Two terrible events can befall a cherished economic theory. Someone can actually put it into action to see if it works, or impartial economists can employ regression analyses and other refined academic tools to see how the idea performs in the real world.
Now both have happened to the Republican notion that what you must do to get the economy roaring and creating jobs is to turn business and the investor class loose by lowering their taxes. They will run out and hire more workers. That is the heart and soul of the Republican campaign in 2012 for the White House, Congress and state legislatures, at least if other states are like Arkansas, where Republican legislators are talking about lowering the top income tax rates or repealing the tax altogether.
The idea has always had a certain seductive charm, as long as you don't think about it more than a minute. Then you have to ask yourself, does a business hire workers simply because the owner is going to keep more of his profits this year or next year and needs a place (the pockets of new employees) to park his new profits, or does it hire because the company needs more workers to meet a demand for more of its goods and services? Why, the latter of course. If there is no demand for more of your goods, no amount of tax savings will make you hire a new clerk or start a new production line. Tax savings have absolutely nothing to do with it, unless taxes are so high that the owner would keep little or none of the extra profits from increased production. And that is not the case — not in the United States, and certainly not in Arkansas. Even in the worst possible case, at current tax rates a businessman will keep two-thirds of his extra profits.
As it happens, we have a lot of history of tax cuts and tax increases, both in the United States and in Arkansas. I have pointed out that even a casual look at tax actions since the 1920s shows that income tax increases tended not to slow the economy (see the only Arkansas personal income tax increase in 1971 and the only corporate rate increase in 1991) and tax cuts did not produce economic surges (see Reagan in 1981 and Bush in 2001). But that was just looking at the growth or decline in jobs and gross domestic product in the aftermath of a tax cut or increase, which does not require special know-how.
We learned last week from a report in The New York Times that the Congressional Research Service, a nonpartisan research arm of Congress, did a scholarly study of the theory and concluded, just as armchair economists had, that it was pure bunk.
The study was concluded some time ago, but Republicans, who were keenly interested in it, got an advance copy and saw that it was not going to be useful in the fall campaign for Congress and the White House. So Senate Republican leaders talked to the head of the research bureau, who agreed to quietly file it away.
The thing leaked anyway, but fortunately for Republicans too late to have any impact. It probably would have had little impact anyway. Politicians will believe what they want to believe, and so will most voters.
Mitch McConnell and Orrin Hatch, the Republicans who deep-sixed the study, said the report had partisan phrases, like "Bush tax cuts," and that the study looked at the effect of tax cuts only in the immediate aftermath rather than in the out years. The study actually examined the long-term effects of reductions in the top marginal rates, not just the first year or so, and, besides, the principal Republican argument has been that a reduction in the top marginal rate for high-income taxpayers would have an immediate jolt by giving businesses the assurances they need to expand and hire.
The CRS researchers followed the steady decline in the marginal tax rate on high earners from World War II to the present and the GDP growth rate and the per-capita GDP growth rate in the years after each reduction. The top tax rate was above 90 percent from 1945 through the '50s. Then Congress lowered it every few years until it reached the current rate of 35 percent. The rate went up briefly a few times, in the Vietnam War, and ever so slightly under George H.W. Bush and Bill Clinton, but it has gone down pretty steadily. The current 35 percent rate was part of waves of tax cuts under George W. Bush, including special reductions in taxes on investment income.
So what happened? There are lots of figures but two groups tell the story. In the '40s and '50s, when marginal rates were over 90 percent, GDP growth averaged 4.2 percent a year and per-capita growth averaged 2.4 percent. But in the last decade, when the top rate was 35 percent and the tax on capital gains dropped to 15 percent, real growth averaged only 1.7 percent and less than 1 percent per person.
But while all those reductions in top tax rates did not ignite the economy the CRS found that they did have a dramatic effect. They sharply increased the share of the nation's wealth going to the top one-tenth of one percent of taxpayers. The share of the nation's income that accrued to the top one-tenth of one percent rose from 4.2 percent in 1945 to 12.3 percent, before the big recession in 2007.
Republican leaders want to get that trend moving again, and they are not going to let a stinking report get in the way.
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