After 30 years of creating large deficits through tax cut legislation (Starving the Beast), often to the detriment of our economy and jobs growth, Republicans are getting closer to their goal of reducing the size of government through sharp cuts to our entitlement programs.

A pressing issue following the mid-term elections is the scheduled expiration of the Bush tax cuts at year’s end. Conservative politicians want to extend the tax cuts to all income classes (some even calling to make the cuts permanent) while the president has proposed letting the tax cuts for the wealthiest of Americans expire (perhaps with a negotiated limited extension) while extending them for the rest of America during our economic recovery.

There is much partisan spin to this issue, no doubt much of it driven by both special interests and ideology.  Typically subjective statements are used by Republicans such as ‘It is a bad idea to raise taxes on anybody during a recession’.  But is it?  On the other hand, Democrats advocating the expiration of the tax cuts to the wealthy should provide sound reasoning as we need some level of assurance that such a move would not compromise the recovery.  What were the tax cuts to the wealthiest intended to achieve?  What actually happened?  With debt rising in this nation to near historic levels and with the economy struggling to recover it is important that decisions be made on an information-based level.  As the public we should demand no less from our elected officials if indeed they represent the public.

Mark Twain once said, and credited the statement to Benjamin Disraeli, “There are three types of lies: lies, damn lies – and statistics”.  A point that one reader of this blog has made is that economic analyses have been spun by both conservatives and progressives to their own benefit.  For that reason it is important that we use hard numbers and tie them to periods where policy has been in place.  Our GDP, real gross investment, non-farms payroll, income, and federal gross debt are numbers we rely upon as a read of our economic health and they will be the ones referenced in this article.  Also, as conservative politicians argue that the effects of tax cut policy are quick, i.e., it gets money into the hands of the public rapidly (and I agree), it is unreasonable at the same time to assume a delayed effect from that policy, crediting for example the economic outcomes of one administration to the tax policies of a former administration as I have heard some argue.

Based on my study of this issue, I provide eight reasons as to why the tax cuts to the wealthiest of Americans should be allowed to expire.   References have been provided to support each point.  I have in some instances referenced past articles I have written that provide greater detail.  A discussion section follows where I will explore the intent behind creating deficits through tax cut policy.

The Eight Reasons

1.  The Key Objective of Tax Cut Policy, Stimulating US Capital Investment, Failed

Tax cuts, largely favoring the wealthiest in the nation who have high saving rates, were supposed to increase US capital investment that in turn would stimulate the economy.  This simply failed.  US capital investment in the decade following the Bush tax cuts was by far the weakest in the post WWII era (ref) (ref).  Additionally, the 1990’s, where supply-side tax cut policy was reversed (taxes were raised on taxable income above $250,000), experienced more than a 3-fold greater growth in US capital investment than did either of the supply-side tax cut periods under the Reagan/GHW Bush and GW Bush administrations (ref);  the authors concluded that without better investment growth being associated with supply-side tax cut policy it is difficult to draw any plausible connection between tax cut policy and any observed positive economic performance during the periods this policy was in place.

2.  Supply-Side Tax Cut Policy Has Been Ineffective in Stimulating US Jobs Growth

Median job growth (total non-farm payroll employment) since 1977 from the five complete Republican presidential terms where supply-side tax cut policy was in place versus the 3 complete Democratic presidential terms that utilized progressive tax rate policy was 2.6 million/term (0.0-10.8) versus 11.2 million/term (10.3-11.5), respectively (ref) (ref).  Jobs creation during the GW Bush years where tax cut policy was in place was the lowest since the presidency of Hoover (ref).  Additionally, time to sustained jobs growth following recessions where supply-side tax cut policy was in place was prolonged – 12 months (the 1990-1991 recession) and 22 months following the March – November 2001 recession).  In comparison, time to sustained jobs growth after the current Great Recession was 6 months following passage of the stimulus legislation (ref).

3.  Supply-Side Tax Cut Policy Offered No Advantage over Progressive Tax Rate Policy in Growing Our Economy

Overall, our Gross Domestic Product (the standard measure of our economy) experienced greater growth during progressive tax rate periods than supply-side tax cut periods from 1978-2005, 12.6% vs 10.7%, respectively.  Ranking the presidencies having the strongest to weakest GDP growth during that period: Clinton, followed by Reagan, followed by Carter, followed by GW Bush, followed by GHW Bush (ref).  These data argue that there was no advantage associated with supply-side tax cut policy versus progressive tax rate policy in growing the US economy.

4.  Supply-Side Tax Cut Policy Has Consistently Been Associated With Large Federal Deficits

Between 1977-2008, when expressed as a fraction of our economy, all 5 Republican presidential terms where supply-side tax cut policy was in place experienced substantial increases in gross federal debt;  all 3 Democratic presidential terms where progressive tax rate policy was in place experienced a reduction in debt (ref) (ref).  In 1980 our gross federal debt stood at less than $1 Trillion ($909 Billion); by the end of 2009, the last year of the GW Bush budgets, our gross federal debt stood at $12.3 Trillion (ref).  Although conservative politicians argue that the debt increase during the GW Bush presidency was the result a spending problem in Washington, CBO data showed that the tax cuts played a much larger role than domestic spending increases in fueling the deficits (ref).

5.  Tax Cut Policy Favoring the Wealthiest is an Unreliable Way to Stimulate the US Economy

Investors will invest where the return is the greatest – thus the inherent weakness in providing large tax cuts to the wealthiest to grow our economy.  The US participates in a global economy and many factors can influence where investment capital is placed.   As noted above, US capital investment in the decade following the Bush tax cuts was the lowest in the post WWII era (ref).  However, during this same period, there were record flows to high growth emerging market debt and equity funds.  In short, investment capital leaked out of the US into emerging foreign markets.  What is problematic about this point is that the tax cuts were the largest single contributor of the record deficits during the GW Bush years (ref).  We essentially drove up our national debt by borrowing heavily from China, for example, to support tax cuts intended to grow the US economy, that instead got invested back into China while business investment and employment lagged in the US – and the debt for this activity is being passed to our future generations.

6.  Supply-Side Tax Cut Policy Contributed To a Growing Inequality of Income

The average benefits of the Bush tax cuts are as follows – those with million+ dollar incomes: $10,000/mo; the middle 20% of America: $60/mo; those in the bottom 20%: $1.67/mo (ref).  Additionally, the tax cuts have been regressive regarding increase in post-tax income – those having million+ dollar incomes experienced an average increase of 7.6% in after tax income whereas the middle 20% of America received only a 2.3% average increase in income (ref).  Income inequality in the US has been tied to America’s two biggest economic crashes, the Great Depression and this recent Great Recession, where in both cases 1% of this country held almost a quarter of this nation’s income thus reducing the purchasing power of the remainder to buy what America produces (ref).  In the late 1970’s the top 1% claimed 8-9% of this country’s income.  By 2007 the top 1% claimed 23.5%, back to where they were prior to the Great Depression.  This is not all due to tax policy, but tax policy has been a contributing factor.

7.  The Wealthiest Already Have a Lower Tax Rate Than the Middle Class

Warren Buffet has often complained about a tax system where his 2006 tax rate (for federal income taxes and Social Security withholding) on $46 million of income was 17.7% while his secretary’s combined tax rate was 30% (ref).  The reason for this is that income from capital gains and stock dividends, that make up a disproportionate amount of income for the very rich, is taxed at 15% whereas the bulk of what the rest of America earns, wages and interest from savings accounts, is taxed at up to 35%.  Although the term ‘class warfare’ has been used by conservatives to describe increasing taxes on the wealthy, Mr. Buffett has said “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning” (ref).  Supply-side tax policy has given the wealthiest of American’s the means to increase their income streams from investments where returns are taxed at a lower rate than ordinary income thus lowering their overall tax rate below what the rest of America pays.  It must also be pointed out that during the Clinton years, and what president Obama is proposing, the wealthy pay the same level of tax as do all Americans on wages and interest up to $250,000 – it is only on taxable income above that level does the additional 3.6% tax apply.

8.  Letting the Tax Cuts Expire for the Wealthy Will Be Detrimental to Small Business is Myth

I speak from the experience of having founded and managed a multi-million dollar ‘small business’ in the 1990’s that employed up to 50 workers.  I was amongst the few percent of small business owners that had to pay the additional 3.6% on taxable income over $250,000.  There simply is no tax paid on money that is spent to grow a business.  All hiring, employee costs, leases for space and equipment, etc., including the owners health insurance (excluding FICA, my firm was a sub-S) are paid for with pre-tax dollars, not post-tax dollars.   A business is grown on strength of backlog.  It would be folly for an owner to invest in a business and hope that demand shows up on the doorstep.  Should a small business owner (LLC or Sub-S) be in the fortunate position of having taxable income over $250,000, once the taxes have been paid (corporate profit flows through the personal return) they can pull the profits from the company without further taxation and become the banker to the business, charging a competitive interest rate (good for the business) that more than makes up for the 3.6% surtax that the owner paid on those profits.  Additionally, should the business grow large enough, the owner can also consider converting the business to a C-corp which could lower the overall tax load as corporate profit does not flow through the personal return and is therefore not subject to the 3.6% surtax.  The additional 3.6% I paid on taxable income above $250,000 never once hindered my ability to hire or grow the business.

Discussion and Conclusion

The objective of increasing US capital investment and stimulating our economy through tax cuts largely favoring the wealthiest of Americans simply failed. During periods where supply-side tax policy was in place there is no evidence that it stimulated business investment, economic growth, or employment.  In fact, periods during which this policy was in place underperformed periods where progressive tax rate policy was in place.  The policy has substantially driven up national debt, contributes to lowering the overall tax rate of the wealthiest below that of the middle class, and contributes to income inequality that has been associated with both the Great Depression and this recent Great Recession.  But the most damning point about this policy is its unreliability to pump money into the US economy as investors, participating in a global economy, will place the benefit where it will get the best return.  During the 2000’s money we borrowed to support US investment went abroad, in some cases back to where we borrowed, and the debt being incurred to support foreign economies is being passed to our future generations.  Both the wealthy and ‘Wall Street’ have done quite well with this policy, but the rest of America and our future generations have not.

It has been repeatedly argued by Republican politicians, (McConnell, Boehner, Cantor and others) that we do not have a tax problem but rather a ‘spending problem’ in Washington.  Yet, time and again when pressed in interview the spending problem is left undefined.  In 2001 the Bush tax cuts went into effect when our country not only had a balanced budget (without borrowing from the entitlement programs), but surpluses that were paying down debt (ref).  In 2005, that year being post-recession and pre-economic crisis, this country ran over a half trillion dollar deficit with the tax cuts being the largest single contributor.  So if there is a ‘spending problem’, where does a half trillion dollars come out of the budget?  That amount is in the ball park of what we spend on Defense, or Medicare/Medicaid/CHIP, or Social Security every year (ref).

Starve the Beast

It would be naive to believe that five consecutive Republican presidential terms, all with substantial increases debt as a fraction of our economy, and three consecutive Democratic presidential terms, all with debt reduction, occurred by chance.  Truth be told, what is occurring with our deficits from the tax cut policies is intentional and relates to a conservative fiscal-political strategy called ‘Starve the Beast’ (ref) (ref).  The intent by the right is to use budget deficits via tax cuts to force future reductions in the size of government (the ‘beast’) and the programs it funds, particularly social programs such as welfare, Social Security, Medicare and public schools.  The difficulty I have with this strategy is that polling reveals that most of America, even those identified as Tea Party supporters, feel that Social Security and Medicare are worth the cost to taxpayers (ref).  This tactic is therefore deceitful to the American public that is not being given the opportunity to understand the nature of the sacrifice that will need to be made to support the tax cuts.

If our country is to seriously consider making the Bush tax cuts permanent, we should demand that the ‘spending problem’ be defined and where the cuts will come from so that the public has the opportunity to decide whether it agrees or whether it is willing to support the costs.  And if we feel that the programs are worth the cost, we do have room to move here on the tax front. Despite the rhetoric about the need to further reduce taxes, in 2009 our country’s tax bill was the lowest since 1950, when Harry Truman was in office (ref) and sits at only 15% of GDP (ref), below where it was when we had a balanced budget and surpluses during the Clinton years.  Additionally we have the healthcare legislation that is projected to cut our long-term fiscal imbalance by a quarter and reduce the projected deficit within Medicare by three-quarters ‘as long as Congress sticks to its guns and the Obama administration does a good job in carrying out the provisions of the law’ (ref).

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In conclusion, extending the tax cuts for the middle class during recovery makes sense as there is a greater chance that this benefit will be spent here at home and thus flow into our economy. However, based on the above, it is difficult to defend additional borrowing to keep the tax cuts to the wealthiest in place as long as the entitlement programs remain popular with the public.  So prior to any decision being made about a permanent extension of the Bush tax cuts, we should demand to have the budget cuts defined.

We should all be looking for substance, and honesty, in the upcoming negotiations.  We deserve arguments based on outcomes and information rather than subjective statements and spin that is all too often used to the benefit of special interests or in the name of ideology.  We should demand no less from our elected officials.