The Myth That Tax Cuts Don’t Work

Despite the preponderance of contrary evidence, myths persist that tax cuts primarily benefit “the rich” and have no discernible impact on economic growth.

Months ago, for instance, Hillary Clinton charged that “slashing taxes on the wealthy hasn’t worked. And a lot of really smart, wealthy people know that.”

She’s right that it hasn’t worked, but she failed to mention that it’s also never happened. The tired “tax cuts for the rich” canard is disproven by the 1920s, the 1960s, the 1980s and the 2000s, when tax rates were reduced for all—and especially low—income groups.

As I’ve explained before, the argument is maintained by misleadingly observing raw dollars rather than percentage cuts. Since top earners begin with higher incomes (and tax burdens), a smaller percentage tax cut translates into more dollars than does a larger percentage tax cut for lower earners. For instance, a 10 percent tax cut to someone earning $1 million is a lot more in dollars than a 20 percent tax cut for someone who’s earning $100,000, when in fact the person earning the lesser amount receives a steeper percentage cut.

Consider the rate reductions under George W. Bush. The top rate was lowered from 39.6 percent to 35 percent—a 13 percent decline. Meanwhile, the bottom rate dropped from 15 percent to 10 percent—a 33 percent reduction. So yes, the cuts were tilted, but toward the bottom. (It’s also worth noting that 10,000 low-income earners were removed from the income tax rolls entirely)

Moreover, the result of the cuts was that a larger proportion of total income tax revenue was paid by the wealthy. As Brian Riedl noted,

The share paid by the top quintile edged up from 66.6 percent in 2000 to 67.1 percent in 2004, while the bottom 40 percent’s share dipped from 5.9 percent to 5.4 percent. Clearly, the tax cuts have led to the rich shouldering more of the income tax burden and the poor shouldering less.

Quite the opposite of “helping the rich.”

Furthermore, the notion that they don’t grow the economy is also contradicted by the evidence. Critics point to periods of strong growth under high tax rates to suggest the latter has little impact on the former. As New York Times writer David Leonhardt put it,

The top income tax rates have changed considerably since the end of World War II. Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the second World War.

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth.

But tax changes never happen in a vacuum, and although they influence economic activity, the broader economic environment often has the final word.

Following World War II, the U.S. faced tattered European markets and millions of troops re-joining a labor force freed from wartime command. Small wonder productivity and economic growth exploded through the 50s and 60s. And unlike today, the top tax rate effectively impacted very few. (Also noteworthy, taxes were slashed following WWII, bringing the effective corporate tax rate from 90 percent to 38 percent)

Indeed studies show that—ceteris paribus—tax policy makes a considerable difference. Here’s former Obama economic advisor Christina Romer: “Tax increases appear to have a very large, sustained, and highly significant negative impact on output … [and] tax cuts have very large and persistent positive output effects.” The Tax Foundation adds: “Nearly every empirical study of taxes and economic growth published in a peer-reviewed academic journal finds that tax increases harm economic growth.”

This was confirmed during the “Clinton boom:” (which critics ironically highlight to argue the irrelevance of tax rates, as Clinton raised taxes in the early 90s):

The first period, from 1993 to 1996, began with a significant tax increase as the economy was accelerating out of recession. The second period, from 1997 to 2000, began with a modest tax cut as the economy should have settled into a normal growth period. The economy was decidedly stronger following the tax cut than it was following the tax increase. [emphasis added]

The economy averaged 4.2 percent real growth per year from 1997 to 2000–a full percentage point higher than during the expansion following the 1993 tax hike.

Although tax cuts are neither policy elixirs nor necessarily always revenue raisers, when targeted correctly they cut everybody a break and give the economy some juice.

And those facts we must not cede to the mythmakers.