For so many years we have been told that tax cuts stimulate the economy that most of us cannot accept the fact that raising taxes will not be counterproductive to expanding the economy. But that is exactly the case.
Taxes may influence behavior. If you tax cigarettes or gasoline very heavily, some reduction in consumption may result. But in general, large scale income tax cuts have been proved to have virtually no influence on the growth or the contraction of the economy.
The factors that affect economic growth are primarily these:
1. Technical innovation. New products…television…cell phones…create new industries and employee tens of thousands of people and expand the economy.
2. Inflation and disinflation. When prices continue to go up, at some point they become to great for the consumer or the business to fit in. They become unaffordable and sales fall, suppliers are cut back, employment falls and businesses across a spectrum cut back. When that process has run its course, the economy begins to expand again. It is not rocket science, although rocket science has been a good business. Just ask NASA scientists.
3. Money supply and interest rates. If you cannot get money…if money is tight…then you cannot expand. If money becomes too expensive, then businesses that operate on credit such as auto dealers, homes, appliances cannot function. As a result, many of those businesses lose revenues and those categories slow down.
4. Other external factors, such as wars or large scale devastation, like drought or floods or hurricanes may interrupt business on a large scale.
But the one thing that you will notice is that none of these things had anything to do with taxes.
Let’s suppose that you pay a 74% top income tax rate, as was the case at the time Reagan was elected. You will not pay 74% on all income but only on the highest level of income. Even if your average tax comes to something like 50% of your income, you start to look around for ways to cut it. But let’s say that instead of paying taxes on that entire amount, we established an ability for individuals above a certain income to invest in certain types of businesses, tax free.
If you make a million dollars this year and if you would end up paying $500,000 in taxes, you could invest that money before the end of the year and it would be considered deferred income. Corporations and small businesses do that now. Why not allow certain types of businesses or investments that will advance the domestic economy only to be tax deferred. Let’s say you invest $500,000. Now you have to pay far less in taxes on the remaining money because you don’t hit that top rate…depending on where it is set.
In addition, the $500,000 you invest goes into the economy. In a situation as happened with Ronald Reagan’s tax cuts that dropped the rate to 28% and then adjusted up to 35%, most people no longer had to invest. They simply spent their time hiring people to find as many tax loopholes as possible because they were keeping their money anyway.
Certainly there are natural investors, entrepreneurs who would take advantage of this tax provision. They would probably have invested anyway. But in the meantime, the government gets a higher basic top rate and an enormous amount of investment goes into the domestic economy.
Many contend quite effectively that if we raised the top rate to 74% again, taxpayers would be obliged to find some good investment opportunities. If this were tied to a two-tier investment incentive it would help even more. The first incentive would simply be any investment in lieu of paying taxes.
The second would be a lower capital gains, or a reduction in the time period for the lowest capital gains rates. The domestic investment period for long-term capital gains could be reduced from 5 years down to 3 years, for example. This would be for investments that create a certain number of domestic jobs.
So, if tax rates do not affect the economy, how would these tax cuts affect the economy? Well, the fact is that straight forward income tax rates hiked up or down do not make any difference in the economy, but they do make a difference in government revenues.
Right now, with the Recession, our expenses are higher—for unemployment insurance and other costs of running a government, like the costs of more borrowing. A tax incentive for those at the top end of the income scale is one way to infuse capital into the economy in the midst of a recession.
If you merely say to taxpayers that they should help out by investing in domestic businesses which will quite likely make them wealthier…or simply pay taxes at 74% on that money, many will discover a new-found patriotic spirit within them.
This goes back to the part about how you tax…taxing cigarettes heavily curtails purchases…a good thing for health care costs.
The fact is that President Reagan’s own advisors, many of them now quite wealthy and out of politics are at last writing and telling the truth. The fact is that the Reagan tax cuts of 1981, which brought the rates down by more than half, did not succeed in bringing us out of recession, a year and a half later we were still in virtually no growth.
In the face of growing deficits, Congress…both Democratic and Republican passed another tax bill in 1983 which raised taxes. It was said to have been the largest tax increase in history. But in the face of those tax increases the economy began to pick up and it grew from zero in 1982 to 5% and then up to 8% by 1985. To make a comparision, the U.S. is expanding at a rate of only 2.4% now.
Even Reagan Republicans are now saying that income tax cuts or tax increases generally speaking have no tangible effect on economic growth.
But we know that one thing does work. When you give someone a job, they do spend the money. So, if we do create direct jobs, we can be pretty certain that that money will go directly into the economy and create more jobs.
This is what we need to do now. Act responsibly. Let the Bush tax cuts expire. Create a new tax base at a higher level for those who made out so well, multi-millions in tax cuts in the Bush years. Create 5 million jobs. Put up a standard tariff on all goods made by U.S. manufacturers in foreign lands using foreign workers.
We can make this country strong again. But we must start by acting in a rational manner.