Tax cuts: ideology or pragmatism?

Particularly during election time, Americans are always complaining about their taxes, and I always think that they should go spend some time in Brazil before talking about it. We have a very high tax burden;  in 2012 we had to work on average five months of the year just to pay for taxes from national, state and municipal regulations. Compared to the rest of the world, we come in second on the number of work days needed to pay taxes (the first is Sweden). The US is the fifth.

The problem, to me, is not the cost per se. It is what we get in return. Although we do have universal health care, you can’t compare public service in general in Brazil with what you get in the US, Sweden and other first world countries. Yes, no one likes to pay taxes, but at least in those countries you get something in return.

Now the US has the opportunity to vote for a big tax cut platform with the Romney-Ryan ticket. It is amusing to me that the discussion about what you might lose is absent (and unless you really believe that closing unspecified loopholes will guarantee that revenue doesn’t drop, you must consider that). I also find it interesting how people tend to equate less taxes with higher growth automatically. I can see the reasoning – you spend less on taxes so you might have more money to invest, hire people, and expand your businesses. John Boehner actually said that “we’ve seen over the last 30 years that lower marginal tax rates have led to a growing economy, more employment and more people paying taxes.” But is that how it really happens all the time?

In an article in the “New York Times” today, David Leonhardt says that the answer is no. ”President George W. Bush (…) passed a large tax cut in 2001, sped up its implementation in 2003 and predicted that prosperity would follow”, writes mr. Leonhardt. 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 (…)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.”

Mr. Leonhardt barely mentions that times were much different during Bush’s era, with 9/11, big wars, no more tech bubble and etc. Obviously it would be wrong to reduce the discussion on growth to taxes only. But he points to an interesting historical discussion. Mr. Ryan, quoted in the article, affirms that things could have been much worse during the Bush days if it weren’t for the tax cuts. But even conservative economists, including former Bush aide Phillip L. Swagel, say that “even a tax cut as large as Mr. Bush’s ‘doesn’t translate quickly into higher growth’”.

Growth x Marginal Tax Rates in the US

Ezra Klein wrote at the Washington Post that, hearing Mr. Boehner and other republicans speak, the economy sounds like “a simple system with one decisive variable: tax rates”.  “What we’ve seen over the past 30 years is that lower marginal tax rates have not led to particularly impressive economic growth, labor markets or revenues. Growth was actually more impressive back when marginal tax rates were higher”, he says: Again, I would point out that taxes are far from the only variable impacting growth. But well, we can’t ignore that evidence either. As Mr. Klein stresses, “no one should think that high marginal tax rates drive growth. All else being equal, lower marginal tax rates are probably better for growth, though that can flip if they begin driving large deficits or starving important government functions. But (…) marginal tax rates don’t determine growth in either direction”.

I don’t even know if the Republicans plan to cut the marginal tax rate (which are paid for the last dollar earned and is different from the average taxation on total income) or do something totally different when redesigning the tax system (they are not 100% clear on where the cuts will fall). But considering recent history, it seems that what drives them to focus so much on tax cuts is ideology rather than pragmatism. It is almost a conservative tenet that tax cuts are the way forward. Left wingers would disagree.

This clash of ideologies in the political economy arena can be seen very clearly nowadays on several other topics as well, such as expansionary policies, fiscal discipline and etc. In fact, that will be the theme of the next edition of our journal Democracy&Society. The call for papers will begin circulating on Monday. Stay tuned!