The Heritage Foundation

WebMemo #1309 on Taxes

January 16, 2007

January 16, 2007 | WebMemo on Taxes

Why Tax Cuts Matter

The following is Steve Forbes' November 13 address to members of The Heritage Foundation's Executive Committee at the fall 2006 President's Club meeting, held at the Ronald Reagan International Trade Center in Washington, DC.

Steve Forbes:  Thank you very much, Danny, for those very kind words, and thank you, Heritage Foundation, for my free lunch today.  That seems to be the mood of this new Congress. [laughter] But it is a delight to be here and Ed, thank you, Whitney, thank you, and thank all of you for being here.  It's an honor and the timing of this actually couldn't be better. 

It is fitting that we now mark the 25th anniversary of Ronald Reagan's tax cuts. It's also fitting that we meet at a time when those who don't share our principles are going to take over both Houses on Capitol Hill because it reminds us that the real strength of the principles we represent and believe in come from grassroots efforts.  We cannot count on leadership; we have to educate the grassroots and then the leaders will be educated in turn.  If they want to be leaders, they have to know what their followers want. You know that old bromide about the French Revolution, the mob goes by, one of the putative leaders of the Revolution says, "I have to leave and get ahead of the parade to show that I'm still in charge," [laughter]

That's what we have to keep in mind in the months ahead, because make no mistake: for all of the talk of being soothing and bipartisan in this town, bipartisanship means being liberal and it means capitulating.  It does not mean a real compromise, and a good example was over the weekend when one of the Democratic leaders was asked about Social Security.  He said, "Well, we'll see if Mr. Paulson"-that's the Treasury Secretary-"is serious about bipartisanship on Social Security because if he mentions personal accounts, that shows bad faith because we don't like it." 

We can see what we're in for.  And our task in the next two years is not simply to educate but also to block-offense and defense.  It's not a good strategy to simply count on the mistakes of our opponents.  First of all, they may be able to spin it in such a way that the mistakes don't readily become apparent but even if they did, there are long term consequences.  As some of us were discussing earlier, Jimmy Carter paved the way for one of the greatest Presidents in American history, Ronald Reagan, but we're still paying the price for the Carter Presidency, with one of the great crisis of today, the mullahs in Iran. 

So these things have long term consequences, so we have to get our ideas across, do the grass roots effort as you are willing to do, and also to make sure the damage is minimized before the true principles can come into office again.  

Once again, we are in political and intellectual disarray, that is a danger, but it is also for a dedicated group like The Heritage Foundation, a huge opportunity.  Ronald Reagan, a guiding light, understood something on taxes.  He understood that it was a moral issue, not an economic issue.  It's not about numbers or GDP.  Numbers represent people, and he understood that the essence of the American dream is in those words in the Declaration of Independence, the pursuit of happiness, and that whatever stands in the way of the pursuit of happiness are barriers that have to be removed.  And the tax code, when he took office, was a huge barrier to realizing-for millions of people, to realizing the American dream by artificially hurting the American economy.  Well, to him tax cuts then were a means to an end and in 1981 and again in 1986, fundamental tax cuts were enacted, the top rate was slashed from 70 percent down to 28 percent, a rate we've reached never since, but those tax cuts achieved removal of a major barrier. 

The growth of the 1980s was then unprecedented.  The growth alone of the American economy in the 1980s, as Bob Bartley at the Journal and others pointed out, exceeded the entire size of the third largest economy in the world then, West Germany-just the growth alone.  That is amazing. 

Reagan understood that growth comes from innovation, it comes from invention.  It does not come from just increasing aggregate demand, giving people money.  If you wanted to give people money to spend, you could go on an airplane and just throw out hundred dollar bills, but that's not going to get an economy moving.

And it wasn't just growth.  Reagan understood that growth comes from innovation, it comes from invention.  It does not come from just increasing aggregate demand, giving people money.  If you wanted to give people money to spend, you could go on an airplane and just throw out hundred dollar bills, but that's not going to get an economy moving.  Its new ideas, new services, new goods, new ways of doing things that make for a real higher standard of living.  Reagan understood and for a while even Republicans, some of them understood, an occasional Democrat as well, that taxes aren't just a means of raising revenue for government, taxes are a price and a burden.  This sounds so simplistic to say, but it is something that policymakers so often ignore.  Tax and income is the price you pay for working.  Tax on profits, the price you pay for being successful.  Tax on capital gains, the price you pay for taking risks that work out.  The proposition is a very simple one but so often ignored.  If you lower the burden and price of good things like successful work, productive work, risk taking, you get more of those good things.  Raise the burden, you get less of those good things. 

And so Reagan understood it, he created the climate in which these basic things could be done, and we in the world are still reaping dividends from it.  Make no mistake: even though he was firm on national defense, if America's economy was not moving ahead, showing the world how we can innovate and do spectacular things, we would not have won the Cold War, it would still be with us today.  People say, "Well, the '80s were full of deficits."  Well, what else is new?  Sadly, sadly, Congress in those days-less so than today-liked to spend money.  The problem was not a lack of income.  Revenues doubled in the 1980s.  Part of the spending was for winning the Cold War.  You don't win wars on the cheap.  You never do, so we did spend a lot, but that was paid off with the fall of the Berlin Wall.  But there's a lot of other spending as well, but we shouldn't just focus on Washington's inability to say no, we should focus on the nation. 

This town is too inner-focused, too obsessed with itself and its own special interests.  The nation as a whole during the Reagan years boomed.  Yes, the national debt went up 1.7 trillion dollars, but-amazingly in this town-I guess nobody understands a balance sheet.  You don't look just at liabilities, you look at assets.  What's overlooked during the 1980s was that the wealth of the nation went up 17 trillion dollars.  Now, is there an entrepreneur, an executive who wouldn't trade one dollar of debt for 10 dollars of new wealth?  But they just focus on one side of it, if you always look at liabilities, it's always going to look like a disaster. 

Reagan saw the bigger picture.  He knew Washington was not America.  He also recognized that when people have more, they give more.  Even though tax rates went down in the 1980s, charitable giving went up and the growth of charitable giving went up.  When people have more, they give more.

What's amazing and disheartening in a way today is here we are 25 years later and these basic principles of taxation are still not understood.  Even though we did it, Britain under Margaret Thatcher did it, Ireland did it- I mean, my goodness, what a more inspiring story than Ireland?  For centuries, the poorest economy in Western Europe, its biggest export was people.  We benefited but Ireland didn't.  They had fine learning institutions, but when people got out, they had to go elsewhere to pursue their talents and ambitions and dreams. About 30 years ago, Ireland finally said, "Enough of this."  So they aggressively sought foreign investment, gave out tax breaks like confetti, set up offices around this country and other countries seeking out opportunities, they cut personal tax rates in the late '80s and even today in the European Union, Ireland's corporate tax rate is 12-and-a-half percent.  In Brussels, where the EU is headquartered, is perpetually complaining about Ireland's low tax rate.  When Brussels complains, you know something is being done right.  [laughter, applause]  And today, Ireland, once the poorest economy in Western Europe is now the most vibrant economy in Western Europe.

In this country we've been treated for five years of stories about the housing bubble.  On the west coast of Ireland-I was there a little while back on a bike trip, the property values there in the last decade or so have gone up seven- or eight-fold because of the boom, and those of you who know the troubled history between Ireland and England, the Irish now have the best revenge which is success. [applause] Today, Ireland's per capita income is higher than that of Britain, France, and Germany.  And they did that in a generation and a half.  When you go to central and Eastern Europe, they don't look to France or Germany as their inspiration or models, they look to Ireland.  They say, "That's what we want to do.  Pull ourselves up from lost opportunities, from being behind and surging ahead." 

Even Germany in the '50s and '60s when Ludwig Erhard was the Economics Minister, every two years cut tax rates.  That was behind the German miracle.  Today Germany is the sick man of Europe, precisely because they forgot those principles of taxation.  And so you look around us today, what are the nations that are doing best?  Central and eastern Europe, most of those that are booming have the flat tax.  You look at Hong Kong, a variation of the flat tax put in back in 1947.  Singapore-highest rate 20 or 21 percent-is doing very nicely, thank you very much.  Now China, ostensibly, has very high tax rates, but you can tell there's a lot of innovation bubbling there.  There the first $1500 of your income is free of taxation-and then the rates get very high very quickly.  No surprise that if you work for some of these companies in China suddenly you become four people.  They pay you $6,000 and suddenly there are four people on the payroll, not just one, even though it's the same person.  You know, maybe amoebas divide up but in China they do it with workers.  So guess what?  No taxes. 

Now, in the 1990s, Clinton put in tax increases and today people like Bob Rubin, the former Treasury Secretary, are saying, "See, it works.  High taxes work."  No, they don't.  If you look at 1992 after the '90-'91 recession, it didn't help George Bush Sr. The economy in the latter part of 1992, especially the fourth quarter, started to move up, with five percent growth rates.  President Clinton comes in, puts in big tax increases and even though history says that growth should have accelerated, instead we nearly went into another recession.  You pay a price when you put a burden on people doing good things. 

In 1998, capital gains tax on housing, thanks to Republicans, was virtually eliminated.  That's when the housing boom began, that's when housing prices really went up.  You lower the burden on something, the value goes up.  And John Kennedy showed the way in the early 1960s.  Maybe some Democrats someday will discover that heritage, certainly the late President's brother hasn't. 

And in 2003, as you well know-family squabbles-but as you well know in 2003, we passed a tax cut in this town, capital gains levies were reduced, dividend tax was slashed, personal tax rates were cut, incentives were put in for business to invest, especially small businesses, and guess what happened?  We went from a one-percent-growth-rate economy-that's a boom in Western Europe but not here-to three-and-a-half, four percent. Stock market up since then $5 trillion.  More jobs created than Japan and Western Europe put together.  Profits going up and now wages going up.  That's the pattern.  When you come out of a slump, first you've got productivity gains, profit gains, and then salaries go up, and that's exactly what's unfolding here today.  And yet like Rodney Dangerfield, this economy gets no respect.

To put it in perspective, in the last four years the growth of the American economy alone exceeds the entire size of the Chinese economy.

Again, to put it in perspective, in the last four years the growth of the American economy alone exceeds the entire size of the Chinese economy.  China's booming but it's off of a very low base.  No developed economy has been doing as well as we have, so the thing works.  Productivity has gone up twice the rate in this new decade as it did in the mid-19 and early 1990s, and for all of the blame and bad rap given to the American consumer, we're portrayed as spendthrifts, living from paycheck to paycheck, going binging on credit card debt, the fact of the matter is, consumer balance sheets in America have never been stronger than they are today.  If you take what people-what their financial assets-stocks, bonds, bank CDs, 401Ks, life insurance policies and the like and subtract out what people owe on their credit cards and other forms of debt-by the way, 54 percent of America's families have no credit card debt, and those that do, the median is $2,200. Yes, some people are over-extended, but most Americans deal with their financial situation fairly well.  If it gets out of hand, they take corrective measures.  That's what you would expect from a free people.  And if you add to those liabilities-mortgages-don't even count the value of people's homes and apartments, just treat mortgages as straight debt, so you have assets, financial assets, subtract out all those debts and American households today, plus 27 trillion dollars.  American households are the biggest suppliers of credit to the global financial markets today.  When was the last time you heard that factoid?  The answer is, you haven't.  Add in housing, another 26 trillion dollars. 

So Americans are in fairly decent shape. People say, "well, that's just because of Bill Gates." You know the joke: Bill Gates goes in a bar and the average of the bartenders is now everyone's a millionaire.  But if you take median increase in household wealth, it's up almost 40 percent between 1995 and 2004. The thing works, and yet today Nancy Pelosi says we need a middle class tax cut to increase demand.  Again, throw money and somehow good things will happen.  They have this Keynesian mindset: the only way to get an economy moving is throwing money at it.  Well, if that worked, Argentina would own the world today.  [laughter]  It's not just Nancy Pelosi, you see in Robert Reich, you see it in a lot of so-called Republican economists.  They still have this Keynesian mindset that grew out of the Great Depression. 

Again, remember the real source of growth, the higher standard of living is innovation, and you have to have the right environment, an environment of freedom.  That's why the Dutch moved ahead, that's why Britain moved ahead, and ultimately we moved ahead of everyone else, because we had a greater environment of freedom.  Back in the medieval ages, northern Italy, when those city-states were fairly free before the French and Spanish invaded, they invented modern banking.  Flanders, when it wasn't subsumed, was a source of then the biggest industry, textiles.  Freedom works.  You see the importance of innovation throughout our history-railroads, placing canals.  Twenty years ago you take the word internet and type it into a spell-check-no such word.  Yet it's now having huge ramifications for our economy. 

What we have to remember is that change brings disruption.  You see it in the newspaper industry, you see it elsewhere, and that's what we have to remind ourselves.  It's not just increasing everything we see, some things surge ahead, others go through the convulsions of change.  I mentioned railroads.  They did in canals.  If you owned canal bonds when railroads came along, you are not a happy investor.  But there is disruption, and part of the political process, a good political process, is creating an environment where you deal with those disruptions and not stop innovation and invention which ultimately benefits us all. 

Just another example, it may seem a frivolous example, but just look at the iPod.  Whoever heard of an iPod 5 or 6 years ago?  If you heard an iPod, you'd think of some alien movie, you know, pod people taking over the world or something.  Now it's something a lot of people think they can't live without.  We added tens of billions of dollars to Apple's market value, revived their computer business.  Innovation.  It is absolutely crucial.

One of the things that Republicans can be rightly criticized for is not just spending, you know. Republicans have been compared to drunken sailors on spending, which as you have been reminded before, is an insult to drunken sailors because drunken sailors spend their own money.  [Laughter, applause]  But one of the things we can rightly criticize Republicans for is when they took over in 1994 they did not change the way tax cuts are scored on Capitol Hill and then in the White House and the Executive Branch.  They made some minor attempts a few years ago but it's a pathetic effort.  Why they didn't change it, who knows, but it was a huge missed opportunity. Now, under the guise of pay-as-you-go-that sounds fiscally conservative-Pelosi and others will say, "We need to increase taxes," because tax cuts cost money. 

Properly structured tax cuts increase not only the wealth of the nation but the revenues.  In the last two years, Washington's had a record increase in revenues.  Never has there been a two year period where in real terms revenues have grown as much as they have in the last two fiscal years.  And yet, they want to wreck that by increasing taxes. 

So what happens now?  Well, the White House-who knows what's going to happen there.  There's going to be a lot of pressure for President Bush to in effect, capitulate.  The whisper in his ear-look what Clinton did after '94, pretended he was a Republican, said the era of big government was over.  Look at Arnold in California.  He didn't capitulate on taxes but everything else he pretend he was a Democrat.  Look, he won by a landslide.  "Mr. President, you can regain your popularity by just going along, showing you can work with people."  That'll be a temptation.  I mentioned Rubin and others saying we need higher taxes-they may try to come along with a Social Security reform that involves means-testing and tax increases.  Again, remember, statesmanship and bipartisanship in this town mean capitulation to ever-bigger government and ever-higher levels of taxation.  I choke on that.  [Laughter] 

So which will the White House go?  For all of the raps against Jerry Ford, he did on spending bills in 1975 wield the veto pen.  Will this President do it, and at the same time, make the case why we need fundamental domestic reforms?  Even though he won't get them through this Congress, he can set the foundation for the future so when these things happen he can say, "I did the pioneering work to make it possible."  That is a real legacy, not giving in to the opposition. 

On the House side, there's a race for leadership.  Will the Republicans elect a reformer like Mike Pence or John Shadegg?  Too many Republicans, sadly, still prize pork over principle, and that's something we have to guard against. 

The bottom line gets to the importance of The Heritage Foundation. The battle of ideas is going to be joined again.

The bottom line, ladies and gentlemen, gets to the importance-and this is a commercial, but hey-of The Heritage Foundation.  The battle of ideas is going to be joined again.  We don't have to be deferential, allegedly complicating life on Capitol Hill, no, all those inhibitions are gone.  We're in the battle of ideas again and we shouldn't hesitate, shouldn't be discouraged, because this what America's about. 

The Democrats didn't win this election, Republicans lost it.  [applause]  As someone said, the Democrats are like Forrest Gump.  They happened to be there and got the victories, but they had very little to do with them.  All they made clear was they weren't Republicans, they weren't the President, they were unhappy with the war in Iraq-who isn't-and that's how they won, unlike the Republicans in '94 which put out a platform, contract with America, they just said, "We're not Republicans."  It's like going to a restaurant and you want chicken but you find on the menu parrot and pelican.  You're mad at the parrot so you go for the pelican, not because you want it.  That's all the choice that was there.  You wanted to send a message.  It was the only way to do it.  In this day of multiplicity, of the internet giving us choice, well, that's what happens.  So the Democrats think they have a mandate, we have to make sure that the American didn't give them a mandate, they wanted to send a message to a job poorly done in the in party and now soon to be the out party. 

We should take heart that unlike when Ronald Reagan came in America is much more conservative than it was back then.  The spread of ideas, what Heritage and others have done, has borne fruit.  We can build on very, very solid foundations.  We don't have to dig the foundation, it is there.  All we have to do is make sure people understand and we have to work to get the message out there of basic principles, right principles, and then when we meet again it will be to celebrate a victory, not just winning an election, but winning the battle of ideas and making America what it should be, the inspiration for the world, that freedom works, that we can fight evil and advance at the same time.  Thank you.  [applause]

Question: Your comments are so full of common sense and so essential in my view.  My question is, why can't those ideas be disseminated regularly throughout the United States so that people can hear them again and again and understand what you are saying? I believe that most Americans, if they were exposed to that kind of commentary, would be excited about the prospects for their country.

Forbes:  Well, I think this is why we're here.  Heritage-they set the foundation for it, there are many good think tanks out there today-is developing these principles and applying them to real everyday policy problems and opportunities. We're here, we know the work of Heritage, we're working to have our friends and neighbors and colleagues know about it and that's what we have to continue to do.

Ronald Reagan could do one speech in 1964 before the election which electrified the nation when he spoke on behalf of Barry Goldwater, made the case better than anyone else was that year, but most of us don't have that kind of ability and so it takes a lot of hard work to get those ideas out and that's what Heritage is about, that's what other good groups are about, working to get those ideas out there and it takes blogging, it takes newspapers, it takes television, radio, TV, position papers, and eventually I think that the message will get through.

If I had given these remarks say, 30 years ago or 40 years ago, most people wouldn't understand a large part of what I was saying.  The idea that tax cuts work, that was a radical idea 40 years ago, that you could reduce the- Republicans in the 1960s opposed the Kennedy tax cuts because they thought it would increase the deficit.  If you're going to reduce tax rates 23 percent, you're going to take away 23 percent of the government revenue.  So a lot of work has been done and we sort of take it for granted that we can say things and people immediately understand or at least have some vague notion of where we're coming from.  And that's what we have to do so that the common language we use.

You know, it's like learning a new language. Especially after the Depression, New Deal collectivism, we had to reestablish the old fashioned language so that people would immediately understand when you said certain things. Oh yes, a whole train of thought goes into people's minds, and that takes a lot of work, and we can see that, even though I think you're right, most Americans would say, "Yes, that makes sense," bad ideas still linger in the minds of the elites, in the minds of the general media, minds of a lot of politicos, the minds of a lot of academics.

So we've won a lot of battles, but it never is over.  It's a constant battle and it's amazing, the seduction of power where you begin to think the state is moi, and Louis XIV could legitimately say that, but this is not supposed to be Versailles and-even though it pretends to be, I'd love to-I know what Ronald Reagan would say about this place that his name is attached to. There's a lot of work to be done. 

So yes, we've got to get that message out there.  I'll be doing it, you'll be doing it, and that's how it happens.  We're a big country, a big country, but Reagan has shown-you saw where he was in the late '50s, early '60s with his ideas and where we are today. It's a huge change.  It's the liberals that are winning these things on the sly that have to pretend that they're conservative.  That's why they ran a lot of seemingly moderate candidates.  They knew that if their true colors showed, they still wouldn't have won even though people are mad at the Republicans.

Question:  (Inaudible)-a position paper where we can have uniformity on immigration reform, taxation, national defense, war in Iraq, and just to keep the Democratic Congress on their toes up to the next election.

Forbes:  I hope that, especially the House Republicans, will take the opportunity, and we'll start to see in the next few days, of realizing there's no way they can out-Democrat the Democrats, and instead, go into the loyal opposition, even if it means the White House, establishing firm principles, coming up with exciting proposals, and we may have some fights from time to time internally but so what, that's what freedom's about-jousting, getting these ideas, hammering them out, discussing them, honing them, and putting them out there, even if we get through.  The Senate won't do it, they'll use the Rules Committee and the House to make sure some of this stuff won't see the light of day.

But as we saw in the late '80s and early '90s with C-SPAN, now we have blogs, we've got talk radio.  There's a lot of ways to get the word out even if they try to bottle it up on Capitol Hill and set the stage.  Forget about trying to create a legacy by getting a bill signing.  If you want a bill signing, you do that very easily.  Give out pens and-cheap ones I hope, but give out pens-but that's not progress.  Progress is changing the political atmosphere so that positive things can get done.  I hope the House realizes it.  Their mission is now educating, propagating, agitating, and not going along and playing along to get a favorable editorial in a newspaper or two.

Question:  You're the biggest for the flat tax that I know of in this country.  I'm wondering if you can address what problems that conversion to the flat tax would cause to this economy.

Forbes:  The question concerns about what problems the flat tax would cause to the economy.  Other than the obvious ones, H&R Block wouldn't like it [laughter], a lot of lobbyists wouldn't like it, a lot of IRS agents wouldn't like it and even though we've had a lot of spending, I would support job re-training for IRS agents [laughter] with the flat tax.

To answer your question, the answer, amazingly, is you can do it overnight.  How?  How can you do it overnight?  Part of the flat tax proposal is giving people a choice.  That is, when you have the new system, simple 17 percent rate, generous exemptions-$46,000 for a family of four free of Federal income tax-17 percent above that no tax on savings, and no death taxes.  I always believe you should be allowed to leave the world unmolested by the IRS.  As our founders would say, "No taxation without respiration."  [Laughter, applause] 

Give people a choice.  When you have the new system, say, "You can go with the new, or if you wish, stay with the old.  That way people won't get hung up on what they might lose.  You can argue to some people until you're blue in the face that you're going to come out ahead with this thing.  They're just going to focus on "I'm going to lose this, I'm going to lose that."  Okay, see for yourself which one is the right way. 

Now, in Hong Kong, amazingly, they have a single rate, 16 percent, but they also have a little progressive system of 2 to 20 percent, and you choose which one you want to go with.  It's sort of the happy version of the alternative minimum tax.  You choose which one is lowest, so when you give people a choice, then if you feel you have special issues with the old system that you don't want to lose-depreciation and all that kind of stuff-fine.  Stick with it.  The rest of us will move ahead. 

So that way you can do it overnight. Again, remember, we have two systems today, the regular one as you all are familiar with, you do the calculations. or you hire someone to do the calculations for the AMT-there's nothing minimum about it, it's a maximum tax, and there's nothing alternative about it, whichever is the worst for you, that's what they hit you with, so we just flip that.  We just flip that.  If you want to stay with the old, fine, but if you want to go with the new lower one, you're free to do so, and that's the way to get around transitions issues. 

Ed says we have to get onto the exciting program we have this afternoon and tomorrow. So with that, let me say again, thank you, and don't lose heart.  The fight's just begun.  Thank you.

Steve Forbes is a Trustee of The Heritage Foundation.

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