James Pethokoukis

Politics and policy from inside Washington

5 reasons why the Tea Partiers are right on taxes

April 16, 2010

Here is the new Washington Consensus: American taxes must be raised dramatically to deal with exploding federal debt since spending can’t/shouldn’t be cut. Only the rubes and radicals of the Tea Party and their Contract from America movement think otherwise. And don’t worry, the economy will be just fine.

Don’t believe it. While you will never hear this in the MSM, there is plenty of academic research supporting the idea that cutting taxes and spending is the ideal economic recipe for growth, jobs incomes and fiscal soundness. (This all assumes that America’s amazing turnaround since 1980 isn’t proof enough.)  Just take a look:

1) Tax cuts boost economic growth more than increased government spending. Cutting spending is a better way to reduce budget deficits than raising taxes. “Large Changes in Fiscal Policy: Taxes Versus Spending” — Alberto Alesina and Silvia Ardagna, October 2009:

We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.

2) Tax cuts boost growth. Tax increases hurt growth, especially if used to finance increased government spending. “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” — Christina Romer and David H. Romer, July 2007:

In short, tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects. … The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

3) Cutting corporate taxes boosts growth. “The Effect of Corporate Taxes on Investment and Entrepreneurship” — Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, Andrei Shleifer, January 2008:

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy.

4) Tax rates are reaching dangerous levels where higher rates bring in less money. “The Elasticity of Taxable Income with Respect to Marginal Tax Rates” — Emmanuel Saez, Joel Slemrod and Seth Giertz, May 2009:

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above [X] is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above [Y] and increase government revenue, which can in principle be used to benefit other taxpayers. Using our previous example … the revenue maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

5) Cutting corporate taxes boosts wages. “Taxes and Wages” — Kevin Hassett and Aparna Mathur, June 2006:

Corporate taxes are significantly related to wage rates across countries. Our coefficient estimates are large, ranging from 0.83 to almost 1-thus a 1 percent increase in corporate tax rates leads to an almost equivalent decrease in wage rates (in percentage terms). … Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.

There are plenty more, of course. The Tax Foundation lists a dozen recent studies how harmful business taxes are to growth, jobs and wages. Economist Greg Mankiw has determined America is far from a low tax nation. More like in the middle. And let me add this from economist Scott Sumner:

When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state.  …   Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. … So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. … Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil?


You guys voted Obama in, so vote him out come November. Problem solved.

Posted by Gotthardbahn | Report as abusive

Unless the POTUS and every living and dead liberal wants us to live in a socialist state. #6 Low taxes keeps manufacturing in the USA #7 Low taxes means less government and that is always a good thing #8 Low taxes means less government spending because they have less to “give” away #9 Low taxes means more for non profit agencies that help the poor #10 Low taxes means doctors remain doctors and don’t quit with socialized healthcare

Posted by tgambogi | Report as abusive

The best example is never used. That is the depression after World War I. Harding and Coolidge took over in March 1921 with the country in the worst collapse since the Panic of 1873, perhaps worse. They cut taxes and cut government spending. The recovery was prompt.

http://en.wikipedia.org/wiki/Depression_ of_1920–21

In 1929, the stock market crashed and President Hoover, a Progressive like Wilson, signed the Smoot-Hawley Tariff, raised government spending and when revenues collapsed, raised taxes. The Great Depression followed and Roosevelt continued Hoover’s policies. The country did not recover until 1946.

Posted by mtkennedy1 | Report as abusive

Great article.

Posted by AminCad | Report as abusive

You guys just don’t get it… the reason for the massive expansions during the period of 1982-2007 and 1921-1929 wasn’t some miracle caused by lower taxation; it was because beginning at those points, interest rates were hacked and slashed followed by borrowing going through the roof!(gov’t and private sector) Cutting taxes is a political move to gain political favour, with the ultimate result being the gov’t has to borrow more to cover the losses. There is no true economic gain, it’s just a mask. And as for Obama being socialist by raising taxes, taxes are essentially coming off 100 year lows in America, and his increases are minimal at best. Get your heads outta your asses and realize that your $70T debts need to be paid and it won’t be paid by not taxing. Cuts are very important too, but no politician in America has the stones to do that anytime soon, so DEAL WITH IT! Wanna kill the deficit? Get far far away from Iraq. There’s $500B back in your pockets every year. It’s only an illegal war based on prejudice and lies.

Posted by CDNrebel | Report as abusive

This guy seems to be confusing economic growth with creating an economic bubble.

The simple reality is that tax increases lead to higher GDP growth and lower unemployment. And cutting taxes lead to lower GDP growth and higher unemployment.

Take a look at the stark reality yourself.

http://img27.imageshack.us/img27/3633/ta xrates.jpg

Posted by alvagoldbook | Report as abusive

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