If tax cuts are to raise revenues, broader culture of economic freedom is required
Among the favorite maxims of fiscal conservatives is the idea that tax cuts, not hikes, increase revenues. Inarguably, slashing personal income tax rates buoyed the size of the federal government’s coffers following the Mellon income tax cuts of the 1920s, the 1964 Revenue Act signed by President Kennedy and President Reagan’s reform measures in 1981 and 1986.
The rationale behind this somewhat counterintuitive phenomenon is that lower tax rates leave individuals and sole-proprietor businesses with more extraneous capital. The former group feels more financially secure and spends more on non-necessities, thus fostering economic development; the latter group has more money to reinvest, thus bolstering the job market and creating more robust industry.
Today’s politicians assume that a similar result will hold true given a new program of cuts to the personal income tax rates. But this assumption may be fallacious. The Bush tax cuts, implemented in 2001 and 2003, did not result in increased revenues even though they, like earlier reductions, most drastically pared back the highest brackets. One explanation for this involves the strengthening of the alternative minimum tax, designed to prevent rich Americans from dodging taxes through loopholes and deductions.
But another involves the burgeoning of government and the fiscal myopia of politicians who understand growth only in terms of revenue.
The historic and oft-cited examples of the Mellon, Kennedy and Reagan tax cuts occurred in eras where the federal government was much more constrained. The burgeoning of the federal regulatory code means that, even when business owners have more capital available to spend, they lack the freedom to act as they wish. Growth is difficult when licenses must be acquired and regulations must be complied with; these measures are costly and time-consuming, meaning growth is stunted. Further, the cost of compliance eats into the excess money proprietors might have available from lower marginal tax rates, further limiting the amount they can put towards industrial development.
And consumers are also affected, for these higher costs are passed on in increased prices, meaning the dollar no longer goes as far.
In the modern political era, politicians are no longer conscientious that stimulating economic growth requires more than citizens and businesses being flush with cash. There is a broader culture of fiscal freedom that must accompany tax cuts, and this requires reducing the size of government and devolving power.
If government cuts are discussed at all by today’s politicians, it is in the tenuous and relativistic language of spending cuts as compared to past levels or as a reduction to projections of future growth. But a culture that fosters durable, long-term growth in the economy must go beyond withholding funds from the federal programs that happen to be out of favor with the majority party. This is the fiscal equivalent of simply pulling the leaves off a weed; unless the plant is completely uprooted, it will grow back.
Tax cuts are not enough; they must be accompanied by serious attempts to rein in and reform government waste and abuse. Too often regulation has a stifling effect on business that is all the more dangerous because it is largely invisible. Public policy often hinges on the scoring of projections of future spending and the impact it will have on debt. No such measure exists to gauge how individual consumers and business owners act in response to public policy, so there is no way to know the extent to which potential growth is impeded by particular types of government behavior.
Tax cuts are only in aid of increased revenues when there is a broader culture of economic freedom which allows consumers and business owners to act in accordance with their inclinations. It is no mistake that the Mellon, Kennedy and Reagan tax cuts occurred in eras where the political lexicon was that of protecting citizens and their rights from the dangers of runaway government. Nor is it a mistake that the Bush tax cuts did not foster growth, for there was no sense that government was an ill in any sense other than it had over-extended itself in what it took from the pockets of citizens.
No new program of taxing cuts will foster the kind of growth on which politicians are counting; it is impossible for growth to occur in the current political client. Federalism is understood not as a bottom-to-top flow of power, but an exporting of functions to the state at the tolerance of federal overseers. Not only is this sheer laziness, for it simply defaults responsibility for those functions of governance which federal regulators have decided are too difficult or controversial to handle to the states, but it is also a dangerously inaccurate comprehension of how growth occurs in a free market system. Indeed, free markets, which are built by the organic interactions of consumers and producers at local levels, cannot exist under this kind of configuration. They can only exist — and growth can only occur — in a culture lacking the overhanging shadow of fear which government regulation casts. Taxes must be married to serious cuts in federal spending which spring, not from a reduction in the size of budgets, but from the repeal of government programs if any real growth is to occur.
Originally published at The Politics of Discretion.