Our prevailing mythology is that tax cuts help the economy.
They stimulate it. They promote growth. They create jobs.
The truth is that tax cuts cause crashes.
Tax hikes end depressions and recessions.
Those are the broad strokes.
They need some parameters and qualifications.
In modern times -- since the introduction of the income tax by constitutional amendment in 1913 -- there have been three basic types of recession.
Economists, historians, and, as we move into the present, journalists and pundits, offer a mixed multitude of reasons for each of them.
But now that we've had four of them (including the crash of 2001), we can see a pattern.
The sequences of boom, bubble, and crash have, in each and every case, been preceded by a significant tax cut.
Coming out of World War One we had a top marginal tax rate over 70%.
From 1921-25 it was cut, in steps, down to 25%.
There was a boom, particularly in the fiscal sector.
The crash came in 1929.
When Ronald Reagan came into office in 1981, the top marginal rate was, once again, 70%.
Reagan started cutting in 1982, down to 50%, then to 38.5% in 1987, and 28% in 1988. There was a boom in the fiscal sector. In the mid-eighties the collapse began, and over 1,600 banks failed. There was a huge bailout.
It was followed by the recession of 1990.
Taxes went up slightly under George H.W. Bush, then again under Bill Clinton. The economy recovered.
However, in 1997, the Republican congress pushed Clinton into cutting the capital gains tax from 28% down to 20%. It was called The Taxpayer's Relief Act. It marks -- almost exactly -- the moment when the dot.com boom turned into the dot.com bubble.
It burst in 2000, and, along with the 9/11 attacks, there was another recession.
George W. Bush launched another round of tax cuts. The top rate went down to 35%. Capital gains rates were cut to 5%.
This was followed by the Bush boom.
There was huge growth in the fiscal sector, but "mysteriously," it was a jobless recovery. The boom was hollow. It was a bubble. It led to the Crash of 2007, with massive bank failures, followed by our current recession.
How does this type of recession -- boom, bubble, and crash -- end?
In 1932, Herbert Hoover raised taxes. He did it to balance the budget. In 1933 the economy changed direction and began moving upward.
In 1991, George H.W. Bush, disturbed by the huge deficits that followed Reagan's cuts, raised taxes. The economy subsequently turned around. When Clinton raised taxes again, the economy really took off, leading to the longest sustained period of growth in modern times. With some of the highest employment growth.
The 2,000 recession was followed by tax cuts. Not tax hikes.
A very strange think followed. There was great growth at the top. Corporate profits rose, there was a boom in real estate and in the fiscal sector generally.
But for normal people the recession never ended. There were no new private sector jobs. Median income went down. Manufacturing continued to decline.
The historical record suggests that this recession won't end until there is a tax increase.
Economies are complex. There are always a multitude of factors that effect booms and busts, growth and recessions. It is also a commonplace that correlation does not necessarily imply causality.
Nonetheless, if the same sequence takes place a multitude of times in different circumstances and the sequence takes place four out of five times -- tax cut, fiscal sector boom, bubble, crash, bank failures and recession or depression -- it makes a very good case for causality.
There is one significant tax cut that does not quite fit the model. In 1964 and 1965 the top marginal rate went down from 91% to 70%.
Tax cut enthusiasts always refer to them as the Kennedy tax cuts, but they took place under Lyndon Johnson. They also always cite them as a great stimulus to the economy.
In the short term, they had the same effect as the other tax cuts.
The Dow Jones had an upsurge and then a crash.
Over the next twenty years, it bounced around between 600 and a 1,000, a lot of fun for speculators, but as a measure of serious economic growth over the long term it is astonishingly flat.
The other standard measure of economic policy success is the increase, or lack thereof, in the Gross Domestic Product. Over the next two decades, there was only one year in which the rate of increase in the GDP matched the high tax periods that preceded them. Those rates go lower and lower with each tax cut.
Our public policy dialogue has little basis in fact or rationality.
Much of it, even in the academy, is bought and paid for. There is no interest group willing to pay foundations, endow universities, buy radio ads for commentators, who will advocate higher taxes.
But there's lots of money willing to invest in propaganda that calls for lower taxes and claim that they're good for the economy.
So you won't hear calls for higher taxes. You won't find politicians who dare to propose higher taxes.
If the Bush tax cuts are allowed to expire they will, hopefully, work as tax hikes. That will mark the beginning of a real recovery.
If they don't, and there are no other tax increases, expect lingering unemployment, lower wages, increased corporate profits, especially in the fiscal sector -- which we're already seeing -- a short term boom in the stock market, and another crash.
Rep. Jay Inslee: URGENT: Last Chance to Get a Better Tax Cut Deal
Tax rates in the 1945 period were required to be high to combat massive inflation driven by the end of the war. In fact, anytime you come to the end of a period of exagerated government spending there is a need to raise taxes to control the amount of money in the system.
To imply that lowering the capital gains rate created the massive use of the internet (which was the driver behind the dot com bubble) is difficult to believe.
What is clear is that tax policy (the way taxes are structured) influences behavior and high personal tax rates typically result in higher corporate profits (makes sense, you pay people less since the "incentive" function of pay is muted by the taxes) and typically higher corporate profits are followed by investment and hiring.
What is clear is that tax rates don't change the total tax receipts (which have been 18%-ish of GDP for the last 60 years). You are not sucking out more money, you are just changing where it comes from. The big change in the last 30 years has been the globalization of the dollar. Since we are the big consumer (others get dollars, we get goods) there is a potential for asset inflation when the economy operates below capacity. That drives booms and busts, not the tax rate.
If the Bush/Republican 2001 and 2003 tax cuts were SO good for the economy, why did we end up in the worst recession since The Great Depression? And why did we have a near-complete financial collapse?
I for one liked the idea of a flat tax on everything, say what you will but then every single person in the United States pays the same tax, is that harder on the poor yes it is is it fair for the rich yes it is. But I am not a economist.
Re President’s Budget Commission report: If you thought things were bad, they are even worse.
Credits to K. Parker, op Ed, Wash Post News 12/5/2010. Her article is inspired by Dec. 3, 2010 issue of Foreign Affairs by Roger Altman, former Deputy Treasury Secretary and Richard Haas, president of the Council On Foreign Relations.
“The (sic American) national debt was only about 35% of GNP JUST 12 YEARS AGO. (emphasis added) Furthermore the debt had been shrinking - - - --”
“With the 2001 and 2003 tax cuts - - - - -, we are now faced with an era of austerity.”
“The 8 years OF THE BUSH ADMINISTRATION saw the largest fiscal erosion in American history.”
One possible consequence the posited was that
“ --one or 2 global capital markets may impose a solution which would be ugly and punitive”
Conclusion: Which is the biggest devil ? A. federal spending? or tax cuts?
Now, also what this article fails to explain is that unfunded tax cuts have zero-sum effect on the economy. The government cuts taxes, but then has to take that money back from the loanable funds market, as to pay expenses. What funded tax cuts afford the economy is a greater allocation of goods and services across the economy because the government, a third party payer, is not the
spender -- scrupulous individuals are. Natural increases through tax cuts that allow businesses and individuals to expand wealth, spur investment, and increase output, is not speculative, manipulative, or the impetus to a future crash. Manipulative actions from the Federal Reserve, attempting to institute its dual mandate, is the bane of our economic system. By manipulating the market interest rate, the Federal Reserve is manipulating economic expansion -- much different than the effect of tax rate decrease.
What is the solution to tax policy? Low rates, broader base -- just like the Deficit Commission explained.
I suggest that this writer go back to do economics 101 and also read the fine print of the “Commission Report". When it says “broad based” tax rates, they are not suggesting that the highest earning 2 percent of the country get more tax relief. It is obvious to me that they mean that it is the middle class that needs a tax break in these difficult times.
The chorus that, if the super rich had another dollar or so, they would rush out and hire/invest is getting so repetitious from the rightists as to be downright nauseating.
It supported lowering all income rates, corporate tax rates, and capital gains/investment rates for the middle and lower classes.
This is the same report that received support from liberal Democrats (Dick Durbin) and conservative Republicans (Judd Gregg).
Your spending and consumption economic philosophy is the reason why the United States can't see growth -- we don't save; we don't invest. Why is China seeing such rampant growth? Because it has a massive savings rates. By saving, we encourage investment (both financial and capital), stimulate the loanable funds market, increase productivity, increase wages, et cetera.
Your "soak the rich" reasoning is severely flawed... of the 250k+ tax filers, approximately 70% are small businesses filing as individuals. Concerning millionaires... 60% of their consumption is in business consumption (investment or capital).
If you took economics 101, you would understand that long term growth does not come from demand, but does come from supply. Demand only changes price rates; increased long term supply and productivity drive the economy.
http://www.wealthvest.com/blog/wade-dokken/the-history-of-what-things-cost-in-america-1776-to-today-247-wall-st-wade-dokken/
Thanks
Wade Dokken
President
WealthVest Marketing
Government spending creates jobs in the the USA. Personal spending (beyond essentials) creates jobs overseas and increases the trade deficit.
Just cause I don't like taxes or government spending doesn't change this. I'm NOT saying government should spend more - just that we should understand how things work when we make decisions.
Would you not also be tempted to plow money back into the business at a higher rate to avoid paying taxes on profit - assuming there was demand for your product or service in the long term that would make an investment in the business pay off.
It seems that the electorate was determined to reward the folks who caused the recent near financial meltdown, real estate mortgage bubble and debt crisis, and penalize those whose courage AVIODED A TOTAL CATRASTROPHYE. GO FIGURE IT OUT.
You are absolutely correct about the complexity of factors and the ways they affect the economy. Economy is a non-linear system (there are many economists that apply so called chaos theory to it). Never the less there are many non-linear systems in this world that are successfully studied by scientific methods, producing workable solutions.
Some might be interested in my feeble attempt to look at one aspect of taxation here:
http://alexeiz.com/blog/2010/12/economics-taxes-and-wailing-speakers/