This column by ACRU General Counsel and Senior Fellow for the Carleson Center for Public Policy (CCPP) Peter Ferrara was published April 19, 2012 on Forbes.com.
Persistent economic fallacies hurt working people and the poor the most. They are the ones most in need of the new jobs and higher wages that capital investment and economic growth produce. And they suffer the most from unemployment and declining wages and incomes when the economy falters. Self-styled Progressives are the source of the economic fallacies that are hurting working people and the poor today.
One common fallacy popular among self-proclaimed Progressives is to reply to the point that America now has the highest corporate tax rate in the industrialized world at nearly 40% with the counter that the average effective corporate tax rate is only around 25%. But it is the marginal tax rate on the next dollar earned, not the average rate, that influences new investment, business expansion, and hiring.
Pro-growth tax reform would involve reducing that top rate in return for closing many of the loopholes that make the average rate so much lower. The average rate would rise as a result. But the lower marginal rate would increase incentives for more capital investment, business expansion and job creation.
Another fallacy among Progressives is to argue that America has enjoyed historically low taxes under President Obama with federal revenues around 15% of GDP compared to the long-term, postwar average of 18.3%. But that is due to the persistent weakness of the economy under Obama, which lowers federal revenues as a percent of GDP, as bankrupt businesses and unemployed workers pay little or nothing in taxes.
Again, what influences the capital investment, business start ups, and business expansion that creates jobs and bids up wages for working people and the poor are the marginal tax rates, not taxes as a percent of GDP. Obama has persistently focused on raising those marginal tax rates across the board, the exact opposite of what Reagan did with so much success, which is a main reason Obama is getting the opposite results of Reagan. Obama has recently taken to citing Reagan for the opposite of what he believed and implemented as President, in claiming his support for the so-called Buffett Rule. But the real economy will not be fooled, and working people and the poor will not benefit from dishonest rhetoric.
When the economy recovers, with more businesses making more profits, and more workers earning more in income, federal revenues as a percent of GDP will rise. That is how Paul Ryan’s budget is scored by CBO as restoring federal revenues to their long term postwar historical average at 18.3% even while cutting corporate and personal income tax rates sharply. Cutting those rates as Ryan proposes will lead to stronger recovery sooner because of the incentive effects of those lower rates, an effect not even counted by CBO.
Progressives also purport not to understand the multiple taxation of capital. Under our tax system the earnings from capital investment are taxed not once, but multiple times. First, by the corporate income tax, then again by the individual income tax through the tax on dividends, then if you sell the capital investment, through the capital gains tax, then when you die, by the death tax. When Progressives like Obama complain that the rich are not paying their fair share, they are just looking at the rate on any one of these taxes, and not considering all of the others.
The tax on capital gains is especially egregious because the market price of any capital asset just reflects the present discounted value of the future income stream to be produced by that asset, which will be taxed when it is earned. Progressives claim that they can’t understand all that math, but it means the capital gains tax itself is inherently a double tax. It is like taxing an orchard not only by taking some of the apples it produces, but also taking some of the trees in taxes as well.
Moreover, it is worse, because some of the gain taxed is just inflation and not real. It is like assessing a tax on some imaginary apples as well. These are all reasons why there should not be any tax on capital gains at all. It is enough to take some of the apples. Taking some of the trees as well is just abusive, multiple overtaxation. That means not just unfair tax piracy, but the squelching of the capital investment at the root of jobs and rising wages and incomes for working people and the poor.
These are the reasons why fourteen out of thirty OECD countries, plus China, Taiwan, Hong Kong, Singapore, and others, already enjoy zero capital gains taxes. They can understand it, but America’s “Progressives” cannot. This is part of the reason why these countries have been booming, while America is stagnating. “Progressives” seem to think of economic growth and prosperity as just occurring naturally, like trees growing in the forest. They don’t see the decisions made by investors to put their capital at risk, the decisions by entrepreneurs to start or expand businesses, the decisions by employers to hire new workers, and how incentives affect those decisions. When “Progressives” hold governing power, their blindness becomes America’s blindness, and the American Dream recedes.
Failure to understand this multiple taxation of capital is why “Progressives” also do not understand that “the rich” actually pay almost all of the federal income taxes, not the middle class. Even before President Obama was elected, official IRS data showed that in 2007 the top 1% of income earners paid 40.4% of all federal income taxes, almost twice their share of adjusted gross income. The top 5% paid 60.6% of all federal income taxes, while earning 37.7% of adjusted gross income. The top 10% paid 71.2% of all income taxes, while earning 48% of adjusted gross income.
By contrast, the bottom 95% of income earners paid 39.4% of all federal income taxes. That means the top 1% of income earners paid more federal income taxes than the bottom 95% combined! This is before all the tax rate increases President Obama has already enacted into current law go into effect next year, and the confused “Buffett Rule” he wants to enact on top. These “Progressive” tax policies are unhinged from reality. The “rich” already pay more than their fair share.
“Progressives” also suffer from the Keynesian fallacy that what drives economic recovery and growth is government spending, deficits and debt. At least that notion has a respectable academic pedigree, even though that is actually all phony political posturing by academics playing politics. While some government spending does help the economy, increased federal spending, deficits and debt are all on net a further drag on the economy, which is why the stimulus did not work, and was actually counterproductive in slowing and delaying recovery. Borrowing a trillion dollars out of the economy to spend it back in is all a net wash at best. What drives economic recovery, growth and prosperity is production, not spending, and what drives production is market incentives, not government spending, deficits and debt.
The failure of “Progressives” to understand that is why we have had no real recovery. It is why we have suffered the longest period of unemployment this high since the Great Depression, with an all time record of long term unemployment for more than 6 months, more Americans in poverty than at any time in the more than 50 years that the Census has been tracking poverty, and declining real wages and incomes. “Progressivism” is supposed to be about fairness. But what is fair about any of that?
A final major economic fallacy of many Progressives is that the stratospheric income tax rates of the 1950s, with the top income tax rate at 91%, should be restored, as the economy perked along just fine in that decade. But in the 1950s all the major economic competitors of the U.S. had been bombed out just a few years before by World War II. And the exploding young families of the postwar baby boom produced a housing and consumer goods boom. Yet, even with those enormous advantages the period was plagued by four recessions, November, 1948 to October, 1949, July, 1953 to May, 1954, August, 1957 to April, 1958, and April, 1960 to February, 1961. Liberals at the time complained that economic growth under Eisenhower was inadequate.
John F. Kennedy came into office calling for cuts in those tax rates to get the economy booming. He explained,
“It is a paradoxical truth that tax rates are too high today, and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the tax rates….[A]n economy constrained by high tax rates will never produce enough revenue to balance the budget, just as it will never create enough jobs or enough profits.”
Kennedy’s proposed tax rate cuts were adopted in 1964, cutting the top tax rate from 91% to 70%, as well as reducing the lower rates by similar degrees. The next year, economic growth soared by 50%, and income tax revenues increased by 41%! By 1966, unemployment had fallen to its lowest peacetime level in almost 40 years. U.S. News and World Report exclaimed, “The unusual budget spectacle of sharply rising revenues following the biggest tax cut in history is beginning to astonish even those who pushed hardest for tax cuts in the first place.” Arthur Okun, the administration’s chief economic advisor, estimated that the tax cuts expanded the economy in just two years by 10% above where it would have been.
Reagan delivered quite similar results first by cutting tax rates by 25% across the board through Kemp-Roth in 1981. Then in the 1986 Tax Reform Act, he reduced the top tax rate from 70% when he entered office all the way down to 28%, with only one more rate for the middle class at 15%. (The poor were exempted from income taxes under Reagan’s policies).
As a result, the stagflation of the 1970s ended, and by late 1982 the economy took off on a 25-year boom, what Art Laffer and Steve Moore call in their book The End of Prosperity “The greatest period of wealth creation in the history of the planet.”
During the first 7 years alone, the economy grew by almost one-third, the equivalent of adding the entire economy of West Germany, the third largest in the world at the time, to the U.S. economy. Nearly 20 million new jobs were created during just those 7 years, increasing U.S. civilian employment by almost 20%.
Real per capita disposable income increased by 18% from 1982 to 1989, meaning the American standard of living increased by almost 20%, in just 7 years. This was reflected in income increases in every income quintile. The poverty rate declined every year from 1984 to 1989, dropping by one-sixth from its peak. Yet, despite the dramatic rate cuts, federal revenues doubled during the 1980s.
Similarly, helping to extend the Reagan recovery into the 25-year boom, Congressional Republicans led by then House Speaker Newt Gingrich pushed through a capital gains tax rate cut of nearly 30% in 1997, from 28% down to 20%, expanded IRAs, and other tax cuts on capital. Despite the 30% capital gains rate cut, capital gains revenues were $84 billion higher for 1997 to 2000 than projected before the rate cut. This was a bipartisan success because Bill Clinton went along with it.
George W. Bush then cut income tax rates across the board again in 2001, cutting the lowest rate more than the highest rate. In 2003, Bush cut the capital gains tax rate by 25%, and the income tax rate on corporate dividends by over half. These tax rate cuts first quickly ended the 2001 recession, despite the contractionary economic impacts of 9/11, and the economy continued to grow for another 73 months. After the rate cuts were all fully implemented in 2003, the economy created 7.8 million new jobs and the unemployment rate fell from over 6% to 4.4%. (That unemployment rate will never be seen again in America until the “Progressive” Obama leaves office.) Real economic growth over the next 3 years doubled from the average for the prior 3 years, to 3.5%.
In response to the rate cuts, business investment spending, which had declined for 9 straight quarters, reversed and increased 6.7% per quarter. That is where the jobs came from. Manufacturing output soared to its highest level in 20 years. The stock market revived, creating almost $7 trillion in new shareholder wealth. From 2003 to 2007, the S&P 500 almost doubled. Capital gains tax revenues had doubled by 2005, despite the 25% rate cut!
But the economy still did not perform at its best during the Bush years because monetary policy began to veer off track, with the Bush cheap dollar policy replacing the Reagan strong dollar policy. That combined with the continuation of Clinton’s affordable housing, subprime mortgage, regulatory excesses produced the financial crisis that ended Reagan’s 25 year boom. Obama has since prevented any real recovery from that crisis, with his “Progressive” economic fallacies.
Over the entire 25 year economic boom, 50 million new jobs were created. Real per capita consumption increased by over three-fourths, unprecedented in world history over such a short period. As Steve Forbes wrote in Forbes magazine in 2008,
“Between the early 1980s and 2007 we lived in an economic Golden Age. Never before have so many people advanced so far economically in so short a period of time as they have during the last 25 years. Until the credit crisis, 70 million people a year [worldwide] were joining the middle class. The U.S. kicked off this long boom with the economic reforms of Ronald Reagan, particularly his enormous income tax cuts. We burst from the economic stagnation of the 1970s into a dynamic, innovative, high tech-oriented economy. Even in recent years the much maligned U.S. did well. Between year-end 2002 and year-end 2007 U.S. growth exceeded the entire size of China’s economy.”
In other words, the growth in the U.S. economy from 2002 to 2007 was the equivalent of adding the entire economy of China to the U.S. economy.
Going back to the untutored, nave tax policies of the 1950s for the religious superstition of Marxism parading as tax policy would relatively reverse all of these enormous, bipartisan gains. But that is what many “Progressives” are urging, because “Progressive” is simply a polite, Americanized term for “Marxist” after all.