The idea that tax cuts produce economic growth has been drilled into the minds of many Americans. Many hear this nonsense and ask will the deficit not explode because of the lack of revenue? Think tanks, pundits, and politicians across the country have been claiming that the increased economic growth will lead to more government revenue. Romney even ran on further tax cuts which he claimed would boost the economy. Fortunately a majority of Americans were able to see through this non-sense and keep Romney out of the White House, but even Obama wants to extend tax cuts for the first $250k of income. Certainly further tax cuts like the Republicans want are fiscally irresponsible, but is it even reasonable to keep the Bush tax cuts for Americans “who need it” as Obama says? That is what we are going to explore here.
First let’s imagine a government that is trying to maximize its revenues. If the government had a 100% income tax and redistributed everything in the way it saw fit, perhaps people wouldn’t be motivated to work hard. Lets then imagine the government implemented an 80% tax, so now people took home 20% of what they were paid. It is reasonable to assume that people may become more motivated to work hard because if they do so, they may take home more pay than their lazier counterparts and thus work harder. This boosts the economy enough so that the government takes in more revenues than it did when it was taxing everyone at 100%. The government then gets the idea that tax cuts increase revenue so they cut taxes to 0% and wonder why the government no longer has any revenue. There will be a certain sweet spot where taxes have to be in order to maximize government revenue. In economics, this is called this the Laffer curve peak and it is much higher than taxes have been for a long time. Academia claims this number is quite high, but let’s take a look at the facts and judge for ourselves.
Reagan, who is hailed as a god-like figure by conservatives, implemented tax cuts and increased military spending which created record setting deficits. Reagan’s tax cuts may have spurred some economic growth, but even he understood that he went too far and had to raise taxes because he was accumulating too much debt. George H.W. Bush, who followed in the White House after Reagan, famously said “Read my Lips: No new taxes” at the Republican convention in 1988, but then raised taxes as president. Bush knew that going against his word could mean a one term presidency, but it was important for the country, so he did it anyways. Then Clinton was elected and proposed raising the top tax rates to 39.6% to tackle the Reagan/Bush deficits. The Republicans spat out the usual routine “job killer” babble and claimed the tax increases would hurt the deficit. Every single Republican in the house and senate opposed him. It is clear that the Republicans were just flat out wrong about taxes because in his second term, Clinton went on to do just what he said; raise taxes and balance the budget.
Bush then defeated Al Gore in a very controversial election. Clinton had left Bush with a successfully balanced budget. In fact, the CBO had projected a $5.6 trillion dollar surplus over the next ten years. That year, President Bush announced changes to the tax code which would become known as the "Bush Tax-Cuts." A basic idea in Keynesian economics is to pay off the debt when the economy is "booming" and to increase spending when the economy is "busting" or hard economic times. This is supposed to stabilize the economy. During the press release when Bush announced these cuts, he went on to talk about how the money belongs to the people and it is only right to give it back to them. Unfortunately, the national debt was completely ignored. In 2002, Dick Cheney famously claimed that “deficits don’t matter” since Reagan had tripled the national debt and won a second term. Of course we all know that Bush doubled the debt and left the next president with an unprecedented $1.3 trillion dollar deficit.
When President Obama took office, the country was bleeding jobs and in the beginnings of one of the worst recessions since the great depression. Obviously revenue goes down in a recession and the first priority was to stabilize the economy. Obama has reduced the deficit slightly, but more drastic action must be taken now. The Republicans have irresponsibly advocated for tax cuts and many have pledged never to increase taxes. Now that Obama has been elected for a second term, he wants to keep the Bush tax cuts for the first 250k of income and let them return to Clinton-era rates for the rest. The CBO says this will not negatively affect the economy. The non-partisan Pew Charitable Trust said in 2010 that making the tax cuts permanent for all taxpayers, regardless of income, would increase the national debt $3.3 trillion over the next 10 years. Limiting the extension to individuals making less than $200,000 and married couples earning less than $250,000 would increase the debt about $2.2 trillion in the next decade. It seems that the Republican ideas are terrible, but extending tax cuts for everyone is also a bad idea if balancing the budget is a priority.
If we could just continuously cut taxes and economic growth expanded enough to produce more revenue for the government, that would obviously be a win-win scenario. Unfortunately as the tax rates stand now, it is not like that and hasn’t been like that for a long time. Now that we have established that tax rates are far lower than they could be in order to maximize government revenue, should the government actually do something about this and implement much higher taxes? Not necessarily. It is not the job of the government to maximize revenue. It is the job of the government to do what people want and if people in a democracy vote to have higher taxes and more government services, then that is their right to do so. What has to stop is voting for lower and lower taxes when the deficit is huge and further cuts will lead to more debt in the future. If the people do want a small government with low taxes, pay off the debt and cut spending first and then you can have that debate. Right now these guys are just completely out of touch with anything resembling fiscal responsibility.