January 24, 2005
Supply Side In Action
Economists think themselves rational and scientific, but so many become so involved in political agendas that the science does not follow the rules of the traditional "hard sciences."
We have more than a hundred years of economic data. You can do regression on the data and see what policies have worked and which are a fluke -- that is if you really want to see.
Time and again, tax cuts have lead to economic growth and concomitant gains in tax revenue. That's predicted by my hero, Professor Art Laffer. The WSJ Ed Page notes today (paid site, sorry!) that the previous cut in Capital Gains rates has, yet again, proven Dr. Laffer right:
Some people continue to believe, or at least still assert, that tax rates don't influence taxpayer behavior all that much. We therefore direct their attention to the Treasury Department's latest historical data on revenues from taxes on capital gains.The numbers look like a 25-year demonstration of the Laffer Curve in action. Taxes paid on capital gains have been highly responsive to the maximum capital gains tax rate. Especially notable is how, over the years, capital gains realizations and the taxes paid on those gains have tended to increase in the years following a cut in the capital gains tax rate.
The reductions highlighted in the chart include the famous William Steiger tax rate cut that passed Congress in late 1978 over Jimmy Carter's objections, the Reagan tax cut passed in 1981, and the cut that was part of the Clinton-Gingrich balanced budget deal of 1997. All of those reductions caused taxpayers to cash in more of their gains and thus yielded revenue windfalls for the federal Treasury in succeeding years.
On the other hand, the capital gains tax increase of 1986 -- which moved the rate back up to 28% from 20% -- proved to be a revenue disaster. Taxes paid on long-term capital gains (those typically held longer than one year) fell off a cliff to $33.7 billion in 1987 from $52.9 billion a year earlier. And they stayed at close to that mediocre lower level for nearly another decade. In other words, higher rates didn't do anyone any good, not even the politicians who thought they'd be getting more tax revenue to spend.
Compare this to "Ruebenomics" which dictates that if we raise taxes enough to pay off the deficit, that will lower interest rates and spark a boom, like it did in the 1990s.
Side note: this dot-commer would do anything to bring back the 90s. I am reading Dinesh D"Souza's "Virtue of Prosperity" which chronicles the rise of Yahoo and Sun and Silicon Valley dotcom fever. Never has a four year old book seemed so dated.
Though that was a fun time to be a computer programmer, few economists will admit that there is zero historical correlation between government debt and interest rates. Yet there is a half-century of direct correlation between lower marginal tax rates and prosperity. "Who you gonna believe, say the Reubenomics boys. Me or your lyin' eyes?":