The theory is simple: Cut taxes and people will have more money to spend. Increased spending will heat up the economy and create more jobs. This in turn will increase the number of incomes the government can tax, thereby offsetting the loss in tax revenue from the tax cut. The problem is that there is no proof that any previous tax cut has ever actually paid for itself in this manner. In reality, history tells us this theory is nonsense.
Tax cuts have been proposed by many presidents. It’s a popular concept for voters, most of who believe they are being taxed at an exorbitant rate. In fact, the tax rate is at its lowest rate in the past 70 years.
While proposing tax cuts, many presidents have used the false premise that the cuts will pay for themselves by stimulating the economy. Some have paying for the tax cuts by cutting spending, while others believed that by cutting revenue congress would be forced to cut spending. Unfortunately, just about every tax cut has resulted in an increase to the deficit.
Under president Reagan, the Tax Reform Act of 1986 reduced the top personal income tax rate from 50% to 28%, and the corporate tax rate from 46% to 34%. Yet there was no increase in the rate of economic growth in subsequent years and by 1990 the economy was in a deep recession. Concerted efforts by economists to find a growth effect from the 1986 act have failed to find any significant growth.
The flip-side of tax cut mythology is the notion that tax increases are an economic disaster. However president Clinton raised taxes in 1993 and the 1990’s was the most prosperous decade in recent memory. At 37.3 percent, aggregate real GDP growth in the 1990s exceeded that in the 1980s.
Despite huge tax cuts almost annually during the George W. Bush administration that cost the Treasury trillions in revenue, growth collapsed in the first decade of the 2000s. Real GDP rose just 19.5 percent, well below its ’90s rate.
We saw another test of the Republican tax myth in 2013, after President Barack Obama allowed some of the Bush tax cuts to expire, raising the top income tax rate to its current 39.6 percent from 35 percent. The economy grew nicely afterward and the stock market has boomed — up around 10,000 points over the past five years.
The details are still missing from Trump’s tax cut proposal (surprise, surprise). However, without actual cuts in spending, any tax revenue cuts will surely balloon the deficit even further. Thinking that an increase in the economy from a tax cut simply has never worked, and no economist has been able to prove otherwise. It’s a good story, don’t believe it.
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