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Kevin Korenthal: Tax cuts can help the US economy

Posted: December 7, 2012 2:00 a.m.
Updated: December 7, 2012 2:00 a.m.
 

A majority of Americans voted to re-elect President Obama despite or maybe because of the economy. Doesn’t that mean he should be allowed to put his signature economic policy into practice? Obama has long championed allowing the expiration of the Bush tax cuts on families earning more than $250,000 per year, plus additional tax hikes for that income level. All of this is intended to raise revenue to pay for spending and to reduce the budget deficit. But questions remain as to how much revenue raising tax rates will generate on a dollar-for-dollar basis, because $1 trillion in stimulus spending proved that giving money to the government does not have a good return on investment.

So I think this is a good time to discuss an alternative method for raising revenue through taxes. “Supply-side economics” is a method of raising tax revenue that does not include raising taxes. Here’s how it works: (via Wikipedia) “economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as lowering income tax and capital gains tax rates…” The benefit of allowing Americans to keep more of the money that they’ve earned has been demonstrated a number of times through history. In each instance, tax revenue and economic activity grew while the number of jobs that were produced in subsequent months increased. Calvin Coolidge, John F. Kennedy, Ronald Reagan and George W. Bush all used tax cuts to prime the faltering economies of their time.

The logic of supply-side economics is best represented in a diagram called the Laffer curve. Arthur Laffer, a member of Reagan’s Economic Policy Advisory Board is said to have first illustrated this diagram on a napkin at a Washington, D.C., restaurant in a conversation with disbelieving colleagues. Represented as an arc, it depicts two extremes in taxation: taxing at a rate of 0 percent and taxing at a rate of 100 percent. The amount of revenue at either extreme is zero because you don’t produce revenue at a 0 percent tax rate and at 100 percent you have zero revenue because there is no motivation to be productive when every dollar earned goes to the government. Interestingly, the net effect of lowering tax rates on upper income earners is that they pay more taxes to the government. As the marginal tax rate on earners in the highest tax bracket was cut (under President Calvin Coolidge) from a maximum of 73 percent to 25 percent, taxes paid by that group soared from roughly $300 million to $700 million per year. This result is explained by the fact that the rich introduce (rather than hide) more money into the economy in the form of economic investment and capital purchases, when the rate of taxation on them is lessened. In each instance that tax rates were cut, tax revenue increased (a $785 billion increase under George W. Bush alone).

So if more revenue is the goal why aren’t both parties supporting lower tax rates? The answer comes in the form of an unfortunate fact about previous tax cuts. They were followed by increased spending. It does not matter how large a payment you make on the credit card, if you keep spending that much or more on it each month the debt keeps growing. Same is true of America’s “credit card.” Thus, increased spending that occurred separate to the tax cuts has been made the scapegoat for why tax cuts have not produced sustained economic growth or lower deficits.

A tax cut is like an individual getting a raise at work. What that individual does with the extra money is what determines the net benefit or negative that the extra money has on that person’s finances. If the raise is used to pay for savings or to pay off debt, it has a net benefit, but if the new found income is used to buy more stuff there is little to no benefit. And that is generally how America has squandered the revenue that was generated through lowering tax rates. The key is to lower rates and spending simultaneously.

The president is likely to stick with his plan to raise tax rates. That leaves Republicans with only one option to maintain fiscal sanity and that is to insist on real spending cuts. It is difficult to imagine however that the president is interested in cutting spending, so Republicans should stand firm against higher tax rates.

Kevin D. Korenthal is a conservative policy consultant and 30-year Canyon Country resident.

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