If there is anything more infuriating to some liberals than
George Bush himself, with his religiosity and embarrassing accent,
it is the common sense, neoclassical idea that tax cuts are good
and tax increases are bad.
Tax cuts are good because they stimulate economic growth, making
people better off by several multiples of the amount of tax revenue
the government loses. A good rule of thumb is that a $1 tax cut
induces $1 to $2 of additional economic growth.
Conversely, tax increases are bad because they impair economic
growth, making people worse off by several multiples of the extra
amount of tax revenue the government collects. Generally speaking,
an additional $1 of tax money for the government to spend costs the
economy not only the $1 of tax but an additional $1 to $2 in lost
Another good common sense rule of thumb is that when the
government gets extra tax revenue, it usually spends $3 to do a $1
So why not cut taxes and spending? There is plenty of room for
reducing the $2.9 trillion federal budget, without cutting anything
even resembling muscle and sinew.
Just think how good it would be if the Congress were to do its
duty; if all federal spending were exposed to the light of day and
honestly evaluated, in public, on a cost-benefit basis. What if tax
increases became the last instead of the first resort, to be used
only after every ounce of political spoils, patronage, waste and
just plain silliness had been squeezed out of the federal
They Don't Get It
The virtues of lower instead of higher taxes and spending are,
however, not always apparent to folks in Washington whose entire
life experience, career success and, in many cases, secular
religion are all bound up in making big government even bigger.
Unfortunately, they often control the levers of power. If they do
not pull them, they whisper in the ears of those who do.
For example, Washington's most widely read newspaper is
pro-government on most matters - and when it comes to fiscal
policy, yields to no one in its zeal to stamp out seditious talk
about tax cuts.
Last month, the Washington Post attacked with a particularly
snarky editorial ("A Heckuva Claim," Jan. 6) after President Bush
had said in the Wall Street Journal that tax cuts in his first term
had stimulated economic growth and that economic growth had
contributed to a recent surge in tax collections.
Intending to hoist tax-cutters on their own petards, the Post
cited a recent paper by Gregory Mankiw, a distinguished economist
at Harvard who recently served as chairman of the President's
Council of Economic Advisors. "Gotcha!" said the Post, even Bush's
own economic guru can't make the case for tax cuts.
Mankiw's analysis, reduced to its essence, concluded that a $1
tax cut on dividends would reduce government revenue collections by
about 50 cents, after taking into account taxes on $2 of additional
economic growth induced by the tax cut. A $1 tax cut from an
across-the-board rate reduction would cost the IRS about 77 cents,
after taking into account taxes on $0.95 of additional economic
growth induced by the tax cut.
To the Post, from the perspective of big government, the main
point of the Mankiw study was clear and conclusive: The amount of
tax on the amount of induced economic growth was not sufficient to
make up for the full amount of revenue lost to the Treasury from
the original tax cut. Ergo, the government has less money to spend.
Ergo, tax cuts are bad.
To those of us who prefer economic growth over government
growth, the Mankiw study confirmed a different and powerful point.
If Congress were willing to forgo 50 cents of additional tax
revenue, the economy would grow and people would have $2 more
income. If given the choice, most people would make that trade.
Apparently the Post would not.
The other important point is derived from applying the Mankiw
study in reverse - to a tax increase. Because of the damage to the
economy, a purported $1 tax increase on dividends nets the Treasury
only 50 cents - but costs Americans $2 in lost income, plus $0.50
When achieved by a rate increase on all forms of income, an
attempted $1 tax increase yields only $0.77 - but costs Americans
$0.95 in lost income, plus $0.77 in tax. If the government were to
kick up the tax increases enough to collect a full additional $1,
the cost to the public would be $2.25 to $5, counting tax paid and
The devastating inefficiency of tax increases was addressed by
Harvard's senior and most distinguished public finance economist,
Martin Feldstein, in "The Effect of Taxes on Efficiency and Growth"
(NBER Working Paper No. 12201, May 2006).
Based in part on empirical studies carried out over a period of
years, Feldstein concluded that when the government undertakes to
raise $1 of tax revenue by an across-the-board rate increase, it
will, after taking into account the economy's predictable adverse
reaction, end up with only an additional 57 cents to spend. To get
a full $1 to spend, the government must kick the nominal tax
increase up to $1.75, which further exacerbates the damage to the
economy and, therefore, to incomes and living standards.
The Mankiw and Feldstein studies lead to the conclusion that, at
the margin, each additional $1 of tax obtained by the federal
government costs the private economy $2 to $5. Of that amount, $1
is the tax - money that taxpayers give up and the government gets.
The remainder is a "dead-weight" loss. Nobody gets it. It is wages,
salaries and other income that the economy would have produced but,
because of the tax increase, does not.
The proponents of high taxes and big government like to pretend
that the economic burden of the dead-weight loss falls solely on
the rich, but it does not. The economic loss falls mainly on low-
and middle-income earners in the form of salary increases not
obtained and jobs not obtained (or lost), and this burden applies
irrespective of whether the victims do or do not pay income
Furthermore, the regressive nature of the adverse economic
fallout from high taxes cannot be avoided by concentrating those
taxes on ostensibly rich capitalists. As Mankiw and others
correctly point out, concentrating taxes on capital exacerbates the
damage to the economy.
No Better Off
If one is to believe their rhetoric, the new majority in
Congress intends to impose higher tax rates on dividends, capital
gains and the incomes of upper-bracket taxpayers in general. They
will tell themselves and the public that they are raising $50
billion in new revenue from the malefactors of great wealth and
that they will spend this windfall wisely to make us all better
But they won't tell the American people that the higher tax
rates will damage the economy. The amount of that damage will be
about $60 billion in the form of lower incomes and fewer jobs. They
also won't tell the people that because of that economic damage,
the revenue yield from the tax hike will, in fact, be only about
$33 billion (not $50 billion); and that, at the margin, the entire
$33 billion likely will be spent on perks, pork, patronage and
other waste that benefits members of Congress, not the public.
Christian is executive director and Robbins chief economist of
the Center For Strategic Tax Reform. Both are visiting fellows in
taxation at the Heritage Foundation.
Frist appeared in Investor's Business Daily
If there is anything more infuriating to some liberals than George Bush himself, with his religiosity and embarrassing accent, it is the common sense, neoclassical idea that tax cuts are good and tax increases are bad.
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