Do Tax Cuts Lead to Economic Growth?

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Budget season in Charleston and Washington, D.C. has once again presented the spectacle of competing tax philosophies. Conservatives argue for cutting taxes as a way to unleash economic growth and job creation. They assert that high taxes discourage the most creative class from economic activity that will ultimately raise all boats. Liberals and progressives, on the other hand, believe that tax cuts unfairly benefit the rich and eliminate revenues that are required for programs that secure a just society. They further argue that tax cuts do not stimulate economic growth in the long term and point out that some jurisdictions with the highest tax rates in the country and the world also have the highest rates of growth. Who is right?

There is one aspect of tax cuts that is not debatable – it is simple arithmetic. If a government cuts taxes it lowers revenues. Unless spending is cut by an equal amount, the government creates a budget deficit. Budget deficits at the federal level are funded by government borrowing. But the more the government borrows, the higher its debt service burden will be in the future. This has two major consequences.

First, the more money that must be devoted to paying off debt, the less money is available for direct spending on needed government activity. Second, government borrowing sucks up investment funds from the market that would otherwise be available to businesses for making capital investment – new plant, machinery and technology. New capital investment is required for productivity growth, and productivity growth is required for overall economic growth.

Conservatives dispute that tax cuts lower revenues by resort to a form of economic voodoo called “dynamic scoring.” They argue that because tax cuts will stimulate economic growth, which will lead to a healthier base economy upon which the lower tax rates will apply, it is incorrect to focus only on the immediate drop in tax revenues created by the proposed tax cuts. According to this argument, eventual new tax revenues created by future economic growth should be counted to assess the true impact of the tax cuts.

Very few economists are comfortable relying on dynamic scoring because there are no certainties about the effects of tax cuts on economic growth. Revenue feedback from increased growth fluctuates, when it occurs at all, and never gets above 20% of the original cuts. Nevertheless conservative politicians love dynamic scoring. It is a sales pitch they can use to undercut opposition and it does not require them to provide facts or credible explanations. For example, Treasury Secretary Steve Mnuchin asserted on April 26 that the lower tax rates in President Trump’s tax plan will boost GDP growth from its current 1.7% rate to a new level of 3%, and that surge would completely pay for the plan. But in a poll of 37 economists conducted by the University of Chicago’s Booth School of Business, not one believed that the proposed tax cuts could pay for themselves.

The historic evidence is that tax cuts do not lead to long term economic growth. Recent history provides support for this. Both President George H. W. Bush and President Clinton raised taxes in the 1990s and the economy boomed. Incomes grew at the fastest rate since the 1960s. Then President George W. Bush passed a large tax cut in 2001 and boldly predicted that prosperity would follow. It didn’t. The economy stumbled at a low growth rate until it crashed in 2008. A similar example of this at the state level is provided by the Kansas experience, in which sweeping tax cuts were followed by sluggish growth. Of course, correlation is not necessarily causation – tax increases may not cause booms and tax cuts may not cause busts. Instead we are asking whether tax cuts lead to economic growth and there is just no evidence for this.

From what little we know of the proposed Trump tax plan, wealthier taxpayers will be certain to benefit from lower marginal rates on income and capital gains. The Congressional Research Service, a non-partisan service of the Library of Congress, analyzed the effect of reductions in the top marginal tax rates since 1945. In a September 2012 report the CRS said:

There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth.

The CRS did find, however, that decreasing the top marginal tax rates was associated with increasing the share of national income going to those who were already wealthy.

So on the question of whether tax cuts lead to economic growth the careful answer, based on the evidence, is no. This begs the question what policies do increase economic growth, which will be the subject of a future article.

Rep. Alex Mooney Ignores the Panhandle’s Economic Needs

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Let’s face it. Panhandle voters did themselves no favor when they elected Alex Mooney as West Virginia’s 2nd District Congressman. Characteristics we’d like to see in a Congressman – independence of thought, sensitivity to constituent needs, flexibility in problem solving – appear to be lacking in Rep. Mooney. His actions and statements show him to be one dimensional. Whatever outrage President Trump proposes for the environment with the false promise of putting coal miners back to work is just fine by him.

For proof of this I invite anyone to review Rep. Mooney’s website for his public statements and news releases. Don’t expect to find any evidence of initiative in Congress meaningful to the Panhandle. Instead, a favorite Mooney posting is a “statement” lauding something President Trump has done and repeating tired Republican attacks on the Obama administration. Here is one issued on March 28, 2017:

Today, President Donald Trump signed an Executive Order that rolls back devastating [Clean Power Plan] regulations on American energy production. . . . . This Executive Order is just one of the many ways President Trump is standing up for West Virginia energy production and I am proud to stand with him in this fight. For eight years, former President Barack Obama waged an all-out war on coal and West Virginia values. As unemployment skyrocketed and coal mines closed, President Obama and his left-wing supporters focused on executing on his promise to bankrupt the coal industry.

Earlier, Rep. Mooney celebrated President Trump’s roll-back of the Obama administration’s Stream Protection Rule, which was designed to blunt the harmful effects of mountaintop removal mining. Based on wildly inflated figures from the National Mining Association, Rep. Mooney claimed that the Rule would have cost 70,000 coal mining jobs. Pretty soon Rep. Mooney will have to come up with some ideas that actually move us forward, instead of ritually dismantling what was done during the previous administration. But don’t hold your breath. This may take a while.

Six of eight counties in the Eastern Panhandle are part of the 2nd District – Jefferson, Berkeley, Morgan, Hardy, Hampshire and Pendleton. According to Census Bureau estimates, the 2016 total population of these six counties was 231,766, making up 37% of the 2nd District. Simply from the standpoint of the total votes in the Panhandle, you would expect Rep. Mooney to pay some attention to our economic needs.

There is no coal mining in the Eastern Panhandle. Our economy is heavily weighted toward white-collar jobs in healthcare and government, tourism and agriculture. Our conservation and environmental interest groups are thriving. A ruined environment, fueled by Big Coal and science-denial, directly harms our means of achieving prosperity and our enjoyment of life. Rep. Mooney’s dogged support of the coal industry is completely out of touch with our needs. In fact, it is out of touch with the needs of the entire state. Coal mining jobs make up only a minor slice of West Virginia’s current employment. Counting generously, there are 20,000 miners employed in West Virginia out of total employment of 740,000.

Instead of legislation to improve our economic prosperity, Rep. Mooney seems more interested in right-wing social legislation. He has twice introduced a Bill called the Life at Conception Act (H.R. 816), and has introduced a resolution (H. Res. 514) imploring the states to permit individuals to disregard laws and regulations on the ground of their personal religious beliefs. In the 114th Congress none of the Bills introduced by Rep. Mooney became law.

Certainly, there is more to being an effective legislator than the number of your Bills that are passed. But Rep. Mooney was one of those Congressmen who wouldn’t meet his constituents in face-to-face town hall meetings to explain what he’s doing for us. No doubt he was afraid to hear the pent up anger in his District. There is still time in his current term for Rep. Mooney to demonstrate that he understands the Panhandle’s economic needs. But it is hard to be optimistic.

How We Talk About Economic Growth

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In the last few years of the Obama administration, The Wall Street Journal relentlessly criticized the administration’s failure to achieve sufficient economic growth. That newspaper complained that Obama’s over-regulated economy was to blame for a GDP growth rate of 2.1% — tepid compared to recoveries in the past.

The Journal is, of course, the voice of business people who often favor the conservative agenda of low taxes and lower regulation. But the Journal was on to something. The need for economic growth is hugely important and one thing both conservative business people and progressives should be able to agree on.

Progressives can rally behind strong economic growth because material prosperity improves the quality of life and opportunity for everyone. Unfortunately, as with so many other things, conservatives and progressives are each mired in their own rhetoric. Every issue seems to have its predictable arguments. A proposal for raising the minimum wage will inevitably be met with the argument that employers will have to cut jobs. A proposed international trade deal will be opposed by arguments that globalization harms the little guy.

But neither side talks about the social and political benefits that accrue to a country with a steadily growing economy. These non-economic benefits must be counted along with the hard financial and environmental factors when we evaluate any serious policy question. Doing so may actually tip the scale in favor of some policies that will promote growth versus the predictable counter arguments.

In his 2005 book The Moral Consequences of Economic Growth, Benjamin Friedman catalogues the social and political benefits of growth: openness, tolerance of different ethnicities and points of view, philanthropy, and a satisfaction with the democratic process, if not always its results. A stagnating economy, on the other hand, leads to rising intolerance and incivility, defensiveness, eroding generosity, rigidity of institutions, and a disrespect for the democratic process.

The mechanism for this effect is psychological. Economic growth, or the lack of it, drives a person’s perception of whether he is getting ahead or falling behind. There are two benchmarks for this. One is a person’s current economic situation compared to his past situation. The other is a person’s current economic situation versus the current situation of other people. These two benchmarks can be substitutes for each other. In a steadily growing economy, a person’s satisfaction with being better off than he was in the past can mitigate his impulse to be better off than his neighbors.

On the other hand, when an economy stagnates and a person is not better off than he was in the past, his need to be better off than his neighbor (or people of color, or immigrants) intensifies. His view of the economic pie becomes zero sum – his situation can only improve if someone else’s declines. If someone else seems to be getting ahead, he assumes it must be at his expense. Both the positive effects of a growing economy and the negative ones of a stagnating economy are magnified when people consider the opportunities available for their children.

This is not some pop social theory. American history provides many examples to confirm its accuracy. Between 1880 and 1895, real income per capita grew by only .7% per annum. In the same period Jim Crow laws, segregation in every aspect of life and appalling violence became the norm in the South. In rural America populism led to nativism, ethnic intolerance and open religious bigotry. In the West, riots protested the use of Chinese labor for railroad construction and immigration laws were tightened.

Contrast this with the post-WW II expansion. With the exception of several brief but painless recessions in the Eisenhower years, Americans enjoyed uninterrupted economic growth from the end of the war to 1973. Over the prolonged period from 1948 to 1970 real income growth per capita averaged 2.4% per annum. Home ownership became a realistic possibility for most Americans and white collar jobs opened to many. It is no coincidence that during this period political and economic democracy was extended to non-whites. Brown v. Board of Education mandated school desegregation and a decade later the Civil Rights Act of 1964 outlawed discrimination in employment, public accommodations and housing.

While none of the foregoing changes – good or bad – happened overnight, political change is possible when only a small number of voters change their minds. The recent shift in public sentiment about gay marriage comes to mind. Likewise, a stagnating economy need only influence a small segment of the populace to produce unfortunate results. Many political analysts have said that fewer than 20,000 economically frustrated voters in Michigan and Wisconsin elected the incompetent Donald Trump with his agenda of anti-Muslim animus and disregard for environmental and social justice.

Economic growth is a good thing. It strengthens not only our material prosperity but it permits the kind of positive social and political behavior we all want to see in our country. This is not to say that bad policies – ones that would irreparably harm the environment, for example – should be adopted simply because they are said to promote growth. What it does mean is that we should evaluate our economic policy choices by also considering the indirect non-economic benefits of growth. In the end, this may lead progressives to be less instinctively critical of pro-growth policies and bring the left and the right together toward a common economic agenda.