With the key House vote on the income‐tax rate cuts coming today, now is a good time to dispose of the peskiest and most oft‐repeated and arguments of all. The reader will doubtless discover that some of the charges levied against the tax bill contradict each other. Herewith a counterassault:
Anti‐tax cut argument #1. “Tax cuts won’t stimulate the economy, because the money will be saved, not spent.”
Now, there’s a very legitimate argument to be made (in fact, I make it all the time) that the Bush tax‐rate cuts are too puny to provide a short‐term economic stimulus to the economy. But that isn’t the complaint we’re confronted with here. This is more of a standard, discredited Keynesian analysis. The Wall Street Journal’s Al Hunt wrote last week that the tax cut wouldn’t work because “the tax relief is too slanted toward the rich who will save the money, rather than the working class who would spend it.” Thomas Mann of the Brookings Institution echoed this baffling logic the next day in a USA Today editorial. He criticized the plan on the grounds that it wouldn’t elicit a burst in consumer spending. (In that same editorial Mann also wrote that he likes to pay taxes!) When I testified before the Senate Budget Committee last month, I was surprised to hear my fellow panelist, former Clinton OMB Director Alice Rivlin, tell the Senators that in order for this tax cut to stimulate the economy, it will have to get people to go out and spend the tax cut for the economy to be jolted back to life.
No, no, no, a thousand times NO. The purpose of a supply‐side tax‐rate reduction is not to put more money in people’s pockets so they can rush out to the mall and spend it. (Admittedly, if they did spend every new dime, this would arguably increase overall economic efficiency. After all, I can spend my own money more efficiently than the government can. I assume you can, too.)
Tax‐rate reductions are economically beneficial because a cut in tax rates reduces the negative effects of the tax on economic behavior. A tax‐rate cut increases the after‐tax rate of return on capital investment, on starting a business, on saving, and on working. When you tax something, you get less of it. When you tax something less, you get more of it. This is why every time we’ve cut federal tax rates in the U.S. we’ve seen a spurt in productivity, employment, investment, asset values, and output. Bush was right to invoke the examples of JFK and Reagan. Both those tax‐rate cuts were followed by record economic expansions, namely, in the production of goods and services.
Anti‐tax cut argument #2. “The adverse consequences of the death tax can be solved by simply raising the exemption.”
Wrong. The death tax has the most injurious economic‐disincentive effects on saving and investment of any federal tax. That’s primarily because the 55 percent death‐tax rate is high in its own right, but is also levied on money that was already taxed when it was originally earned. The National Center for Policy Analysis has shown that the effective tax rate on saving at the end of one’s life can reach the 70 percent to 80 percent range because of this confiscatory regime. Now you know why the super‐rich spend millions of dollars on tax attorneys and estate planners to find ways around paying the tax. It’s nutty to raise the death‐tax exemption but not to lower the tax rate as quickly and steeply as possible with the goal of someday getting to zero.
Anti‐tax cut argument #3. “The tax cut will squander the budget surplus, reduce national savings, and raise interest rates.”
This is the Robert Rubin special. The former Clinton treasury secretary says the Bush plan will reverse the “hard fought fiscal discipline of the 1990s” and cause higher interest rates. But wait. When Reagan cut taxes in the 1980s, interest rates fell very dramatically even as demand for credit was rising. (In 1980 the mortgage‐interest rate hit 20 percent, remember?) And in the two years after Clinton raised taxes, interest rates rose. Higher taxes usually lead to higher, not lower, interest rates.
In any case, this argument contradicts the first. In the first line of attack, the Left complains that the tax cut won’t work because people will save the money, not spend it. But if that’s true, then how can the tax cut reduce national savings and thus raise interest rates? If the tax cut is primarily saved, then we would be simply reducing the government rate of savings (i.e., the surplus) by roughly the same amount that private savings would rise. In other words, in argument one, the tax‐cut adversaries warn that it would be bad for people to save the money from their tax cut, and in argument two they say that it would be harmful if people spend their tax cut. If both of these things are true, then we really are doomed.
The historical evidence indicates that tax cuts almost always lead to a surge in national savings. Why? Because the propensity to spend an extra dollar of income is nearly 100 percent for the government, but much lower for individuals. If you give Congress an extra dollar, it will spend every penny of it. If you give Americans an extra dollar, they might only spend 90 cents of it. Almost none of the tax‐cut opponents really doubt this. In fact, many are quite open about their desire not to cut taxes so that the federal government can spend the money on health care, child care, the schools, foreign aid, congressional pay raises, etc. Dick Gephardt and Tom Daschle have conceded that they would rather spend the $1 trillion Bush has earmarked for tax cuts on more social programs.
Wealth creation is the ultimate form of saving. Tax‐rate cuts fueled stock‐market booms in the 1920s, the 1960s, and the 1980s in the wake of supply‐side tax cuts. After the Reagan tax cuts, the wealth of American citizens ballooned by more than $10 trillion, as the stock market soared from 800 on the Dow Jones to more than 10,000 today.
In the past 18 months, Japan, Germany and France have all cut their income taxes. They’re on to something. European economic ministers have started to begrudgingly concede that their taxes are simply too high to compete internationally. They finally seem to have taken off their socialist blinders to discover that taxes matter a whole lot in today’s hyper‐competitive global economy. Is it asking so much to expect America’s Left — inspired by Dick Gephardt and Tom Daschle — to acknowledge their bullheaded economic thinking?
It probably is.