Politics is conflictual by nature, and just one of the many controversial issues that divide the parties is that of tax cuts. The blog’s resident Business Editor and economics buff, Jake Sonderman, offers an analysis of this issue.
By Jake Sonderman, Business Editor
“What we don’t need is more spending, and what we don’t need are taxes, and what we do need is a lot less of both.”
— Ronald Reagan
It is the age old question. Tax more, or tax less? In 2017, under Donald Trump, the Tax Cuts and Jobs Act was passed, and after-tax revenue for the top marginal income tax bracket went up 3% (taxpolicycenter.org). So it would seem that the “tax less” side had won. But, with President Biden in office, it seems inevitable that taxes will go up for some to offset spending in many other areas. There is a lot of criticism on both sides of the aisle on tax policy, with Republicans ripping Biden for proposed tax hikes, and Democrats ripping Trump for tax cuts for the rich. I would like to put a pin in the politics of this issue for a second and discuss whether tax cuts are really productive for an economy and whether they do indeed “pay for” themselves.
Are Tax Cuts Productive?
To start, any tax cut will result in more money in the hands of citizens. For a tax cut or any spending to be effective, it needs to “multiply” or circulate through the economy instead of simply going straight into the bank. So if any tax cut puts more money into the economy, who should get the tax cut to make it the most “productive”? Owen M. Zidar at The National Bureau for Economic Research looked back at history to see which tax cuts are the most effective in states in terms of employment growth. He found that tax cuts for low-income brackets produce substantially more growth than tax cuts for income brackets in the top 10%. Specifically, he found that a 1% tax cut for the bottom 90% of earners resulted in 3.4% employment growth over two years, and that a cut for the top 10% produced 0.2% employment growth over the same period. (nber.org)
Summed up, tax cuts are productive for the economy. But tax cuts for low income brackets produce much more growth than tax cuts for higher brackets.
Do Tax Cuts “Pay For” themselves?
The short answer to this question is “No.” For a tax cut to “pay for” itself, it would need to produce an absurd amount of economic growth. For example, if the government introduced a tax cut that costs $200 billion and brings the income tax rate to 20%, the tax cut would need to produce about $1 trillion in growth. 20% of $1 trillion is $200 billion. This is an oversimplified essence of the idea. The idea that tax cuts produce more revenue for the government is based on the Laffer curve, an idea adopted in the Reagan era. It is based on the idea that if an income tax rate is 100% or 0% the government will receive the same amount of revenue. In the Laffer curve, there is a “sweet spot” where the government produces the most amount of revenue (investopedia.com) (taxpolicycenter.org).
The problem with referring to the Laffer curve in my opinion is that it is often used out of context and used incorrectly. The Laffer curve is often misconstrued to say that somehow lowering tax rates for high income earners and large corporations will result in booming growth that pays for itself entirely. The Laffer curve has to work both ways, meaning that cuts can substantially lower tax revenue if the tax rate goes too low.
Too often politics gets in the way of the facts when it comes to taxes. Too often politicians say “tax cuts” when they mean tax cuts for only high income earners. Tax cuts are an economic tool that can be more effective even than government spending, but they are only sometimes used effectively. Tax cuts for low income earners undoubtedly spur substantial employment growth, and those are, in my opinion, the tax cuts we should be talking about.
First Editor-in-Chief: Elizabeth Shay
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