Howard University School of Law



THE ECONOMIC THEORY BEHIND THE DESIRE OF SOME ON CAPITOL HILL TO REDUCE FEDERAL INCOME (BY CUTTING TAXES) IN THE FACE OF STEADILY INCREASING EXPENSES:

THE QUESTION OF HOW TO REPLACE LOST REVENUES DUE TO TAX CUTS THAT MOSTLY BENEFIT THE WEALTHY

By

Professor W. Sherman Rogers



Is it a Fantasy to Claim That a Tax Cut Will Pay for Itself Because of a Corresponding Boost in Economic Growth?

PRELIMINARY NOTE:

The current top federal income tax rate is 39.6 percent (actually 43.4 percent for some due to provisions of the Affordable Care Act).

People are sometimes shocked to learn that the top rate was:

67 percent in 1917 (World War I related)

63 percent in 1932 and thereafter (Great Depression related)

94 percent in 1944 (World War II related)

70 percent and higher during the 1950s, 1960s, and 1970s

As you can see, there was a time when the federal government taxed the wealthy at high rates in order to pay the government’s bills. Interestingly, some of these high rates were in place when U.S. productivity was booming.

History of Federal Income Tax Rates: 1913 – 2017[pic]



Supply-Side Economic Theory

Supply-Side Economic Theory posits that if the government reduces tax rates and eliminates burdensome regulations, individuals and business firms will have an incentive to become more productive. See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 207.

Under supply-side theory, a cut in tax rates is assumed to increase tax revenues because, after the tax cut, people will have an incentive to work harder and make more money knowing that they will be able to retain more of their earnings because their earnings are being taxed at lower tax rates. Id. However, studies done subsequent to income tax cuts indicate that any revenue growth generated by the tax cuts replace only 15 to 30 percent of the massive losses in revenues caused by the tax cuts. See Glenn Kessler, Trump Aides are Trying to Sell Plan With a Pair of Four-Pinocchio Claims, Washington Post, October 1, 2017, sec. A4.

Commentators with a progressive/liberal view somewhat pejoratively refer to supply-side economics as trickle-down economics. See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 207.

What Programs are Typically Cut to Make-up for the Loss of Revenues Because of the Tax Cuts?

Research indicates that politicians who support the philosophy underlying supply-side economics tend to target “roughly two-thirds” of proposed tax cuts “from programs for low-and moderate-income people.” See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 8-9.

In other words, to replace the lost revenues due to the reduction in income taxes for the wealthy, supply-side supporters tend to slash programs for the poor, slash funding for infrastructure programs, slash funding for education, public libraries and similar programs. You will be able to vividly see how this works momentarily when you read about the real-life results of the Kansas experiment with supply-side economics and the disastrous consequences experienced by Louisiana in its experiment with supply-side economics.

The Wealthiest 1 Percent are the Primary Beneficiaries of the Proposed Trump Tax Cuts

The nonpartisan Tax Policy Center estimates that the top 1 percent of income earners, by 2027, would be receiving 79.7 percent of all the proposed Trump cuts. On the other hand, persons in the 80th to 90th percentile of earners would be getting NEGATIVE 5 percent. Interestingly, even 60 percent of upper middle class professionals (i.e., households between $150,000 and $300,000) would see an increase in their taxes according to the Tax Policy Center. See Matthew O’Brien, Tax Plan Gives the Richest What They Want….,” Washington Post, October 7, 2017, sec. A13. See also, Roger Lowenstein, A Loser Tax Plan—Unless You are Rich, Washington Post, October 1, 2017, sec. G1.

A poll by Bloomberg found that taxes were way down the list of Americans’ public policy wish list with only 4 percent claiming that it was their top concern. And a Pew Research Center study showed that what most Americans want more is for government to spend more to educate their children, rebuild infrastructure, and provide health care and an income safety net for the elderly, veterans and the deserving poor. See Steven Pearlstein, The Middle Class Does Not Want a Tax Cut, Washington Post, October 1, 2017, sec. G1.

Does the Supply-Side Economic Theory Work in Real Life?

Unfortunately, the only problem with supply-side theory is that it doesn’t work in real life. The claims of supply-side economics theoretically work when the starting tax rates are very high. However, when the government cut the federal income tax rate in 1981 and 1982, tax revenues declined and did not lead to faster economic growth as its proponents maintained. By the last two years of the Reagan administration, it had become apparent that supply-side economics was a concept whose time had come and gone. [i] See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 207.

The Kansas Experiment and the Louisiana Experiment With Supply-Side Economics

The Kansas Experiment

Dinah Sykes, a Republican member of the Kansas State Senate, discussed the disaster that the state experienced after five years of a “revolutionary” tax overhaul that promised to be a “shot of adrenaline to the heart of the Kansas economy.” These promises were based on the notion of supply-side economics. See Dinah Sykes, Washington Post, Kansas’s Lesson to Congress, October 20, 2017, sec. A19.

The Kansas experiment began in 2012 and mercifully ended in 2017. According to state Senator Sykes, as a result of the massive tax cuts enacted by the Kansas legislature:

Roughly 3,000 state employee positions were cut, salaries were frozen,

and road projects canceled. We delayed payments to the state employee

retirement system and emptied our savings accounts. Even as we issued more than $2 billion in new bonds to float our debt, Kansas received three credit down-grades, making that debt costlier.

In 2012, traditional budget forecasts models accurately predicted the

devastating effect the tax breaks would have on state revenue. Proponents of

the plan used dynamic scoring predicting incredible economic growth and

supporting their own preconceived ideas. Today, we know which forecasts

were correct.

Across the state, citizens may have been paying less in income taxes, but

those decreases were offset by increases in sales taxes, property taxes and

fees. These changes alone were not enough to put the state on the right path.

Education and infrastructure, key investments necessary for strong economic

growth, were treated as the enemy. As we went through our 2017 legislative

session, the ‘shot of economic adrenaline’ still showed no signs of

materializing. Our state functioned as though the Great Recession had never

ended.

Senator Sykes concluded by noting that “Kansas should serve as a cautionary tale” as “Republicans in Congress begin working to modify the federal code….”

The Louisiana Experiment

As of March 5, 2016, Louisiana’s experiment with trickle-down economics had left the state on “the brink of economic disaster.” As a result, news reports stated that without sharp and painful tax increases in the coming weeks, “[a] few universities will shut down and declare bankruptcy. Graduations will be cancelled. Students will lose scholarships. Some hospitals will close. Patients will lose funding for treatment of disabilities [and] [s]ome reports of child abuse will go uninvestigated.”[ii] See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 207.

Pope Francis’ View of Trickle-Down Economic Theory

Pope Francis, in a formal statement, lambasted the excesses of capitalism and trickle-down economics championed by conservatives. See W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 42-43.

In his statement, Pope Francis surprisingly made a direct reference to trickle-down economics. In this regard, Pope Francis pointedly noted that:

Some people continue to defend trickle-down [economic] theories, which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by the facts, expresses a crude and naïve trust in the goodness of those wielding power and in the sacralized workings of the prevailing economic system. Meanwhile, the excluded are still waiting.

The Classical School of Economics That Underlies Supply-Side Theory

Classical liberalism is a political ideology that advocates individual liberties, limited government under the rule of law and stresses economic freedom. It developed in the United States and Europe in the 1800s as a response to the industrial revolution and urbanization.[iii] W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 199.

Classical liberals view humans as motivated solely by pain and pleasure and the possibility of great reward or fear of hunger (i.e., greed and fear). They define liberty to mean freedom from government interference and the ability to organize relationships on the basis of free contracts between consenting adults. Accordingly, they believe that individuals should be free to pursue their own self-interest without control and restraint by society.[iv]

It is for this reason that classical liberals departed from earlier views that saw society as a family and, therefore, greater than the sum of its members. Instead, they view society as no more than the sum of its individual members. Accordingly, they do not desire a society where citizens work together to establish the governing framework for their interactions. This largely explains why they define liberty to mean freedom from government interference and the ability to organize relationships on the basis of free contracts between consenting adults.[v]

Therefore, it should not be surprising that classical liberal economists agree with the views of Thomas Malthus, who viewed the starvation of the masses as an acceptable means for limiting population growth among the poor whose increase in numbers would otherwise outstrip food production.[vi] Therefore, it should not be surprising that some see the classical school of economics with its emphasis on the efficient allocation of goods and services as social Darwinism.

These critics look upon classical economics as based on economic anarchy (i.e., the absence of any government regulation) that requires a blind reliance on market forces (i.e., the laws of supply and demand). They maintain that the consequences of adhering to classical economic thought results in the allocation of resources “to people who are most successful at gaining social power. Accordingly, the critics of classical economics maintain that, in an economist’s ideal world, the rich get richer and the poor get poorer. W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 195-196.

Notable contributors to classical liberalism over the years include Adam Smith, John Locke, Jean-Baptiste Say, David Ricardo, Thomas Hobbes, Thomas Malthus, Jeremy Bentham, John Stuart Mill, and Herbert Spencer. In the 20th century, Friedrich Hayek and Milton Friedman led a revival of interest in classical liberalism which some commentators refer to as “neo-classical liberalism.”[vii] Id. at 199.

Why Treasury Secretary Steven Mnuchin’s Statement That the Trump Tax Plan Would Cut Down the Deficit by a Trillion Dollars Earned Him a Number Four Pinocchio Rating for Making a Patently False Statement

Treasury Secretary Steven Mnuchin stated in an interview with Fox News on September 28, 2017 that the Trump Administration’s proposed tax cuts would cause $2 trillion in economic growth and cut the nation’s budget deficit by a trillion dollars. See Glenn Kessler, Trump Aides are Trying to Sell Plan With a Pair of Four-Pinocchio Claims, Washington Post, October 1, 2017, sec. A4.

However, “[n]o serious economist believes that a tax cut boosts economic growth so much that the tax cut pays of itself, let alone reduces the deficit.” Id. Credible evidence from both Republican and Democratic sides of the aisle indicate revenue generated from a tax cut, at most, “is 35 cents on the dollar” for every dollar of revenue that is lost as a result of the tax cut. Id. citing William A. Niskanen, Chairman of President Reagan’s Council of Economic Advisors.

Similarly, “[t]he Congressional Budget Office in 2005, under Douglas Holtz-Eaton, a Republican, estimated that a 10 percent reduction in federal tax rates” would produce no more than a 15 cents to 30 cents of every dollar of revenue that was lost as a result of the tax cut. Accordingly, the article took the position that “it’s a fantasy to claim that the tax cut will pay for itself—and even reduce the deficit—especially in an economy that already had a low unemployment and a booming stock market.”

Why Gary Cohn, the Director of the White House Economic Council, Received a Number Four Pinocchio Rating for Making the Patently False Statement That The Wealthy are not Getting a Tax Cut Under the Proposed Trump Plan.

The Wealthy Disproportionately Benefit From Any Income Tax Cuts

Gary Cohn, the Director of the White House Economic Council, made a false statement on September 28, 2017 when he stated in an interview on ABC’s Good Morning America that “[t]he wealthy are not getting a tax cut under [President Trump’s proposed tax] plan.

However, the truth is that “the vast majority of American taxpayers pay little or nothing in income taxes; they instead mostly pay payroll taxes such as Social Security and Medicare. So it strains credulity for administration officials such as Cohn to say the wealthy will not get a tax cut.”

Indeed, in 2016, the top 1 percent of income earners paid 24.5 percent of federal income taxes; the top 10 percent of income earners paid 80 percent of federal income taxes; and the top 20 percent of income earners paid 94.8 percent of federal income taxes. And the Trump tax plan drops the top tax bracket from 39.6 percent to 35 percent and allows for the possibility of a 25 percent rate through ownership of a pass-through entity. Therefore, when you cut income tax rates, it mostly benefits the wealthiest taxpayers. Id.

Conclusion

Economists generally agree that when the government attempts to help the poor and downtrodden by diverting money from those who produce it through tax and spend programs, it harms economic efficiency by weakening the incentives of producers to work, save, and to invest.[viii] “[O]n the other hand, leaving matters to the capitalistic free market system can worsen inequality by widening income and wealth gaps.”[ix] W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 317-318.

Studies indicate that in 2010, the average member of the top 1 percent in America made 92 times as much income as the average member of the lowest 20 percent of earners in. But after factoring in the effect of government benefit programs—e.g., food stamps, social security, the tax code and other programs—the ratio was 43 to 1.[x] Accordingly, some economists believe that government should be concerned not only with achieving economic efficiency but in an equitable distribution of income. These economists believe that government should be willing to sacrifice some efficiency to gain greater equality.

The central question in the American political debate today is whether people—who are the sole producers and consumers of wealth—should be able to exclusively decide how they wish to spend their money; or whether the government should have a significant role, a small role, or no role at all in deciding how it will spend people’s money that it coercively takes from them through its ability to impose taxes.

All nations say that production is for its people. But that does not answer the question of who gets what and how much. In Scandinavian countries, for example, the government distributes the proceeds of production fairly evenly to their citizens because of their relatively high taxation of the rich.

On the other hand, in many developing nations, the wealthiest 1 percent of the population receives most of the nation’s output while the remainder of the population lives at a subsistence level.

In the United States and most industrialized nations, there are typically a few rich families, a fairly large middle class, and a minority of poor people. Accordingly, countries vary in how they determine how they will slice up their economic pie. [xi]

One commentator has noted that capitalism can create prosperity but, if left unfettered, it doesn’t create broadly shared prosperity — and never will. In his opinion, if belief and participation in democracy are sustained by people’s conviction that democracy produces good economic outcomes, then the growing concentration of wealth and income in the United States is a long-term threat to everything we profess to stand for. And he warns that a nation where 93 percent of income growth goes to the top 1 percent is not a nation that will embark on great projects, or long command the allegiance of its people.[xii] W. Sherman Rogers, Winners and Losers in the American Capitalistic Economy: A Primer, 317-318.

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[i] Ibid., 175.

[ii] Chico Harlan, “Deficit Leaves Louisiana at the Brink of Disaster,” Washington Post, March 5, 2016, sec. A1.

[iii] Classical_liberalism, .

[iv] Ibid.

[v] Danielle Allen, “The Land of the Free? Don’t Be So Sure,” Washington Post, May 1, 2015, Sec. A9.

[vi] See Jay Hanson, Economic Efficiency as Social Darwinism, . See also Classical_liberalism, .

[vii] Classical_liberalism, .

[viii] Robert J. Samuelson, “Poof Goes the Big Tradeoff,” Washington Post, May 11, 2015, sec.A17.

[ix] Ibid.

[x] Zachary A. Goldfarb, “Income Gap: Is Obama Making a Difference?” Washington Post, August 3, 2014, sec. G1.

[xi] Steve Slavin, Economics: A Self-Teaching Guide (Hoboken, NJ: Wiley & Sons, Inc., 1999), 32-33.

[xii] Harold Meyerson, “The Rich are Different; They Get Richer,” Washington Post, March 27, 2012 (citing to a study Berkeley economist Emmanuel Saez).

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