The Fallacy of Always Cutting Taxes

← Back To Blog
Posted on: 01/25/2015 by Pat O'Brien

A bedrock principle of conservatism is that it is always a good time to cut taxes. To some conservatives, it is even more than a principle - it's an ideology. It's a religion. To those people, if a local, state or national government cuts taxes then the magic starts to happen. The economy will start to grow because businesses will invest more money and hire more people and everything will be wonderful. It always works - except, the world doesn't work that way and it never has worked that way.

In "The Radical Moderate", I wrote that when the GOP cuts taxes and good things happen they immediately view it as evidence that the tax cuts were solely responsible for the positive economic results. And, when good economic things don't happen the GOP blames Democrats for creating some other barrier to growth. A favorite scapegoat is over-regulation. But, what is really going on is that the GOP is calling heads every time when a coin is being flipped. When the coin lands on heads the GOP can claim they knew it would happen all along. When the coin lands on tails they can blame Democrats. The game is rigged in that regard. It is a complete fallacy to think that always cutting taxes will result in strong economic growth and an improved employment market. The world is so much more complicated than that.

The most famous example of recent note is the State of Kansas. Governor Sam Brownback cut $1.1 Billion in taxes and promised voters that this would lead to strong economic growth. It hasn't. In fact, the economic growth in Kansas has lagged the national economic recovery while the state revenue collections have dropped by 12%. In other words, taxes were cut, economic growth is stagnant and the state is bleeding cash. The coin landed on tails.

Now, GOP Governor Brian Sandoval of Nevada is going in the opposite direction by proposing a $1.1 Billion increase in state taxes to fund some new education initiatives. Sandoval is not alone. GOP Governor Rick Snyder is proposing a $1.9 Billion tax increase in Michigan. The new GOP Governor in Arizona, Doug Ducey, has now flipped on his campaign promise to cut the state income tax because of a large state budget shortfall. The ideology is not meeting the demands of governing apparently.

Don't get me wrong. There are times when it makes sense to cut taxes. The classic example was when President Reagan cut the income tax rates. The circumstances of that tax cut were unique and those circumstances have not repeated themselves since the early 1980's. They were the exception and not the rule. Between 1981 and 1986, Reagan cut the highest federal income tax rate from 70% to 28%. And, the economy did grow primarily because of the tax cuts which acted essentially as a stimulus plan. The reason the tax cuts worked, though, was they were long overdue. The 70% tax rate was a relic of a World War II era when the government needed money to fight the wars. That rate should have been reduced gradually over the decades but instead Reagan had the good political fortune to be the person that cut them. In other words, this was one of the few times that calling heads was actually a predictable event.

There are two reasons why we know the Reagan tax cuts were well-timed but unique. First, Reagan himself allowed taxes to increase in 1982 and 1984 through "base broadening" which eliminated some tax loopholes. He realized that the tax cuts would otherwise be too much for the economy to handle. Second, the Bush tax cuts in the early 2000's did almost nothing to stimulate the economy. The reason? The income tax rate only dropped from 39.6% to 35%. This cut acted as a giveaway to the wealthiest Americans but was not a significant factor leading to economic growth. In other words, unfortunately for Bush the coin landed on tails. When President Obama allowed most of those Bush tax cuts to expire in 2012 the affect on the economic recovery was non-existent.

Creating and sustaining economic growth is dependent on a huge number of factors. The tax rate is one of those factors. The regulatory environment, population demographics, strong educational systems, access to health care, innovation by individuals and many other items are contributing factors that affect the economy. It's not easy. It's not as simple as always cutting taxes. That notion is a theory that has never been proven. Lately, it may be a theory that has been completely proven to be wrong.

comments powered by Disqus