George H.W. Bush famously called it voodoo economics. Ronald Reagan called it a winner and took the White House in a landslide, and it’s been a mainstay of Republican fiscal policy ever since.
“It” is the tenet that cutting income taxes will generate enough growth that the lower tax rates will increase the amount of taxes flowing into the government.
Like Reagan, Republicans pursuing the White House in 2016 want to cut taxes. Unlike Reagan, though, they’re not promising a flood of new tax revenues.
“We’ve seen a number of episodes where it didn’t work,” said Kevin Logan, chief economist for HSBC Securities (USA) Inc., an arm of the giant global bank HSBC, pointing to the 2001 and 2003 tax cuts under President George W. Bush, which helped turn a budget surplus into a steep deficit.
At the state level, Republican Gov. Sam Brownback of Kansas slashed tax rates in 2012 and is now struggling with budget shortfalls exceeding $600 million.
The idea that lower taxes would lead to higher tax collections started with economist Arthur Laffer. If Reagan’s 1981 tax cuts have been the guiding star of Republican fiscal policy for decades, Laffer was the astronomer who led Reagan, and the party, to it.
The center point of his theory was his Laffer Curve, which holds there is a point at which taxes are so high that they discourage work and thus generate less revenue. Lowering taxes, the theory holds, should boost the economy so much that more people will make more money, pay more taxes and flood the treasury.
When Reagan ran in 1980, the economy was in deep trouble. Inflation was skyrocketing. Interest rates were sky high. And the top marginal income-tax rates topped 70 percent, meaning the federal government took 70 cents out of every dollar over a certain level of taxable income.
“Laffer comes along a time when there was increasing attention . . . to that issue,” said Gene Steuerle, a former Treasury official under Reagan.
Reagan pushed through sweeping tax cuts, slashing the top rate from 70.1 percent to 28.4 percent and the lowest rate from 14 percent to 11 percent. The reductions helped stimulate the economy.
It wasn’t just lower tax rates that provided the lift. The Federal Reserve was quashing inflation, Reagan’s predecessor Jimmy Carter had launched deregulation efforts, and government purchases – while creating a deep deficit – stimulated the economy too.
“The notions that formed the basis of the Reagan recovery . . . were not all Art Laffer’s influence,” reminded Jim Miller, part of Reagan’s inner circle on economic policy and his budget director for three years.
Miller led Reagan’s effort to reduce government regulation, and he said there was “something of a consensus set of recommendations” to also reduce government and lower government spending.
An arms race with the former Soviet Union meant that government debt swelled under Reagan. Today debt again is punishingly high, and there’s little economic evidence that trimming the top individual income-tax rate from 39.5 percent to, say, 35 percent would generate more revenue than it loses for a fiscal outlook deeply in the red.
In fact, the 10-year budget resolution recently passed by the Republican-controlled Congress assumes no changes to tax policy.
“They recognize that their ambitions to balance the budget require such large spending reductions that further revenue cuts are unrealistic,” said Logan, the HSBC economist.
Debt held by the public stands around $13 trillion, and overall government debt is above $18 trillion.
After Reagan, George H.W. Bush raised tax rates.
But since he was ousted in 1992, much of the Republican push during presidential races has been to lower tax rates with the expectation that it would unleash economic activity and more revenue would follow.
“I’m willing to be another Ronald Reagan, if that’s what you want,” Bob Dole said while courting the 1996 nomination. Following through, he later dropped his opposition to what was also called supply side economics and proposed tax cuts.
George W. Bush proposed reducing taxes in his 2000 campaign and then passed two broad cuts as president, though he was financing the tax reductions from a rare federal budget surplus.
Sen. John McCain of Arizona, the GOP’s candidate in 2008, hired Laffer as a personal adviser. Mitt Romney championed Laffer’s view of lowering taxes to raise revenue during his unsuccessful presidential bid in 2012.
Today the major candidates have all sought Laffer’s blessing, many advocating a flat tax like the 9-9-9 Plan offered by 2012 candidate Herman Cain and endorsed by Laffer.
Gone, however, is the promise to raise more revenue by cutting taxes.
It’s not to say Laffer’s theory no longer carries weight. Several state governors cited him in recent years when lowering their own state tax rates.
The Kansas experience led to even more experts questioning the Laffer Curve, but Brownback protégé Rep. Paul Ryan, R-Wis., is not among them.
“What I know, and what is new from when Art did his curve . . . is we are in a global economy now, where we have far more mobile capital than ever before,” Ryan, now chairman of the tax-writing House Ways and Means Committee, told McClatchy at a recent breakfast with reporters. “In the 20th century, we were the undisputed economic leading superpower in the free world – in the world – so it didn’t matter as much where our tax rates were vis-a-vis capital mobility. Well, it sure as heck does now.”
But that’s an argument for lowering taxes to boost competitiveness. It’s not saying that lower taxes will generate more revenue.