Note: There is a cadre of GOP conservatives who looked at the landmark victories by Democratic candidates in 2006 and drew the conclusion that conservatives (which these days is a term automatically interchangeable with Republicans) lost their Congressional majorities by abandoning their dedication to core principles. To regain their momentum, these stalwarts believe, they need only convince voters they've come back to their principles. This is the third diary in the ongoing look at the bedrock ideas behind today's conservative movement, with an eye to explaining how each is grounded in myth and misinformation and for the most part, provably wrong factually.
Today's lesson: The Tax Cut Myth
As we draw near the Iowa and New Hampshire primaries, it's been a load of fun to watch as Republican/conservative candidates beat each other about the head and shoulders over who really will cut taxes. Recent history suggests that even if one of these characters wins the White House, however unlikely that might be, the next president will not cut taxes and most likely will raise them. The 2008 election is about who will pay the increased taxes.
Despite that, the tax cut lie will be issued over and over again until the new president is elected. It will perpetuate the myth that Republicans cut taxes and that tax cuts are always economically beneficial. Neither is true.
But before we get to the reason the next president will almost certainly increase taxes, it's useful to explore the tax-cut myth. This pernicious idea is in part what put us where we are.
What's the economic theory behind tax cuts? From Wikipedia we get this:
The longer term macroeconomic effects of a tax cut are not predictable in general, because they depend on how the taxpayers use their additional income and how the government adjusts to its reduced income. Three idealized scenarios can be hypothesized:
- Government cuts its expenditure, and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination is macroeconomically neutral, but advocates of a free-market economy argue that it improves economic welfare, since people are more accurate than the government in spending money on commodities that they actually want.
- Government maintains its expenditure (thus incurring debt), and taxpayers increase theirs, spending the money on commodities sourced from within the country. This combination provides a stimulus to the economy, and it is on these grounds that advocates of supply-side economics frequently argue for tax cuts. It should lead to economic growth, bringing about greater general prosperity, though unless managed carefully it will also lead to inflation. A government making tax cuts and incurring debt usually hopes that the economic stimulus of the tax cut will be large enough to produce a long-term increase in tax revenues, allowing the debt to be paid off in the future. If that does not occur then the government can be left with a severe budgetary crisis.
- Government maintains its expenditure (thus incurring debt), and taxpayers either save their increased income or spend it on commodities sourced from outside the country. This combination is not inherently deflationary, but it contributes to balance of payments difficulties which may have secondary deflationary effects and as noted above may lead to a government budgetary crisis with a painful readjustment to follow.
In practice it is likely that a mixture of these effects will occur, and the net effect of any tax cut will depend on the balance between them. It will therefore be a function of the overall state of the national economy. In conditions where most goods and services (especially those frequently purchased out of discretionary income, such as consumer durables) are produced domestically, a tax cut is more likely to provide a macroeconomic stimulus than in conditions where most consumer durables are imported. Furthermore, the actual effect will inevitably be difficult to discern, because of numerous other changes in the economy between the time when a tax cut is proposed and the time when its full effects would be realized.
If government does reduce its expenditure to accommodate tax cuts, there must necessarily be reductions in government services, and there may also be a reduction of the government's capacity to redistribute income to reduce income inequalities. Critics of tax cuts argue that this leads to a fall in overall economic welfare because the effects fall disproportionately on those with the lowest incomes.
That pretty much covers the range of possibilities and likely outcomes, including the voodoo economics of supply-siders.
Now bring in a dose of common-sense. We can stipulate that in an ideal world, a tax cut that went mostly to those who would spend the proceeds would likely stimulate the economy and produce a widespread economic benefit, especially if we're in a consumer-driven recession and regardless of whether the cuts are offset by reductions in government spending.
There are a lot of ways to screw up that formula, however. And that's where the myth of the almighty tax cut comes into play. The conservative economic theology is that all tax cuts are beneficial, by definition, and especially when accompanied by offsetting cuts in non-defense spending.
But let's look at reality (yeah, I know):
What happens when you give a tax cut to the wealthiest taxpayers, who are the most likely to a.) not spend the extra money b.)invest the money in non-productive but high-yielding investments (as in hedge funds or derivatives) c.) spend the money outside the country? What happens when legislators -- conservative and liberal alike -- obey their instinct for survival and bring home the pork? What happens when military spending skyrockets on a long-term invasion and occupation of another country? What hapens when spending on critical infrastructure and essential services are diminished to partly make up the difference?
Most importantly, what happens when all this occurs at the same time?
The common sense answer is you've blended together the perfect recipe for a national financial disaster.
A tax cut that is weighted disproportionately toward the wealthy is likely to go into unproductive investments (after all, buying stock provides a benefit to the guy who previously bought it at a lower price, not a company, unless you're buying into an IPO, and don't get me started on hedge funds). The financial benefit of corporate tax cuts may go disproportionately overseas. The middle class, which doesn't get the bulk of the benefit directly from the cut, also doesn't benefit when small and medium size businesses don't see an uptick in consumer spending and employers spend their cuts on executive bonuses.
Steady or increasing government expenditures in the face of tax cuts increase debt -- but with little economic stimulation to generate the revenue to pay off the debt. Massive military spending exacerbates the debt issue and plants a financial time bomb off into the future.
And finally, a failure of government to maintain infrastructure and provide robust essential services (think food inspection, border enforcement, education, public safety) almost guarantees an economic shock down the road.
You can probably think of dozens of other combinations of wrong-headed tax cuts and policy decisions that would be equally bad. (This just happens to be the one we have.) The important message is that when appropriate, tax cuts are a marvelous tool for managing the economy for the good of all Americans. But they're not always, in every permutation, a good thing.
I expect the next president and the next Congress to start working to diffuse the crisis that's coming at us like a freight train without brakes. That's going to mean taking steps to fix both the revenue and spending sides of the equation. It can be done fairly and prudently, but not with further tax cuts.