Since the seventies, tax cuts proponents have argued that cutting taxes spurs economic growth that eventually leads to the collection of more tax revenues and that, in essence, makes tax cuts pay for themselves without having to adjust expenditures accordingly. This has been a bastion position for supply-side economists, especially as it relates to corporate taxes, but it’s an argument that has been extended to individual income tax payers as well, as tax cut proponents have argued that high income earners are predominantly small business owners.
Because the tax cuts, which were implemented at the beginning of the Bush II administration are about to expire, the debate about the benefits of tax cuts is once again at the forefront of our nation’s fiscal discussion. The often noted inspiration of this reasoning is the work by economist, Arthur Laffer, whose famous model illustration is depicted in a graph that bears his name, The Laffer-Curve.
Compared to most graphs dismal science has given to the world, this one is simple. It plots revenue collected against the marginal tax rate the tax payers pay. At lower rates, which I will call the ‘green zone’ each rate increase results in higher revenue, and at higher rates, which I will call the ‘red zone’ each additional rate increase reduces the revenue collected as tax payers adjust their behavior to avoid the higher taxes. At the extremes, if the tax rate is at 0% no revenue is collected, likewise a tax rate of 100% yields similar results as tax payers stop producing to avoid having the fruits of their labor all go to the tax collector. Most importantly, in the “red zone”, reducing the tax rate would actually result in higher revenue.
But where are we on the curve? Are the tax rates so high that continuing the tax cuts is better for the revenue picture than ending the tax cut? In other words, are we really in the red zone? Tax cut proponents’ arguments appear to assume a red zone environment. Many, including Ronald Reagan in 1981, cited the Kennedy tax cut enacted in 1964, a few months after his death, as an example of a tax cut that spurred economic growth that ultimately led to more revenue. That tax cut reduced marginal tax rates from 91% to 70%.
Ronald Reagan managed to score a substantial tax cut in 1981 that reduced the individual marginal tax rates gradually from 70% to ultimately 28% by 1986. Revenues decreased substantially as a result of both the Kennedy and Reagan tax cuts according to figures from the 2006 US Treasury paper and from the Tax Policy Center. By contrast, revenues increased after the Bush I tax increase of 1990 that created a new marginal tax rate of 31%, and during the 1993 Clinton tax hike that created new 36% and 39.6 % tax rates for top earners. These rates stayed in place until 2001 when, for the first time, the federal budget showed a surplus. Bush II tax cuts cut rates for all earners and reduced the top rate to 35%. Deficits returned almost immediately.
Does that not suggest the red zone may be above 39.6%, and certainly not below? Former Federal Reserve Chairman, Alan Greenspan, appearing on NBC’s Meet the Press on August 1, 2010, said unequivocally that cutting taxes does not raise revenues by paying for themselves. That would mean he also thinks we are in the green zone, would it not?
Granted, a lot of arguments can be extended about the role of government, and hence disagreements about what should be funded and how. But it appears to be intellectually dishonest to insist that we are in the red zone when evidence dictates otherwise. Even Laffer, when asked by a Time reporter in 2007 if the Bush II tax cuts paid for themselves, he said he didn’t know.