December 4, 2001 | Commentary on Taxes
These two approaches lead to radically different tax cuts.
Supply-siders want to permanently reduce tax rates, particularly
the top personal income tax rates that have such an adverse impact
on investors, entrepreneurs and small business owners. Keynesians
are just the opposite. They generally favor temporary tax cuts, and
they want them skewed to those with low incomes who might be more
likely to spend the money as quickly as possible.
Historical evidence should have ended this debate years ago.
Ronald Reagan's across-the-board tax rate reductions, for instance,
triggered a record economic expansion. Similar tax rate reductions
also generated strong growth in the 1920s and 1960s.
The track record for Keynesian tax cuts, to be charitable, is
not nearly as strong. The so-called tax rebate distributed earlier
this year was based on Keynesian theory, and it was a total flop.
The economy continued to stumble and unemployment rose. But this
should not have come as a surprise. A similar tax rebate enacted
during the Ford presidency also failed to improve economic
Unfortunately, this historical record seems to have no impact on
the policy debate in Washington. Some lawmakers, using Keynesian
analysis, are talking about temporary tax "holidays." One proposal
is for the states to have a 10-day sales tax holiday, with Uncle
Sam reimbursing them for lost tax revenue. The other idea is to
suspend the Social Security payroll tax for one month.
Both of these proposals are misguided. The notion that tax cuts
should be designed to quickly put more money in peoples' pockets,
in hopes that they will spend more money and jump-start the
economy, is snake-oil economics.
Indeed, it is based on the same nonsensical theory that Bill
Clinton used when he was trying to enact his pork-filled stimulus
bill in 1993. From a Keynesian perspective, tax cuts and new
spending have similar effects.
The Keynesian view is greatly misguided because it fails to
consider both sides of the fiscal equation. More specifically, it
does not recognize that government cannot give a consumer a dollar
- either in the form of new spending or a tax rebate - without
first taking that dollar from someone else.
In the case of tax rebates and tax holidays, every dollar that
is used for that approach means one less dollar that is used to pay
down debt. This means that money that would have wound up in the
pockets of bondholders is now in the pockets of selected taxpayers.
There is no increase in total spending power. The same is true for
new government spending. Every dollar of additional government
spending necessarily means one less dollar for bondholders to
In any event, the Keynesian preoccupation with consumer spending
makes no sense. Economic growth occurs when there is an increase in
national income. This is why efforts to alter the use of income -
by encouraging people to spend instead of save - are so futile. And
since less saving translates into less investment spending, the
Keynesian approach is flawed from both a theoretical and practical
The only way to increase national income is to encourage more
work, saving, investment, risk-taking and entrepreneurship. This is
why supply-side economics has a successful track record. When tax
rates are reduced, people have more incentive to be productive and
create wealth. And when this leads to additional income, this
enables them to spend more and save more.
Advocates of faster economic growth should insist upon a
stimulus package that works. This means all personal income tax
rates should be reduced, and those lower tax rates should take
effect immediately. With the possible exception of capital gains
tax relief, across-the-board tax rate reductions are the strongest
tonic for an ailing economy. It is particularly important to reduce
the top tax rate, since this is the levy that imposes the greatest
disincentive on investors, entrepreneurs and small business
A stimulus bill that fails to include a significant reduction in
all tax rates might be worse than doing nothing. A package
comprised of new spending and gimmicks like tax holidays will not
enhance economic growth. Indeed, such proposals will increase the
risk of recession and unemployment next year. Adding insult to
injury, those that blocked supply-side tax cuts then would point to
the economy's poor performance and argue that this was "proof" that
pro-growth tax cuts do not work. This is why President Bush should
veto a phony stimulus package that does not include a reduction in
all tax rates.
Daniel J. Mitchell is the McKenna senior fellow in political economy at The Heritage Foundation.
Originally appeared in the Washington Times