The ever-changing, ever-elusive rationale for tax cuts
Understanding the "big, beautiful bill"
The recent House-passed Republican budget bill1 costs out at about $3.8T in tax cuts over ten years, much of which comes from extending the 2017 Trump tax cuts.
It’s the same old story — Republican administrations going all the way back to Reagan as a matter of course go big on taxes their first year. Tax cuts have become an integral part of the Republican identity, especially after President GHW Bush reneged on his “no new taxes” campaign pledge in 1990 and was punished at the polls two years later. Lesson learned!
Tax cuts: the all-purpose remedy
What’s amazing is that tax cuts have taken on a snake oil-type quality as advocates have pushed for them as a cure for any imaginable economic ill and, moreover, as an all-purpose prophylactic regardless of the health of the patient.
Let’s take a look at, and evaluate, the varied and sometimes contradictory rationales for tax cuts that have been put forward these last 45 years:
— Tax cuts reduce deficits: In the mid-late ‘70s, as deficits soared, economist Arthur Laffer met with policymakers to sell the idea that dramatic tax cuts would unleash so much economic growth that revenues would pour into government coffers at such a rate that the budget would begin approaching balance. One of the converts to this idea was soon-to-be president Ronald Reagan.
As it turned out it didn’t work out that way, as deficits continued to grow after the tax cuts of 1981 — a turn of events Reagan was warned about by his OMB director David Stockman. Stockman told Reagan massive spending cuts would need to be implemented in tandem with the tax cuts to produce the desired result. Tax rates may have been too high at that time, he argued, but they weren’t so high that they were suffocating the economy as Laffer claimed.
So do tax cuts reduce deficits? The verdict is a resounding “no”. In fact increasing taxes may be more likely to do the trick in the right circumstances, as evidenced by the effects of the higher rates imposed on wealthier people by Clinton and the Democrats in the 1993 budget bill. They were a key factor in producing the balanced budget that was achieved five years later.
— Tax cuts will increase the deficit, but they will also force lawmakers to cut spending thus helping to reduce the deficit: The “starve the beast” theory put forth by Grover Norquist was that cutting taxes would force the hand of policymakers who would be spooked by higher deficits into cutting spending.
Norquist couldn’t have been more wrong. As noted in an overview put out by the Niskanen Center, studies going back almost 70 years have shown that tax cuts lead to more spending. The reason? Tax cuts create a kind of fiscal illusion, according to the late conservative economist James Buchanan, causing spending to feel cheaper than it really is. As Christina and David Romer wrote (quoted in the Niskanen report): “A tax cut without an associated spending cut weakens the link in voters’ minds between spending and taxes, and so leads them to demand greater spending.”
The bottom line — tax cuts have no track record of leading to spending cuts; quite the opposite is in fact true.
— Tax cuts grow the economy: All other things being equal (as economists like to say) tax cuts mean more money in people’s pockets and corporate coffers, some of which could be put to productive purposes thus enlarging the economic pie. The tax cut advocates have a point here, but there is a big caveat. If tax cuts are deemed to be excessive or inadvisable by investors for fear of government debt getting out of control, they — the investors — may demand a greater return on government bonds raising borrowing costs for government. Higher interest rates stemming from tax cuts might, then, actually lead to economic contraction. This may be the situation that pertains today.
So do tax cuts grow the economy? The verdict is mixed — tax cuts can be a good idea or not, depending on economic conditions.
— Tax cuts are the right thing to do if the government is flush: Alas, we may not in our lifetimes again see a day when the government runs a surplus. The last time there was one in 2001 — and it was big! — the case was made by George W. Bush that taxpayers deserved to have their money returned to them if the government was covering its bills.
Well, unfortunately, due to the 2001 Bush tax cuts and other factors (including national security spending in response to 9/11) the government started running deficits again within less than two years.
Summing it all up: the varied rationales for tax cuts are either specious or at best half-right. Still, “thou shalt cut taxes” remains at the top of the list of GOP commandments.
Let’s face it: tax cuts are good politics
The explanation for the rigid adherence to tax cut ideology is pretty obvious. It’s the politics, stupid. For decades beginning in the 1930s the Democrats had a political-fiscal theory that worked wonders. Tax people with lots of money and distribute benefits to key constituencies that will support the party come election day. FDR’s advisor, Harry Hopkins, probably never said “tax and tax, spend and spend, elect and elect” as he has been alleged to have done, but the tax+spend = elect idea was indeed what brought the New Deal coalition together.
What was the Republicans’ competing political-fiscal theory in that era? Keep spending in check and, if necessary, increase taxes for the purpose of making sure the government lives within its means. Sounds responsible, right? A winning philosophy? Not so much.
Reagan and the Laffer-led supply-siders changed all that. Tax cuts were a way to reward people, especially key constituencies. Are they always the right thing to do? Not economically, but you can’t gainsay their political value. With the tax cut ideology Republicans now had a popular political-fiscal theory, and a remarkably flexible one at that.
What the debate on the 2025 budget bill is really about
So, as we sit back ready to enjoy the coming debate surrounding the Senate’s consideration of the House-passed budget bill, keep this in mind: the economic arguments in favor of the bill are fatuous, but rest assured that the politics of it are very carefully considered.