As we reach the climax of the 2010 election season, the Republicans have released their new "Pledge to America". Not surprisingly, the economic portion of the pledge centers on tax cuts designed to stimulate the economy, increase revenues and reduce the deficit. However, unlike most political pledges based on untested rhetorical ideas, these sorts of tax cuts have actually been the subject of exhaustive testing. These are the same tax cuts we have seen in action over the combined 16 years of the Ronald Reagan and George W. Bush administrations. In 2010, the tests are complete and the results are conclusive: tax cuts to the wealthiest Americans do exactly what you would expect them to do - lower tax revenues and raise deficits without stimulating the economy in any way.
So why do we continue the debate as if the tests hadn't been run and the truth determined? The answer lies in the myth of the Reagan Administration.
It all began with the Laffer Curve. In 1974 economist Arthur Laffer attended a Ford Administration strategy meeting also attended by Dick Cheney, Donald Rumsfeld and several others. At the meeting, Laffer argued against Ford's proposed tax increase by presenting what became known as the "Laffer Curve" (although the concept has been around for centuries - Laffer himself attributes it to the 14th century Muslim scholar Ibn Khaldu):
Legend has it that this curve was first presented the modern Republican party on a cocktail napkin, which Laffer used as scratch paper. The curve has two data points: 1) if the tax rate is zero, you get zero tax revenue, 2) if the tax rate is 100 you also get zero tax revenue, since working would provide no more income than not working. A curve is drawn between these two points, creating the theoretical concept that raising taxes raises revenue up to a point, after which it actually lowers revenue by discouraging productivity. This concept remained theoretical and untested until the Reagan Administration.
When Ronald Reagan took office in 1981, the top tax rate was 70%, which Reagan cut to 35%, and tax revenue did, in fact, go up - bringing us to the myth.
Under the Carter Administration taxes were high, but also full of loopholes. Almost nobody in the 70% bracket actually paid that much, since they could afford accountants who could find tax shelters to hide their money from the government. In fact, most of the wealthy in the 70's were so good at finding loopholes that they didn't pay any taxes at all. When Reagan took over he lowered taxes, but he also closed the loopholes, so on paper it looked like he lowered taxes on the wealthy form 70% to 35%, but in reality he raised taxes on the wealthy from 0% to 35%.
The myth is that Reagan raised revenues by lowering taxes.
The truth is that Reagan raised revenues by raising taxes.
This pattern was confirmed in the George W. Bush Administration. Without the distractions of absurd 70% tax rates and complicated loopholes, we were left with the simple math that, when the top tax rates are set at a reasonable level (around 40% in this case), lowering taxes does exactly what you would expect it to do: it lowers revenues and increases deficits. Ironically, this is exactly what the Laffer Curve predicts. The curve is traditionally drawn with the tip of the bell at 50%, which means that at any tax rate under 50%, lowering taxes should lower revenues.
Unfortunately, tax cuts have gone on to become the cornerstone of Republican economic policy. The idea is that tax cuts, especially those to the wealthy, cause the wealthy to spend more personally and to invest more in business, which creates jobs and stimulates the economy, which increases tax revenue and lowers the deficit. It would be lovely to live in a world where this idea could work, but unfortunately we live in this one. In this world we have tested this idea and, once again, proved it false.
In 2001 and again in 2003, George W. Bush passed a series of tax cuts, which lowered the top rate to 35%. Over the next seven years, we saw deficits skyrocket and the economy flounder. Although the weak economic numbers were artificially inflated by the sub-prime mortgage bubble, that bubble burst in 2008, sending us spiraling toward the next great depression. The tax cuts remained in place though all of this and continued during the first two years of the Obama Administration, where they have shown no sign of stimulating the economy or aiding in the recovery while they continue to add to our debt.
Despite this, these tax cuts remain the cornerstone of the Republican's new Pledge to America. They claim that these same tax cuts, which have done nothing but grow the debt over the last 7-9 years, will suddenly start producing results if they are renewed.
