Half a Century of Anti-tax Orthodoxy Is Wrong
Dec 15, 2017
11 Min read time
Taxation is at the heart of any serious economic growth policy.
As the GOP's deeply unpopular, economically dangerous, and indefensible tax plan heads to victory, one thing is clear: a smart critique of bad policy does not spell its doom. Progressives have convinced most Americans of the travesty that will result from the plan: modest and short-lived tax cuts for low- and middle-income Americans; a huge and permanent cut, from 35 percent to 21 percent, for corporations; and much higher taxes on income made from actual work than the wealth that compounds from the ownership of capital. And progressives have the high ground in exposing the politics around the plan: a dead-of-night process, totally party-line, without public hearings or a careful discussion of collective well-being or overall economic benefit, it was horse-trading at all hours to get to the finish line for an increasingly desperate president.
So why didn’t this tax plan go the way of Obamacare repeal, with Democrats able to claim victory? Progressives underestimated several important factors, among them the political desperation of a Trump White House and a Republican Party that has gone a year without legislative victory, not to mention the self-serving demands of donors for a corporate tax cut. But even more important to the presumptive Republican victory is decades of deep-seated economic orthodoxy. The idea that cutting taxes creates growth has been the center of the modern Republican party, and American politics for half a century. Democrats have long been on the defensive on the issue of taxes, and they have yet to offer a positive argument for the role that taxes play in creating a healthy and strong economy.
The idea that cutting taxes creates growth has been central to the modern Republican party, and American politics, for half a century.
The silver lining in the most recent debacle is that the deeply unpopular tax bill provides an opening for progressives to explain something fundamental: that cutting taxes does not lead to private-sector investment and job growth—certainly not in today’s economy where businesses are already awash in the private capital that a tax cut would presumably provide. Instead, tax cutting today has led to financial hoarding at the top. We certainly need to combat corporate tax avoidance internationally and to encourage companies to invest in America. But the way to encourage this private investment is to maintain or even raise rates, and enforce tax collection. Taxation is at the heart of any serious economic growth policy, and Democrats who want to win again must be ready to argue in favor of taxes.
This requires a major pivot. Today when Democrats talk about taxes, they focus on the wealthy paying their fair share and on raising revenue to pay for needed social programs. These are important points. But they must be augmented by an argument about job creation and economic growth: that taxes must stop incentivizing big company executives to take home the lion’s share of the winnings, and instead encourage them to invest in research, development and company operations, and innovation and expansion that will lead to jobs.
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To understand today’s tax politics, we must first take a step back. Beginning with the Tax Revolt of the 1970s, taxes have become core of modern Republican identity. California’s Proposition 13, the famed 1978 ballot initiative that locked in permanently low property taxes, was the first and most prominent victory in an anti-tax movement that became permanent doctrine for conservatives. Critics have pointed out the problems with Proposition 13, including the racialized effects of a policy that secured benefits in perpetuity for primarily older white homeowners at a time when the state was becoming more diverse. The result was cuts in schooling, public safety, and other spending, falling disproportionately on younger black, Latino, and Asian families. The tax cuts also led to the fall of California’s once-famed school system from near-top in the nation to near-bottom in spending, drastic cuts in social services, massively overpriced housing in some markets, a labor market marred by a lack of mobility, radically unequal economic growth, and dysfunction, in the words of the state’s own nonpartisan legislative analyst, across the whole fiscal system.
But Proposition 13’s ballot box success signaled to politicians everywhere that cutting taxes was popular. Ronald Reagan ran for president on a platform of tax cuts, and in 1981 made one of the biggest across the board tax cuts in history his signature accomplishment. Never mind that in 1982 and again in 1984, Reagan, pressured by resultant deficits, signed significant revenue increasing measures. Today the Reagan legacy is “tax relief,” and the politics and the ostensible policy benefits of tax cutting have become internalized on both sides of the aisle. Democrats may be less reflexively dogmatic than Republicans on taxes, but even California’s current Democratic Governor Jerry Brown, once a Prop. 13 foe, noted a few years ago that “Proposition 13 is sacred doctrine that must never be questioned.”
Democrats have long been on the defensive on the issue of taxes. But taxation is at the heart of any serious economic growth policy, and Democrats who want to win again must be ready to argue in favor of taxes.
Underlying tax populism was an economic doctrine: the supply side belief that cutting taxes would spur growth. The economist Arthur Laffer, of the famed Reagan Revolution “Laffer Curve,” is perhaps the most emblematic of this theory. As a University of Southern California professor in the 1970s, he posited that tax cuts would supercharge the economy. The argument: shareholders and the wealthy would allocate their capital more productively than the government possibly could. Scouring for good investments, the rich would fuel business expansion, innovative research, and productivity enhancing training. This would create more and better jobs, increasing economic activity to the point that tax revenue would go up. By achieving “optimal taxation,” slashing government revenues would have no real downsides. Perhaps this was a compelling theory in the classroom at USC. But it was also politically useful to Republican orthodoxy, because it said you could have your cake and eat it too. Tax cuts would bring lower rates for the wealthy, plenty of job creation, and greater efficiency, but no long-term losses in public services.
This was part of a much larger traditional economic view: that markets are inevitably optimal and efficient and that a “rising tide would lift all boats.” In the 1950s, economist Simon Kuznets argued that as economies developed, incomes for those at the bottom would rise and inequality would naturally decrease. In the 1960s, economist Arthur Okun said that greater equality and greater efficiency were “the big trade-off,” and as such any efforts to “intervene” to improve inequality through more progressive taxes would slow growth. Profit-seeking within a free market, by definition, was value-creating.
This faulty wisdom remains the basis for today’s Republican Party platform on taxation: the “establishment of a pro-growth tax code” is a “moral imperative,” and that “wherever tax rates penalize thrift or discourage investment, they must be lowered.” Why work, the theory goes, if success means, at the upper limit, your money will just be taxed at 90 cents on the dollar?
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But now we know that this theory is both seductive and wrong. Decades of evidence show that tax cutting is not associated with growth or greater prosperity; gifts to the wealthy do not “trickle down” in the economy. On tax cutting in the United States, a Congressional Research Service study found no “conclusive evidence . . . to substantiate a clear relationship between the 65-year reduction in top statutory tax rates and economic growth.” In a comprehensive analysis surveying eighteen nations over fifty years, Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva found no link between cuts in top rates and growth. However, they argue that tax cuts increase pre-tax inequality, in that lower top tax rates encourage CEOs and top managers to push for sky-high salaries.
Experience shows that the rate cuts for business and the lower tax rates on capital that are at the heart of today’s Republican tax plan lead to increased dividend payouts rather than increased investment, increased short-term speculation, and income shifting—not job or value creation. Past efforts at corporate tax cutting and repatriation failed. For example the 2004 “tax holiday,” which permitted corporations to bring profits back to the U.S. at a the low rate of around 5 percent, yielded not growth but greater stock buybacks (when companies purchase their own shares to boost paper value), greater executive compensation, and more than 20,000 jobs cut. Similarly, the 2012 Kansas experiment in individual and corporate tax cuts brought no growth, deep deficits, and political disaster such that today state Republicans warn against repeating the mistake federally.
The economic theory driving the tax bill has no basis in reality—but in the absence of any alternative, the anti-tax narrative dominates public discourse.
Conservatives are right that taxes are an important incentive. And in a low-tax, low-regulation market, the incentives facing corporate managers and shareholders is to take home an ever-bigger slice of the pie. Indeed, low tax rates on capital and top salaries have fueled the drive toward short-termism—the practice of managing firms to boost short-term earnings as opposed to long-term business innovation. Where investors once expected a modest annual return on capital, the corporate raiders of the 1980s succeeded in pushing the ideology that a firm’s primary responsibility is to maximize shareholder value.
As business leaders and economists alike have noted, this drive toward high CEO pay and shareholder payouts is correlated with declines in more productive investments in business expansion, innovative research, and productivity enhancing training. Since the 1970s tax revolution, corporations are, in fact, investing less in the exact activities designed to ensure that wealth trickled down.
This brings us to today’s confusing, topsy-turvy economy. Average Americans and economists are, for once, baffled by the same puzzle. Corporate profits are at record highs, the stock market has surged, and unemployment is below 5 percent. Meanwhile, corporate investment remains low, wages are stagnant, and more than 40 percent of Americans say they would not be able to meet a $500 emergency. The mechanisms linking growth and profits to shared prosperity are clearly broken. A big reason is that the tax system is broken: lower taxes on various forms of capital, for those at the top, encourage hoarding, while international tax evasion drives a race to the bottom.
The Republican tax plan supercharges everything that is currently wrong with the way our economy works. From a purely redistributive perspective, it is regressive, with any short-term gains for low- and moderate-income Americans sunsetting, and with gradually increasing gains remaining permanent for corporations and the wealthiest 0.1 percent of Americans. Both the House and Senate bills would cut the top marginal tax rate for individuals.
Job creation does not happen as we have been conditioned to expect. The way to bring back growth is for wealthy Americans and large corporations to pay more, not less.
The incentive structure is simply backwards. Cutting the nominal corporate rate from 35 percent to 20 percent will do nothing to fundamentally alter the fact that corporations are sitting on an excess of $2 trillion in cash and not investing. Many of the largest companies in the United States are avoiding taxation entirely through perfectly legal means. One dollar out of every five is being moved to countries whose corporate rate is zero, or close to it. As economist Gabriel Zucman and colleagues show, the problem of corporate tax avoidance is massive, with $70 billion annually in the United States alone. The Republican bill pays lip service to fixing this, but the “cut taxes even more” solutions proposed have already failed.
And so the economic theory driving the tax bill has no basis in reality—but in the absence of any alternative, the anti-tax narrative dominates public discourse.
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Today’s Democratic argument against tax cuts turns on fairness: the wealthy should not get yet another windfall at the expense of working Americans. It is essentially about redistribution, and rests on an unstated assumption that the economy works as markets would have it work, with as much regulation as we can muster. Where that fails, taxation steps in to provide some balance and shared prosperity. This is an important point. But fairness alone does not mean growth, and misses the incentive structure altogether. Democrats should go further, pointing out that taxes themselves can be a form of regulation, in that they help structure the economy in the first place. Turn the gallingly self-interested Republican trickle-down argument on its head: yes, taxes are a powerful way to create jobs. But job creation does not happen as we have been conditioned to expect. The way to drive private investment to bring back growth is for wealthy Americans and large corporations to pay more, not less.
A growth-focused tax policy should be built on a few key principles: higher marginal income taxes and higher capital gains taxes would help reduce incentives for executive profit-seeking at the cost of private investment; international tax avoidance, a serious problem, could be countered in a number of ways (including an overseas earning minimum tax, or a system that taxes companies where their goods are sold) but all are about tax enforcement and greater taxation, not less; and taxes on relatively unproductive or harmful activity—from excessive financial activity to carbon emissions—should be invested in the foundations of our economic growth: roads, bridges, broadband, education, and training, all common goods that none of us alone can sufficiently pay for, and from which the American economy benefits. With taxation front and center, Democrats should take advantage, play offense, and remind us all that taxes support a high-functioning economy.
Overcoming five decades of deeply ingrained beliefs about taxation will not be easy, especially in an electorate divided by partisanship and riven by racism. But we can learn lessons and take courage from recent research showing that Americans in both parties are proud to pay taxes, the wages of citizenship. This is the moment to reject anti-tax dogma, and embrace the truth about taxes: they are good for our economy and our country.
December 15, 2017
11 Min read time