Paulo Roberto de Almeida
CAPITAL
IDEAS
Do Tax Cuts Lead to Economic Growth?
The New York Times,
September 15, 2012
FOR one of my occasional conversations with
Representative Paul D. Ryan over the last few years, I brought a chart. The
chart showed economic growth in the United States in the last several decades,
and I handed Mr. Ryan a copy as we sat down in his Capitol Hill office. A
self-professed economics wonk, he immediately laughed, in what seemed an
appropriate mix of appreciation and teasing.
One of the first things you notice in the chart is
that the American economy was not especially healthy even before the financial
crisis began in late 2007. By 2007, remarkably, the economy was already on pace
for its slowest decade of growth since World War II. The mediocre economic
growth, in turn, brought mediocre job and income growth — and the crisis more than erased those gains.
The defining economic policy of the last decade, of
course, was the Bush tax cuts. President George W. Bush and Congress, including
Mr. Ryan, passed a large tax cut in 2001, sped up its implementation in 2003
and predicted that prosperity would follow.
The economic growth that actually followed — indeed,
the whole history of the last 20 years — offers one of the most serious
challenges to modern conservatism. Bill Clinton and the elder George Bush both
raised taxes in the early 1990s, and conservatives predicted disaster. Instead,
the economy boomed, and incomes grew at their fastest pace since the 1960s.
Then came the younger Mr. Bush, the tax cuts, the disappointing expansion and
the worst downturn since the Depression.
Today, Mitt Romney and Mr. Ryan are promising another cut in tax rates and again
predicting that good times will follow. But it’s not the easiest case to make.
Much as President Obama should be asked to grapple with the economy’s
disappointing recent performance (a subject for a planned column), Mr. Romney
and Mr. Ryan would do voters a service by explaining why a cut in tax rates
would work better this time than last time.
That was precisely the question I was asking Mr. Ryan
when I brought him the chart last year. He wasn’t the vice presidential nominee
then, but his budget plan has a lot in common with Mr. Romney’s.
“I wouldn’t say that correlation is causation,” Mr.
Ryan replied. “I would say Clinton had the tech-productivity boom, which was
enormous. Trade barriers were going down in the Clinton years. He had the peace
dividend he was enjoying.”
The economy in the Bush years, by contrast, had to
cope with the popping of the technology bubble, 9/11, a couple of wars and the
financial meltdown, Mr. Ryan continued. “Some of this is just the timing, not
the person,” he said.
He then made an analogy. “Just as the Keynesians say
the economy would have been worsewithout
the stimulus” that Mr. Obama signed, Mr. Ryan said, “the flip side is true from
our perspective.” Without the Bush tax cuts, that is, the worst economic decade
since World War II would have been even worse.
Since that conversation, I have asked the same
question of conservative economists and received similar answers. “To me, the
Bush tax cuts get too much attention,” said R. Glenn Hubbard,
who helped design them as the chairman of Mr. Bush’s Council of Economic
Advisers and is now a Romney adviser. “The pro-growth elements of the tax cuts
were fairly modest in size,” he added, because they also included politically
minded cuts like the child tax credit. Phillip L. Swagel, another former Bush
aide, said that even a tax cut as large as Mr. Bush’s “doesn’t translate
quickly into higher growth.”
Why not? The main economic argument for tax cuts is
simple enough. In the short term, they put money in people’s pockets. Longer
term, people will presumably work harder if they keep more of the next dollar
they earn. They will work more hours or expand their small business. This
argument dominates the political debate.
But tax cuts have other effects that receive less
attention — and that can slow economic growth. Somebody who cares about hitting
a specific income target, like $1 million, might work less hard after receiving
a tax cut. And all else equal, tax cuts increase the deficit, as Mr. Bush’s did,
which creates other economic problems.
When the top marginal rate was
70 percent or higher, as it was from 1940 to 1980, tax cuts really could make a
big difference, notes Donald Marron, director of the highly regarded Tax Policy
Center and another former Bush administration official. When the top rate is 35
percent, as it is today, a tax cut packs much less economic punch.
“At the level of taxes we’ve been at the last couple
decades and the magnitude of the changes we’ve had, it’s hard to make the
argument that tax rates have a big effect on economic growth,” Mr. Marron said.
Similarly, a new report from the nonpartisan
Congressional Research Service found that, over the past 65 years, changes in
the top tax rate “do not appear correlated with economic growth.”
Mr. Romney and Mr. Ryan, to be sure, are not calling
for a simple repeat of the Bush tax cuts. They say they favor a complete
overhaul of the tax code, reducing tax rates by one-fifth (taking the top rate
down to 28 percent) and shrinking various tax breaks. Many economists think
such an overhaul could do more good than the Bush tax cuts, by simplifying the
tax code.
The problem for anyone trying to evaluate the Romney
plan, however, is that there isn’t a full plan yet. He will not say which tax
breaks he would reduce, and the large ones, like the mortgage-interest
deduction, are all popular. In a painstaking analysis, the Tax Policy
Center showed that achieving all of Mr. Romney’s top-line goals — a
revenue-neutral overhaul that does not increase the tax burden of the middle
class — is not arithmetically possible. History is littered with vague calls
for tax reform that went nowhere.
Beyond taxes, Mr. Romney has declined to detail what
spending cuts he would make, although he has promised to make big ones. And
some of the programs that would be at risk — medical research, education,
technology, roads, mass transportation — probably have a better historical claim on
lifting economic growth than tax cuts do.
The policies that new presidents pass tend to be ones
on which they laid out specifics, be they the Bush and Reagan tax cuts or
the Obama health overhaul. Based on the specifics, Mr. Romney puts a higher
priority on tax cuts than anything else. Yet the reality of the last two
decades has caused conservative economists, and Mr. Ryan himself, to
acknowledge the limits of tax cuts.
In one of our conversations, Mr. Ryan told me that the
single most important objective of any economic plan had to be raising growth.
“We have to figure out how best to grow the pie so it helps everyone,” he said.
It is certainly true that strong economic growth helps
solve almost every challenge the country faces: the deficit, unemployment, the
income slump, even the rise of China. It is also true that some liberals put
too much emphasis on the distribution of the pie and not enough on the size.
But when you dig into Mr. Romney’s and Mr. Ryan’s
proposals and you consider recent history, the fairest thing to say is that, so
far at least, they have laid out a plan to cut taxes. They have not yet
explained why and how it is also an economic-growth plan.
David
Leonhardt is the Washington bureau chief of The New York Times.
