The Fine Print

Why the Republicans Can’t Be Content to Pass Just Anything on Taxes

The Reagan and Kennedy tax cuts led to growth. The Bush cuts largely didn’t. Therein are found important lessons for today’s GOP on what it should pass.

With apologies to Roy Moore, the biggest story this week should be tax reform. Republicans have a decent chance of actually passing it.

Without getting too deep in the weeds, the big Republican argument for tax reform is that it will jump-start the economy by creating growth. Democrats, meanwhile, will call it a tax cut for the rich and a deficit buster.

In the short run, they may both be right. But if a rising tide lifts all boats, that’s OK—so long as the tax cuts actually do, you know, create a rising tide.

As such, it’s worth examining if Republican claims are even plausible, given the tax plans making their way through both chambers of Congress. After all, not all tax cuts are created equal. The John F. Kennedy and Ronald Reagan tax cuts seemed to lead to tremendous growth in ensuing years, while the Bush years ended in an economic downturn. What could Republicans learn from this?

It turns out this is an important conversation. Republicans are at a crossroads. It’s possible that President Trump will sign a tax overhaul bill that complies with the ingredients conservatives (and history) suggest will stimulate the economy. But there is a very real possibility that political considerations will cause them to take half-measures. In order to pass something—anything!—their bill might end making some of the same mistakes that were made during the Bush years. If this happens, tax cuts will increase the deficit—but the rising tide will never come in.

First, though, a quick refresher is in order: George W. Bush cut taxes in 2001 and 2003—and signed the Economic Stimulus Act of 2008, which included tax rebates (to be addressed below). Most supply-side free-market conservatives I consulted believe the 2003 tax cuts (which also lowered rates on capital gains and dividends and phased out the estate tax) actually did stimulate growth, but that this was essentially wiped out by the financial crisis of 2007 and 2008.

They also tend to agree there are four main problems with the Bush tax cuts that today’s Republicans will have to avoid if they want to create real growth:

The first problem is that the Bush tax cuts were phased in. “You never want to phase in a tax cut,” advises Heritage Foundation economist Stephen Moore. Citing economist Art Laffer, Moore explains, “If someone tells you Macy’s is going to have a 50 percent off sale in a week, nobody is going to go in this week—so you’ve got a delayed effect.” 

A 2012 report authored by Matthew Mitchell and Andrea Castillo for George Mason University’s Mercatus Center confirms this: “The gradual phase-in of the tax cuts had the perverse effect of encouraging consumers, suppliers, workers, and investors to delay economic activity until the anticipated tax conditions were better,” the report says. “The relative success of the 2003 tax cuts compared with the 2001 tax cuts lends support to the argument that instantaneous tax cuts are preferable to gradual ones.”

The problem is that the Senate tax bill would delay the corporate tax cuts until 2019. This is done as an accounting trick to show more revenue when the bill is scored. This is why, Moore tells me, “you don't want to let scoring dictate policy.”

The second problem was that the Bush tax cuts came with a sunset provision in the form of a 2010 expiration date. This was done in order to comply with budget reconciliation rules, but (in terms of how supply-side conservatives view incentives) it essentially guaranteed the tax cuts would not have a stimulative effect.

“[E]xpiration dates diminish the potency of tax cuts by discouraging some investments at the margin that would have taken place if lower tax rates had been promised for a longer period of time,” write Mitchell and Castillo.

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The problem is that today’s Republicans face exactly the same challenge. The Atlantic’s Russell Berman warns that “Republicans likely will adjust their plan by making some of the biggest tax cuts expire in the next decade, a change that limits the legislation’s potential for economic growth and would force lawmakers to confront potential tax increases years in the future.”

Static budget scoring doesn’t account for the dynamic growth that positive incentives unleash. The rub is that only permanent tax cuts actually stimulate the economy, but you can’t make them permanent if scoring shows they will bust the long-term budget. It’s a Catch-22.

To be sure, advocates of the House plan are stressing that the corporate tax cuts will be permanent. But if we are to fail to learn from history, this strikes me as the most likely culprit. It’s vital for the tax cuts to be permanent if we are to actually test whether or not supply-side theory works.

Third, the Bush tax cuts focused more on individuals than on business. Politically speaking, tax breaks for individuals—especially middle-class Americans—are much more palatable than taking about corporate tax breaks. But supply-siders argue that, since Ronald Reagan’s tenure, we have addressed this low-hanging fruit. In fact, many Americans pay zero income taxes. When asked why he robbed banks, Willie Sutton famously said: “Because that’s where the money is.” When it comes to growth, supply-side conservatives believe corporate tax cuts are where you get the most bang for the buck.

Stimulating the economy, they say, will require making American businesses more globally competitive. Ideas like moving to a territorial tax system, imposing a one-time rate of 12 percent for companies to repatriate foreign profits, and cutting the corporate tax rate to 20 percent, are all necessary ingredients for growth.   

“This tax cut doesn’t do much on the individual side,” explains Moore. “The growth this time comes from the business-rate reductions, because that’s where we are the most defective and uncompetitive.” 

Lastly, the Bush tax cuts in 2001 and 2008 were delivered via a rebate. For Bush, the political benefit of sending Americans a check must have seemed irresistible. “Rebates seem popular. Everybody gets a check,” says Grover Norquist of Americans for Tax Reform. “They wanted a tax cut they could brag about... It wasn’t a supply-side project.”

The problem? “Tax rebates are nothing more than government spending through the tax code,” says Andy Roth, vice president of government affairs at the Club for Growth. “It doesn’t change incentives. It doesn’t encourage businesses to hire or invest. It’s merely a transfer payment from future taxpayers to current taxpayers.”

In fairness to George W. Bush, it’s important to remember that his presidency began with a surplus, not a deficit. For this reason, instead of focusing on creating incentives for growth, he prioritized letting people keep more of what they earn—so that government wouldn’t spend it. This is a defensible thing to do, but it has nothing to do with creating the kinds of incentives that conservatives believe create growth. “It wasn’t designed to change behavior the way the Reagan ones and the Kennedy ones and the Coolidge ones were,” says Norquist.

As always, the devil is in the details. Republicans have the opportunity to pass a tax overhaul that conservative economists believe will jump-start growth. But for a president who has failed to score any landmark legislative victories, there will be a great temptation to pursue politically popular tax cuts that will increase the deficit without incentivizing growth.

It seems to me that there are three options: (1) The tax bill fails, (2) the tax overhaul passes—but only by cutting out the measures that conservatives argue would stimulate the economy, or (3) a pro-growth tax plan passes that conservative economists believe will stimulate growth.

Most Republicans and conservatives fear option 1 the most, as it would constitute political failure. But in my view, option 2 is the one to fear. That’s because the public will judge the efficacy of tax cuts based on the outcome of this reform package, regardless of how it’s implemented. Future attitudes about the virtue of cutting taxes could well hinge on how this works out.

It’s one thing to have your idea fail—it’s another to have your idea be discredited without actually having been tried. That is the very real danger supply-siders face.