Lower tax rates stimulate growth

This past Friday, the opinion page of the Wall Street Journal published an article entitled "Liberal Tax Revolt," citing several Democrat Congressmen who are arguing that allowing the tax rate cuts of 2003 to expire would be harmful. Among those cited are Senators Evan Bayh (D-Indiana), Ben Nelson (D-Nebraska), and Kent Conrad (D-South Dakota), as well as Democrat members of the House of Representatives Bobby Bright (of Alabama) and Jerrold Nadler (of New York).

As reported last week in the Evansville Courier-Press, Bayh spoke in favor of keeping the tax rate cuts of 2003 alive by saying: "This is not the right time to raise taxes. First, we need robust economic growth. Second, we need to address our country's long-term fiscal challenges and take a hard look at restraining government spending. The economy is not as strong as it should be in Indiana and around the country. Raising taxes would hurt the recovery and increase uncertainty for Hoosier businesses that compete in the global marketplace."

As the authors of the Journal article point out, it's not likely that Senators Bayh, Nelson, and Conrad, or Representatives Bright and Nadler have suddenly undergone "supply-side conversions." They do not necessarily make the important distinction between "raising taxes" and raising "tax rates" -- meaning, as Art Laffer has famously pointed out, that raising tax rates can and actually does cause changes in behavior, especially at the highest income bracket, resulting in less "taxes" being collected (those who fail to make this distinction talk as though lower tax rates result in lower tax revenues, when in fact lowering tax rates can actually increase tax revenues). Even if all the Congressmen mentioned above don't make this distinction, as the Journal authors say: "it's a start."

Another way of making this important distinction is by focusing on the critical but often-ignored element of growth. Lower tax rates encourage growth, but higher rates discourage it by decreasing the potential reward for the investment of capital, especially among those who have the most capital to invest and the most choices as to where they should invest it, or whether they should invest it at all.

We believe that the recent statements from Senator Bayh and other Congressional leaders are further evidence that growth should be an issue on which everyone can agree. In fact, we have written extensively on this very subject, including a post from February entitled "Why can't we all just get along (on economic policy)?" in which we demonstrate that there really should be no argument that growth is good and that low tax rates stimulate growth. If good people want to disagree with what to do with all the positive byproducts of growth, so be it, but why would anyone argue against growth itself?

Unfortunately, there are still plenty who do not believe that there is much connection between tax rates and growth. In this video clip, for example, economist Larry Kudlow interviews Christian Weller of the Center for American Progress (and associate professor at UMass Boston).

Dr. Weller encapsulates the raise-rates argument in his opening remarks, when he says: "I can't think of any policy that would have less effect on growth than extending the tax cuts for the wealthiest two to three percent of Americans -- even the CBO ranks it as the least-stimulative policy -- and it would blow an over-$800 billion hole in the deficit, and thereby permanently increase interest rates and make business costs even higher in this world. So, if we're really concerned about deficits -- the majority of even Republicans are concerned about deficits -- I think we need to let those tax cuts expire. It's the right economic policy; it's sensible economic policy; and it will have very little -- no impact on economic growth" (beginning at about 3:15 in the video).

Dr. Weller echoes the remarks aired earlier in the clip by Speaker of the House Nancy Pelosi, who said the Bush tax rate cuts "contributed to the deficit, did not create any jobs, and should be repealed."

We recommend that readers interested in the economic arguments against the fantasy promoted by Dr. Weller and Speaker Pelosi that tax rate hikes have no impact on economic growth* go back and revisit some of the posts we have published over the past two and a half years, including:
The last post mentioned is perhaps the most important, containing powerful quotations from finance professor John Cochrane of the Chicago Business School and others who flatly declare the primacy of growth (as well as the importance of low tax rates in unleashing that growth).

While those in favor of raising taxe rates often point to "reducing deficits" as their rationale (as do both Speaker Pelosi and Christian Weller in the video clip referenced above), history and common sense demonstrate clearly that economic growth is the true means of paying for deficits or anything else.

We commend politicians who have recently made a stand for the connection between lower tax rates and economic growth. What surprises us is the fact that this is still an argument at all.

* To the list of those who do not make the distinction between tax rates and tax revenues we would also have to add the Congressional Budget Office (CBO) mentioned by Weller as a supporting authority; they are perennially guilty of acting as though changes in tax rates have no impact on the behavior of those being taxed, which is why they always score tax rate cuts as decreasing tax revenue and tax rate increases as increasing tax revenue, in complete disregard for reality.

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