In the last couple days, I have seen Republicans, most notably John Boehner, do everything in their power to avoid answering a simple question: "Do tax cuts need to be 'paid' for?" For some reason, none of the questioners have taken the next step, which is to question the basic premise behind the idea that tax cuts don't need to be paid for. So I'll do it for them.
I am a teacher of several subjects, of which the relevant one here is calculus. Each year, my calculus class learns about the Mean Value Theorem, which states that, if a function has the same value at two points, then there is at least one point between them where the function has a relative maximum or minimum value.
Economists have taken this simple idea and invented the Laffer Curve, which says that, if tax revenue is $0 at tax rates of 0% and 100%, then there is a point somewhere between those tax rates where tax revenue would be a maximum. This is a gross oversimplification, since we have multiple tax rates, as well as tax credits, deductions, loopholes, etc., but at its root, it is correct: there is a theoretical tax rate at which the tax revenue is a maximum, and either increasing or decreasing tax rates from that point would actually decrease tax revenue.
Here's what the Republicans don't tell you: neither they, nor Arthur Laffer, nor Ronald Reagan know what that point is. The Laffer Curve results from what mathematicians call an "existence theorem", which means that they can prove that such a point exists, but they can't tell you where it is without knowing what the underlying function is. The Republican assertion is one of two things: 1. That our tax rates are on the high side of the maximum, so that lowering tax rates would cause more people to seek work, and therefore increase revenue; or 2. That while cutting taxes decreases revenue, the resulting growth in the economy would offset the decrease. Let's debunk these ideas.
- There is absolutely no logical reason to believe that our tax rates are above the Laffer Curve maximum. Why? Because the reason that there would be such a maximum is that Laffer believed that as tax rates got too high, people would stop seeking work because the overtaxed wages would not be worth it. I suppose I can believe this if taxes were over 95%; I don't think a tax rate of 15% or so would stop anyone. Also, with unemployment hovering near 10%, it seems like there are still plenty of people seeking work.
- In order for economic growth to pay for the tax cuts, the economy would have to grow at a ridiculous rate. The Bush tax cuts dropped most of the tax rates by three percentage points, as well as creating the 10% tax bracket for the first $8000 or so of income for single taxpayers. Since the tax rates are mostly around 30%, the three percent decrease in the rates corresponds to about a 10% decrease in overall tax owed. For the median household income of $52,000, that's about half of the roughly $800 just from the creation of the 10% tax bracket.
So the Bush tax cuts decreased the federal tax liability of the median household by somewhere around 25% (Of course, most people didn't notice that big a savings, since social security, medicare, state and local taxes were left untouched). It was a smaller percentage for higher incomes, decreasing to as low as 10% for the richest Americans, but was up to 33% for a full time, minimum wage employee. For the sake of argument, let's use a more conservative estimate of 20% for the average decrease in federal taxes.
If federal revenues are decreasing by 20%, then incomes would have to increase by 25% just to break even, because 4/5 * 5/4 = 1. Unfortunately, the median income has actually decreased slightly after inflation is taken into account in the last 8 years, but that's not really the point.
Let's assume that GDP is a good tracker of average income. On average, GDP has grown at about a 3.3-3.4% rate since World War II. At that rate, it takes 7 years for the GDP to increase by 25%. If the tax cuts were to create 6% growth (bigger than anything we've seen in 25 years), then in those same 7 years, the GDP would be 50% bigger. However, when you take out the 20% decrease in revenues from the tax cuts, you only get a 20% increase in revenues, compared to the 25% increase from doing nothing. Let me emphasize: This is the best case scenario for tax cuts. You get less revenue than if you don't cut taxes.
So, in summary, tax cuts don't, and never could, pay for themselves. A seemingly small decrease in tax rates is far more significant than even the most optimistic forecasts of the resulting economic growth. Unfortunately, most pundits don't fully understand this rough analysis, because it contains numbers and percent symbols. Oh well.