Why Republicans Hate Tax Increases

Why Republicans Hate Tax Increases

APRIL 22, 2011

By JOHN SEILER

Republicans are ridiculing President Obama’s call to increase taxes on the rich.

And in California, so far Republicans in the Legislature have resisted siren calls to join Gov. Jerry Brown and the Democratic legislators to back tax increases, or even to put tax increases on the ballot. Why is that?

David Cay Johnston is a well-known investigative reporter formerly with the New York Times. He takes a stab at the story in the S.F. Bay Guardian. (A one-page version is here.)

Unfortunately, he seems not to have done his homework, even though he was born in 1948 and lived through this whole period.

His story is called “The Failed Experiment.” Subtitle: “How misplaced faith in tax cuts and other economic myths are destroying the country”

It begins:

For three decades we have conducted a massive economic experiment, testing a theory known as supply-side economics. The theory goes like this: Lower tax rates will encourage more investment, which in turn will mean more jobs and greater prosperity — so much so that tax revenues will go up, despite lower rates.

Actually the phrase “supply-side economics” was popularized in the 1970s, and formed a major part of the theories behind California’s Proposition 13 tax cuts in 1977 and Ronald Reagan’s tax cuts of 1981 and 1986. But the theory goes back much further than the name.

Two examples include the Harding and Coolidge tax cuts of the 1920s, which put the roar in the Roaring 20s. And President Kennedy’s 1964 tax cuts, enacted the year after he died, which propelled massive growth in the mid-1960s (until President Lyndon Johnson’s 10 percent income surtax of 1968 to pay for the Vietnam War and the Great Society).

Here’s a YouTube of JFK explaining why tax cuts are a great idea:

Confusing supply-side economics and monetarism

Johnston continues:

The late Milton Friedman, the libertarian economist who wanted to shut down public parks because he considered them socialism, promoted this strategy. Ronald Reagan embraced Friedman’s ideas and made them into policy when he was elected president in 1980.

For the past decade, we have doubled down on this theory of supply-side economics with the tax cuts sponsored by President George W. Bush in 2001 and 2003, which President Barack Obama has agreed to continue for two years.

But Milton Friedman was a monetarist, indeed the most famous monetarist of that school of economics, not a supply-side economist. He believed that recessions and depressions, especially one as big as the Great Depression, could be avoided through a steady, controlled increase in the money supply; doing so also would prevent inflation.

Along with Keynesianism, this is one of the two major schools of demand-side economics. As you remember from Econ 101, there are two factors in production, supply and demand. The Keynesians and monetarists seek to ensure growth through the proper management of demand

By contrast, the supply-side economists, as their name implies, seek to ensure growth through making it easier to supply goods and services — that is, to invest in, invent, build and sell goods and services.  It’s amazing how many people, including Johnston, can’t see what’s before their eyes: supply-side economics is about supply.

That’s why the supply-siders favor low taxes: That way, producers can invest more in production. Then we all get richer. The supply-siders emphasize that everybody, first, is a producer. You first produce something, then trade it to another producer.

Demand and Monetary Policy

By contrast, other economic theories stress creating demand. That’s why the Federal Reserve Board, under chairmen Alan Greenspan and Ben Bernanke, has been printing money like mad over the past decade, while keeping interest rates low: More dollars printed = more demand = more production = prosperity. At least that’s the theory.

But the problem with Keynesian inflation is that, pretty soon, prices start to soar, smashing producers/consumers. We’re seeing that now with soaring prices for oil, food and other commodities.

Inevitably, to prevent a 1920s Weimar-style inflation, the Fed will have to stop printing so much money, while raising interest rates — which will bring about another deep recession. That’s what happened in 1980-82, when Fed Chairman Paul Volcker shut down the 1970s inflation with two sharp recessions.

By contrast, the supply-siders, along with the somewhat related Austrian school of economics, favor a stable currency, in particular the gold standard. (Austrian economics actually is more popular these days than supply-side economics because of Rep. Ron Paul, a major Austrian adherent.)

It is strange that Johnston’s article doesn’t even deal with monetary policy, even though he lived through the 1970s stagflation (stagnation plus inflatin) economy, which in turn led to the supply-side policies of Prop. 13 and Reagan.

Bush’s Faulty Tax Cuts

Johnston attacked President George W. Bush’s tax cuts of 2001 and 2003. And he notes that President Obama, a Democrat, signed a two-year extension.

But Johnston doesn’t note something essential: Businesses, in the supply-side model, need certainty on tax and other government policy. By definition, a tax cut that expires in a couple of years creates uncertainty.

Businesses usually make plans of at least five years. So when the Bush tax cuts first were enacted, businesses could see that they would enjoy the tax breaks until the late 2000s. But as the 2000s came to a close, it wasn’t clear whether the tax cuts would be extended — or whether taxes would be increased. This was not the major reason for the economic crash of the late 2000s, but it didn’t help.

He also mistakenly includes Bush’s faulty tax cuts in with Reagan’s successful tax cuts, which were mostly permanent. As Johnston himself notes, Reagan brought the top income tax rate down from 70 percent to 28 percent; today it’s 35 percent. That’s about as permanent as one can get for any policy. Thirty years is a lot of time in politics. It helps to distinguish what happened in the 1980s from what happened in the 2000s.

The End of Root-Canal Republicanism

Johnston writes:

Tax policy is something the Framers left to politics. And in politics, the facts often matter less then who has the biggest bullhorn.

Of course, the Framers revolted against a mere tea tax imposed by the British Empire. They never would have tolerated the massive taxes most of us pay today.

And if tax policy is “left to politics,” then Johntson surely must know one reason why Republicans today are so averse to raising taxes: they’ve been burned so many times in the past.

Republicans used to be led by what were called “root-canal Republicans,” such as Bob Dole, President George H.W. Bush and President Richard Nixon. After Democrats enacted massive spending increases and subsequent deficits, the “root-canal Republicans” said, “Look, we’re adults. And adults pay their bills. So, we have to have to increase taxes to close the budget deficits.”

The results: The 1971 “Nixon Shock” included tax increases and inflation that, by 1974, produced a deep recession, followed by the stagflation that continued through the 1970s until Reagan cut taxes in 1981. In 1991, President Bush (the first one) broke his “Read my lips! No new taxes!” pledge, causing the 1991-92 recession.

Bob Dole was branded even by his fellow elephants as “the tax collector of the welfare state.” And in 1996, Dole put forth a tax-cut plan as part of his challenge to incumbent President Clinton. Clinton responded that, in the U.S. Senate, Dole had voted for more than $900 billion in tax increases.

Dole and Bush lost elections, and Nixon was chased from office (with Watergate being the major factor, of course; but the 1974 recession didn’t help Nixon, either).

By contrast, Reagan’s two terms produced strong economic growth. He is fondly remembered today even by liberals who despised him back then.

Even Republicans, never fast on the uptake, finally figured out that, for them, raising taxes is a sucker’s game. That’s why at all levels of government, they almost unanimously oppose tax increases. And they see that tax cuts bring victory at the polls.

Unfortunately, during the years of the second Bush administration (2001-08), Republicans forgot that they needed also to control spending. So deficits set new records, since broken by President Obama’s own record spending. And Bush II, unlike Reagan, allowed the aforementioned inflation of the dollar.

California Tax Increases

California Republicans also have seen how Gov. Pete Wilson’s record 1991 tax increases of $7 billion helped prolong the recession of that year to 1995, when the tax increases expired; that was three years longer than the national recession lasted.

And Republicans also now see how Gov. Arnold Schwarenegger’s record 2009 tax increase of $13 billion did not, as advertised, close the state’s budget deficit, which now stands at $25 billion.

Do You Want to Pay 70 percent in Income Tax?

Johnston goes on at length about how some rich folks don’t pay taxes, and how the middle-class is getting gouged. True enough. He also calls for tax reform. I also used to favor tax reform, but stopped doing so when the “reforms” — such as Bob Dole’s infamous TEFRA of 1982, on which Reagan later admitted he was “snookered” by Dole — end up raising taxes.

The only reform I favor now is cutting tax rates or entirely eliminating taxes. And even for that, I want to look under the hood and kick the tires.

Johnston doesn’t point out that, although the rich got tax cuts under Reagan, so did everybody else — including the middle class.

Johnston also doesn’t consider another key element of Reagan’s supply-side tax cuts: Indexing taxes to inflation. Because of the inflation of the 1970s, middle-class taxpayers had been jammed up into upper-income tax brackets. That’s the real reason middle-class incomes have stagnated since 1971. (Unfortunately, Reagan didn’t back-date the tax indexing to 1971; so the “bracket creep,” as it was called, of 1971-85 remains in place to this day.)

Without Reagan’s tax cuts and tax indexing for inflation, today the middle-class would be paying the 70 percent top tax rates Reagan inherited. Add to that the 15.3 percent Social Security-Medicare tax (including both the employee and employer contributions). And add in the 9.3 percent income tax rate middle-income taxpayer are stuck with in California.

Result: a 94.6 percent tax rate on the middle class in California. Think you could survive on 5.4 percent of your income, Mr. and Mrs. Taxpayer?

If not, then give a little thanks to Ronnie Reagan. He made a lot of mistakes in other areas — especially in not cutting spending very much (spending rose 90 percent in his eight years in office, hence the deficits). But his tax cuts, and the supply-side economic theories behind them, were the right policy, and remain so today.

5 comments

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  1. Cicero
    Cicero 22 April, 2011, 12:06

    Republicans – – – better known as the Right-Wing Socialist Party – – – love tax increases. Governor Reagan signed a massive tax increase, GOP legislators opposed Proposition 13 and put a weak Proposition 8 on the ballot to undermine 13, to the current GOP that gave nearly a million dollars to Arnold to buy TV ads to increase taxes.

    To maintain their corrupt power the Demos & Republicans joined together and put Prop 14 on the ballot last year that in effect bans all independent candidates and all opposition parties from all future general election ballots.

    We live in a one-party Socialist Dictatorship.

    Reply this comment
  2. David Cay Johnston
    David Cay Johnston 22 April, 2011, 13:01

    Mr. Seiler,

    As I have already posted elsewhere in cutting the piece by 40% I agreed to too tight of a lede that conflated a much more complex. Friedman was not a supply-sider.

    But his ideas have been joined with those of the supply-siders into a policy amalgam. One need need adopt every scripture to embrace a canon.

    My full article ran in 40 alternative weeklies, with most of my charts included at
    http://www.wweek.com/portland/article-17350-9_things_the_rich_dont_want_you_to_know_about_taxes.html

    I appreciate your thoughtful critique of my piece and you make some excellent points, especially on the hundreds of annual changes in tax law, which I have written elsewhere are driven by politicians as the easiest way to rile up voters, dole out favors and raise contributions, as documented in my award-winning bestseller Perfectly Legal.

    Also, you misspelled my name.

    Allbests

    Reply this comment
  3. John Seiler
    John Seiler 22 April, 2011, 18:19

    Mr. Johnston: Please excuse my misspelling of your name, which I have corrected in the text. I will check out your full article and your book.

    As to Milton Friedman, I was in Washington, D.C. in the 1980s and there was pretty strong friction between the Friedmanites and the supply-siders (and Austrians). For example, the 1982 Gold Commission that Reagan created was dominated by Friedmanites and conservative Keynesians. But Lewis Lehrman, a supply-sider, and Ron Paul, an Austrian, issued a Minority Report, which is free here:
    http://mises.org/books/caseforgold.pdf

    And here’s a 2000 “Memo on the Margin” to Larry Lindsey by Jude Wanniski, who helped craft Reagan’s supply-side tax cuts, attacking Friedman:

    “In your Wall Street Journal op-ed of Jan. 27, remarking on ‘The 17-Year Boom,’ you opened by saying Bill Clinton would probably take credit for the booming economy when he delivered his State of the Union speech that night. He did. But as I read on, looking for your take on who should get credit, I never found the names of any of the original supply-siders or of Ronald Reagan. Instead, I find this outrageous statement: ‘Economists came to see “supply side” management of both inflation expectations and the supply of labor and capital as at least as important as ‘demand side’ management of spending power. Milton Friedman’s lonely voice gave way to a chorus, and the Reagan administration translated it into policy.’

    “Larry, this 17-year economic expansion had absolutely nothing to do with the lonely voice of Milton Friedman. It was, in fact, Friedman and his dopey monetarist idea that you could manage the national economy to perfection by increasing the money supply by 3 percent a year that caused the worst inflation in world history! When he persuaded Richard Nixon in 1973 to formally break the dollar’s link to gold, the world economy went into a tailspin, from which it has not yet completely recovered. Witness the poverty of five-sixths of the world’s population. It was not until Ronald Reagan abandoned Friedman’s experiment in 1983 — when to continue it would have meant the collapse of all our money-center banks — that the 17-year expansion began. The Fed then was allowed to provide the liquidity being demanded by the market in order to capitalize on the lower Reagan tax rates. That’s what was going on.”

    Here’s the link, with the full Memo: http://www.wnd.com/index.php?pageId=2914

    If Lindsey had listened to Wanniski in 2000, perhaps he would have performed better in 2001-02 when he was director of Bush’s National Economic Council.

    Reply this comment
  4. econprof
    econprof 23 April, 2011, 07:16

    Both supply-siders and monetarists tend to be conservative, small-government types…perhaps that is why Johnston lumps the two together. But we economists love to have intramural fights, so the two groups pick on each other incessantly over arcane matters of ideology.
    They would be united against the Keynesian lunacy of the past three years of government spending, sponsored by Obama and a departing Bush. The proof of their convictions is shown by the awful growth and employment results we are now experiencing. Can there be any better refutation of the failure of mindless government spending to stimulate than our current condition? Those who hire, expand, and invest need certainty, low costs and taxes, and not business-bashing class warfare and increased regulation. They have been driven to invest overseas or in friendlier US states, or to husband their resources until a clearer more certain and profitable outlook emerges. Only then will employment increase and our economy rebound. Look simply at the huge growth that occured once the Reagan tax cuts took effect, or the Kennedy tax cuts took hold. Even the Bush tax cuts stimulated a growth rate we now only dream we could have (yes–I admit much of the growth was due to the destructive housing bubble as well–but the tax environment helped).
    The coming election will provide a great comparison of dueling economic statistics. Obama will obfuscate masterfully, but the truth will win out.

    Reply this comment
  5. David from Oceanside
    David from Oceanside 23 April, 2011, 12:25

    One of Friedman’s bizarre objections to the gold standard was the cost of mining gold is an unnecessary drain on the economy. By the same standards the cost of locks on your doors are an unnecessary drain on your household finances. However the locks may prevent theft from a passerby and the gold standard may prevent theft from the government and Federal reserve.

    Friedman’s steady growth in the monetary supply was later refined in the Taylor Rule. Both Friedman and Taylor attempt to fix our broken central banking and fiat currency system. What they fail to take into account is that there has never been a long term fiat currency success in the history of the world. Confidence that our politicians and Federal Reserve board can get it right, when no one has ever done so before is foolish.

    One of the Federal Reserves stated goals is to control inflation. How stupid do they think we are? The only goal of the Federal Reserve is to inflate our money. That’s what they do. They coordinate inflation among all the banks. They is their only job.

    In a gold standard the value of our money increases by the increase in the rate of productivity, around 3% a year. You could take your gold dollars and hide them in a shoe box and in 23 years they will have twice the purchasing power. If savers received a modest 4% return on their conservative savings, their purchasing power would double in ten years. Try that with Federal Reserve notes.

    The inflation resulting from central banking and fiat currency requires wild speculation in order to keep pace with inflation. Your grandmother should not have to put all her money on black or red in order not to see her life long savings stolen by inflation.

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