February 7, 2001

February 7, 2001 | Commentary on Taxes

ED020701:  Why We Need to Cut Tax Rates

President Bush is facing a bad news/good news quandary. The bad news is that he inherited a weak economy. The good news is that growing concerns about a recession have broadened and intensified support for his tax-cut plan. This is because taxpayers, and even some politicians, understand that lower tax rates encourage more work, savings and investment -- and therefore lead to a stronger economy.

In simple terms, taxes are a penalty imposed on productive behavior. The severity of this penalty is determined by the tax rate, which is why it's important to keep rates low. A 15 percent tax bracket, for instance, does not impose much of a burden on the economy since workers get to keep 85 cents out of every dollar they earn.

Unfortunately, though, our tax code punishes people for climbing the ladder of opportunity. Because of the "marriage penalty," for example, a couple with a combined taxable income of less than $44,000 gets thrown into the 28 percent tax bracket, which means they only get to keep 72 cents out of every additional dollar they earn.

High tax rates discourage work. A factory worker may choose to forego overtime. A spouse may abandon the job market. A part-time employee may decide to spend more time on vacation.

It is particularly important to reduce the top tax rates. Successful entrepreneurs and investors currently are thrown into a 39.6 percent bracket. But that's just the beginning. Many provisions of our complex tax code -- such as the corporate income tax, the capital gains tax and the "death" (or estate) tax -- force people to pay several layers of tax on the same dollar of income. As a result, the effective tax rate can be as high as 70 percent or more.

This is both confiscatory and economically foolish. Every economic theory, even Marxism, recognizes that long-term growth is impossible without savings and investment. Yet our tax code treats this activity as if it were criminal. No wonder so many upper-income taxpayers divert so much of their income on tax lawyers, accountants and financial planners. It's the only way they can keep a decent portion of the money they earn.

But the best reason to reduce the top tax rate is not sympathy for the so-called rich. Instead, the top tax rate should be reduced so that the rest of us can benefit. It is much better for the economy, after all, if well-to-do people put their money in job-creating investments instead of parking it in tax shelters. We are the ones who get most of the benefit when wealthy investors are willing to risk venture capital to create the Microsofts of tomorrow.

There are other reasons to lower tax rates. For one, it will make America more competitive. We live in a global economy, meaning that investors and entrepreneurs around the world are able to shift economic activity to nations with free-market policies. Because America already is a low-tax country by industrial-world standards, our economy has been out-performing our major competitors. Tax rate reductions will cement our No. 1 status.

They will also help Congress control wasteful spending. Massive budget surpluses make it harder for politicians to "just say no" to special interest groups. The federal budget has increased nearly twice as fast since the surplus materialized. Last year alone, politicians approved more than $500 billion in additional spending over the next 10 years. To paraphrase the movie "Field of Dreams," if you send it, they will spend it.

Perhaps more importantly, rate reductions are an important step toward a simple and fair flat tax. Other provisions of the Bush tax cut, particularly the elimination of the death tax, also move us in the direction of an honest tax code that does not force Americans to pay more than one layer of tax on their income.

New budget estimates show the federal government will collect $5.6 trillion of extra tax revenue over the next 10 years. Yes, Congress should lower tax rates so taxpayers can use this money to boost our economy, increase our global competitiveness, and curb runaway federal spending. But we shouldn't lose sight of the most compelling reason of all: the fact that this extra money doesn't belong to politicians. It belongs to the people who earned it.

Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

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