corporate tax rate. Our corporate tax rate is one of the world’s highest on paper, but the effective rate — what corporations actually pay — is on average unexceptional, though it varies significantly from industry to industry and firm to firm.

If coming down from 91 percent to 70 percent was not expected to be a self-financing proposition, and if coming down from 70 percent to 50 percent wasn’t, either, then why should we expect a relatively small change to produce such radical results?

We shouldn’t.

Tax cuts can contribute to economic growth by putting more money into the pockets of consumers and investors. In the free-lunch version of the story, that extra money produces so much new economic activity that the resulting growth in corporate and individual incomes offsets the reduction in tax rates. If that sounds like Keynesian stimulus theory standing on its head, it is. There is a multiplier effect — and politicians looking to sell you a bill of goods always assume that the multiplier is >1, even when there’s no reason to believe this to be the case.

Tax cuts can have anti-growth effects as well as pro-growth effects. Deficits and public debt are a drag on the economy, hoovering up investable capital and putting upward pressure on interest rates. If you want to eventually eliminate those deficits and pay down that debt, then you either have to raise taxes in the future, cut spending, or do both, i.e., you have to invert today’s stimulus measures at some point in the future. (“At some point in the future” is every politician’s favorite timeframe, of course — they all assume they’ll be dead or retired by the time the music stops.)

Republicans are right about the existence of growth effects, but they are fooling themselves about the scale of those effects. There is nothing wrong in principle with “dynamic scoring,” the Republican-favored policy of incorporating growth effects into the Congressional Budget Office’s evaluation of the fiscal effects of legislation. But that should be done responsibly. The current pie-in-the-sky Republican attitude toward taxes is something else entirely. On the other hand, there’s a good conservative case for ignoring dynamic scoring, too: If we cut a dollar in spending for every dollar in tax cuts and find out 20 years from now that we could have gotten away with only cutting 70 cents in spending on the dollar, then that will be a happy surprise. Sobriety in expectations and caution about future developments was, once upon a time, considered “conservative.”

There are many things that Congress should be doing to improve our national economic performance. Blindly hacking away at the tax code with a meat ax isn’t one of them.