I’m a big fan of fundamental tax reform, in part because I believe in fairness and want to reduce corruption.
But I also think the flat tax will boost the economy’s performance, largely because lower tax rates are the key to good tax policy.
There are four basic reasons that I cite when explaining why lower rates improve growth.
- They lower the price of work and production compared to leisure.
- They lower the price of saving and investment relative to consumption.
- They increase the incentive to use resources efficiently rather than seek out loopholes.
- They attract jobs and investment from other nations.
As you can see, there’s nothing surprising or unusual on my list. Just basic microeconomic analysis.
Yet some people argue that lower tax rates don’t make a difference. And if lower tax rates don’t help an economy, then presumably there is no downside if Obama’s class-warfare tax policy is implemented.
Many of these people are citing David Leonhardt’s column in Saturday’s New York Times. The basic argument is that Bush cut tax rates, but the economy stunk, while Clinton increased tax rates and the economy did well.
The defining economic policy of the last decade, of course, was the Bush tax cuts. President George W. Bush and Congress, including Mr. Ryan, passed a large tax cut in 2001, sped up its implementation in 2003 and predicted that prosperity would follow. The economic growth that actually followed — indeed, the whole history of the last 20 years — offers one of the most serious challenges to modern conservatism. Bill Clinton and the elder George Bush both raised taxes in the early 1990s, and conservatives predicted disaster. Instead, the economy boomed, and incomes grew at their fastest pace since the 1960s. Then came the younger Mr. Bush, the tax cuts, the disappointing expansion and the worst downturn since the Depression. Today, Mitt Romney and Mr. Ryan are promising another cut in tax rates and again predicting that good times will follow. …Mr. Romney and Mr. Ryan would do voters a service by explaining why a cut in tax rates would work better this time than last time.
While I’ll explain below why I think he’s wrong, Leonhardt’s column is reasonably fair. He gives some space to both Glenn Hubbard and Phil Swagel, both of whom make good points.
“To me, the Bush tax cuts get too much attention,” said R. Glenn Hubbard, who helped design them as the chairman of Mr. Bush’s Council of Economic Advisers and is now a Romney adviser. “The pro-growth elements of the tax cuts were fairly modest in size,” he added, because they also included politically minded cuts like the child tax credit. Phillip L. Swagel, another former Bush aide, said that even a tax cut as large as Mr. Bush’s “doesn’t translate quickly into higher growth.” Why not? The main economic argument for tax cuts is simple enough. In the short term, they put money in people’s pockets. Longer term, people will presumably work harder if they keep more of the next dollar they earn. They will work more hours or expand their small business. This argument dominates the political debate.
I hope, by the way, that neither Hubbard nor Swagel made the Keynesian argument that tax cuts are pro-growth because “they put money in people’s pockets.” Leonhardt doesn’t directly attribute that argument to either of them, so I hope they’re only guilty of proximity to flawed thinking.
But that’s besides the point. Several people have asked my reaction to the column, so it’s time to recycle something I wrote back in February. It was about whether a nation should reform its tax system, but the arguments are the same if we replace “a flat tax” with “lower tax rates.”
…even though I’m a big advocate for better tax policy, the lesson from the Economic Freedom of the World Index…is that adopting a flat tax won’t solve a nation’s economic problems if politicians are doing the wrong thing in other areas.
There are five major policy areas, each of which counts for 20 percent of a nation’s grade.
- Size of government
- Regulation
- Monetary Policy
- Trade
- Rule of Law/Property Rights
Now let’s pick Ukraine as an example. As a proponent of tax reform, I like that lawmakers have implemented a 15 percent flat tax.
But that doesn’t mean Ukraine is a role model. When looking at the mix of all policies, the country gets a very poor score from Economic Freedom of the World Index, ranking 125 out of 141 nations.
Conversely, Denmark has a very bad tax system, but it has very free market policies in other areas, so it ranks 15 out of 141 countries.
In other words, tax policy isn’t some sort of magical elixir. The “size of government” variable accounts for just one-fifth on a country’s grade, and keep in mind that this also includes key sub-variables such as the burden of government spending.
Yes, lower tax rates are better for economic performance, just as wheels matter for a car’s performance. But if a car doesn’t have an engine, transmission, steering wheel, and brakes, it’s not going to matter how nice the wheels are.
Not let’s shift from theory to reality. Here’s the historical data for the United States from Economic Freedom of the World. As you can see, overall economic policy moved in the right direction during the Clinton years and in the wrong direction during the Bush-Obama years.
To be more specific, the bad policy of higher tax rates in the 1990s was more than offset by good reforms such as lower trade barriers, a lower burden of government spending, and less regulation.
Similarly, the good policy of lower tax rates last decade was more than offset by bad developments such as a doubling of the federal budget, imposition of costly regulations, and adoption of two new health entitlements.
This is why I have repeatedly challenged leftists by stating that I would be willing to go back to Bill Clinton’s tax rates if it meant I could also go back to the much lower levels of spending and regulation that existed when he left office.
[…] will acknowledge that lower tax rates are good for growth, but they will argue other policies can achieve the same […]
[…] why lower tax rates are a good idea if we want more prosperity – keeping in mind the important caveat that taxation is just one of many policies that impact economic […]
[…] I’m cautious about drawing sweeping conclusions from short-run data, especially since we know many other policies also have an impact on economic […]
[…] I’m cautious about drawing sweeping conclusions from short-run data, especially since we know many other policies also have an impact on economic […]
[…] pointed out many times that taxes are just one of many policies that impact economic […]
[…] In conclusion, I suppose I should point out that a flat tax would be very beneficial for Italy’s economy, but other market-friendly reforms are just as important. […]
[…] why lower tax rates are a good idea if we want more prosperity – keeping in mind the important caveat that taxation is just one of many policies that impact economic […]
[…] why lower tax rates are a good idea if we want more prosperity – keeping in mind the important caveat that taxation is just one of many policies that impact economic […]
[…] why lower tax rates are a good idea if we want more prosperity – keeping in mind the important caveat that taxation is just one of many policies that impact economic […]
[…] on that issue. Yes, I think the growth effects will be significant, but I also realize that many other policies also determine economic performance. The most important thing to understand, thought is that even small increases in growth make a big […]
[…] fixated on that issue. Yes, I think the growth effects will be significant, but I also realize that many other policies also determine economic performance. The most important thing to understand, thought is that even small increases in growth make a big […]
[…] and lower-tax nations. Though, given the limited time period in the chart and the fact that many other factors can impact wage growth, I’m actually more persuaded by some of the other empirical research cited in the CEA […]
[…] and lower-tax nations. Though, given the limited time period in the chart and the fact that many other factors can impact wage growth, I’m actually more persuaded by some of the other empirical research cited in the CEA […]
[…] Freedom of the World and remove the fiscal policy variable (and thus measure the degree to which markets are allowed to operate), then Denmark and Sweden are both among the world’s top-10 nations for free […]
[…] Freedom of the World and remove the fiscal policy variable (and thus measure the degree to which markets are allowed to operate), then Denmark and Sweden are both among the world’s top-10 nations for free […]
[…] closing, I did address the taxes-growth issue last year. I wasn’t debunking the CRS study, but I was exposing the errors in some very similar analysis by […]
[…] Tax Rates Impact Economic Performance, but other Policies also Matter […]
[…] Tax Rates Impact Economic Performance, but other Policies also Matter […]
[…] why I’ve argued in favor of lower tax rates and shared the latest academic research showing that tax policy has a significant impact on […]
[…] closing, I did address the taxes-growth issue last year. I wasn’t debunking the CRS study, but I was exposing the errors in some very similar […]
[…] learned to be more careful about being myopically fixated on fiscal policy. As I noted in this post about tax rates, there are many factors that determine a nation’s economic performance. That’s hardly a […]
[…] a strong believer in the importance of good tax policy, it’s also important to understand that taxation is just one of many factors that determine economic performance. So lower tax rates, by themselves, are no guarantee of economic vitality, and higher tax rates […]
[…] strong believer in the importance of good tax policy, it’s also important to understand that taxation is just one of many factors that determine economic performance. So lower tax rates, by themselves, are no guarantee of economic vitality, and higher tax rates […]
This is a bit off topic, but it’s interesting to see that Carter achieved a tiny bit of liberalization after “price+wage controls” Nixon. (Though perhaps Gerald Ford deserves some of the credit.)
Any chance that the EFW index will be extended back in time?
I’d like to compare the US under Reagan to Athens under Pericles.
All the above is true. Mitchell failed to point out that as lower tax rates and thus savings are channeled into productive capital investment, that the system is rigged to favor those with “past” savings and the ability to retain earnings of business corporation owners and incur debt to further invest in productive capital with the result that the already wealthy class further accumulates more wealth ownership and thus more income. Of course, the operating principal is that the investments pay for themselves and generate earnings to retire any debt incurred. This is the principal reason that income inequality is widening exponentially.
The argument flaunted by many politicians and economists that tax savings will be diverted to investment and JOB CREATION, and thus, “full employment” is flawed. It is based on empowering people that benefit from the “job creators” who will put monies otherwise paid to taxes to create opportunities to “work harder” and thus “employment” as in a job. It flies in the face of exponential and tectonic shifts in the technologies of production, which is destroying or degrading jobs and the need for labor workers to produce society’s products and services. Instead, the non-human factor of production––productive capital––generally productive land, structures, human-intelligent machines, superautomation, robotics, digital computerized operations, etc. is now the significant input in the process of producing society’s products and services. This trend will continue at an exponential rate.
While tax and investment stimulus incentives are excellent tools to strengthen economic growth, without the requirement that productive capital ownership is broadened simultaneously, the result will continue to further concentrate productive capital ownership among those who already own, and further create dependency on redistribution policies and programs to sustain purchasing power on the part of the 99 percent of the population who are dependent on their labor worker earnings or welfare to sustain their livelihood. By stimulating economic growth tied to broadened productive capital ownership the benefits are two-fold: one is that over time the 99 percenters will be enabled to acquire productive capital assets that are paid for out of the future earnings of the investments and gain greater access to job opportunities that a growth economy generates.
The question that requires an answer is now timely before us. It was first posed by Louis Kelso in the 1950s but has never been thoroughly discussed on the national stage. Nor has there been the proper education of our citizenry that addresses what economic justice is and what ownership is. Therefore, by ignoring such issues of economic justice and ownership, our leaders are ignoring the concentration of power through ownership of productive capital, with the result of denying the 99 percenters equal opportunity to become capital owners. The question, as posed by Kelso is: “how are all individuals to be adequately productive when a tiny minority (capital workers) produce a major share and the vast majority (labor workers), a minor share of total goods and service,” and thus, “how do we get from a world in which the most productive factor—physical capital—is owned by a handful of people, to a world where the same factor is owned by a majority—and ultimately 100 percent—of the consumers, while respecting all the constitutional rights of present capital owners?”
http://foreconomicjustice.com/11/economic-justice/
Please see my article “Democratic Capitalism And Binary Economics: Solutions For A Troubled Nation and Economy” at http://foreconomicjustice.com/11/economic-justice/ or follow me on Facebook at http://www.facebook.com/pages/For-Economic-Justice/347893098576250 and http://www.facebook.com/editorgary
Also follow the Center for Economic and Social Justice at http://www.cesj.org and http://capitalhomestead.org/ Join the OWN Team at http://capitalhomestead.org/group/the-on-team
Also see The Kelso Institute at http://www.kelsoinstitute.org/
And join the OWN Team to advocate OWNERSHIP CREATION at www.http://capitalhomestead.org/
[…] https://danieljmitchell.wordpress.com/2012/09/17/tax-rates-impact-economic-performance-but-other-poli… […]
Dan, you should update this after tomorrow’s release of the new EFW index!