Taxation Is the Lifeblood of the State

Article excerpt

The clifïhanger debate over whether or not to raise the federal government's debt ceiling threw U.S. fiscal policy into brighter relief than it has been in recent memory.

Suddenly people were calling for significant cuts in government spending in the face of a rapidly growing national debt.

As often happens, calls for cuts in government spending were met by competing calls for higher taxes, especially on higher-income earners and businesses. They can afford to pay the extra taxes, we were told. And what's more, higher taxes could actually help the economy.

In making this case, proponents of raising taxes pointed to the tax increases that came out ofWashington under President Clinton in 1993. The U.S. economy, as measured by GDP growth, was strong in the years after those tax hikes while unemployment and inflation were relatively low. The argument now is that the 1993 tax increases did not inhibit the economic boom the country enjoyed in the last six or seven years of the twentieth century.

In April New York Times columnist Nicholas Kristof made this very argument. He wrote that while it's true higher taxes in general "tend to reduce incentives," this apparently "weak effect" is often overwhelmed by other factors. "Were Americans really lazier in the 1950s, when marginal tax rates peaked at more than 90 percent?" Kristof asked. "Are people in high-tax states like Massachusetts more lackadaisical than folks in a state like Florida that has no personal income tax at all?"

Like other observers, Kristof also contrasted the "golden period of high growth" after the Clinton tax hike with the "anemic economy" that followed George W. Bush's tax cuts.

But do higher taxes really spur (or at least not inhibit) prosperity? Looking at the data from the 1990s, one might believe so. After all, the 1993 tax hikes were followed by years of strong economic performance. Post hoc ergo propter hoc (after this, therefore because of this), many might believe.

But not everyone agrees the data are quite so clear. The Heritage Foundation's J. D. Foster, for example, believes the data show that the U.S. economy was already expanding when the Clinton tax increases took effect. If anything, he believes, those tax hikes slowed overall growth for several years until 1997, when the Republican-led Congress passed a series of tax cuts, including a reduction in the capital gains tax rate from 28 to 20 percent.

The "real acceleration in the economy began in 1997, when economic growth should have cooled," Foster wrote. "This acceleration in growth coincided with a powerful pro-growth tax cut."

Foster also authored a 2008 Heritage Foundation summary of several scholarly studies showing tax hikes corresponding with slower or negative economic growth. In theory higher taxes could encourage greater levels of private investment through lower borrowing costs - if government used the money to retire debt and reduced its competition for lendable funds. But this potential "silver lining" is overshadowed by the negative effects of higher taxes, he stated. However plausible theoretically, in practice the argument runs into trouble, not least from the fact that governments seldom save any of their revenue, Foster notes.

Still, the idea that the 1993 tax increases spurred economic growth will not die easily. For instance, some people argue that those tax hikes provided much needed confidence in the U.S. economy. As Kristofput it: "Tax increases can also send a message of prudence that stimulates economic growth."

With this much disagreement it's hard to know what is really the truth. And this is always the case when looking at the effects of any single economic policy in a vast and complex system. …