Commentary | Budget Taxes and Public Investment

Use Revenue from Top to Fund Stimulus

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On July 22, 2010, EPI Research and Policy Director John Irons weighed in on an online debate about the best tax policy going forward. His response, printed below, can also be read on NationalJournal.com.

In the long-run, a comprehensive overhaul is necessary. But until that time, here’s the simple recipe:

  1. Permanently extend the tax reductions for low- and middle-income taxpayers.
  2. Repeal the tax cuts for the top.
  3. Use the increased revenue from the upper-bracket repeal for the next three years to help fund additional stimulus, including aid to state governments, unemployment insurance payments, and other job-creation policies.

Result: More jobs now, smaller deficits later (relative to a full extension).

Any questions?

(On #3, it appears that some continue to espouse the supply-side notion that higher tax rates for high-income individuals would result in lower revenue. In the past week, Senate Majority Leader Mitch McConnell issued the remarkable claim that “there’s no evidence whatsoever that the Bush tax cuts actually diminished revenue. They increased revenue, because of the vibrancy of these tax cuts in the economy.” His comments followed Senate Minority Whip Jon Kyl’s declaration that “you do need to offset the cost of increased spending… But you should never have to offset the cost of a deliberate decision to reduce tax rates on Americans.”

The reality is that Bush tax cuts resulted in a huge decline in revenue, and permanently extending the upper-income provisions would substantially worsen the long-term budget outlook. The supply-side argument rests on the notion that lower taxes would lead to an increase in economic activity so strong that it would lead to greater revenues. The economic evidence clearly shows this not to be true. For example, in a recent paper with Michael Ettlinger we find that investment, productivity, economic growth, income growth, wages, and employment did not fare noticeably better under supply-side tax regimes (following the 1981 and 2001 tax cuts) than under a non-supply-side tax regime (the 1993 tax increases). At equivalent periods in the business cycle expansion, the average annual GDP growth rate for each of these policy eras was 3.8 percent for the non-supply-side post-1993 expansion, 3.5 percent following the 1981 supply-side tax cuts, and 2.5 percent since the 2001 supply-side tax cuts.

Senators Kyl and McConnell’s claims were so egregiously unfounded that former Reagan economic adviser Bruce Bartlett felt compelled to clarify that top Bush administration economists consistently stated that the tax cuts reduced federal revenue, as was expected.

Another paper by Jeff Frankel notes that the two predominant conservative theories justifying supply-side tax cuts are inherently contradictory; the Laffer Curve, which states that tax cuts pay for themselves by generating a higher degree of economic activity, squarely contradicts the “Starve the Beast,” theory, which assumes that tax cuts increase the budget deficit and will thus force reductions in government spending. Examining the literature beyond the 1981 and 2001 tax cuts, Frankel concludes that marginal tax rates are nowhere nearly high enough for the Laffer Hypothesis to hold traction. As such, a further extension of the upper-income income Bush tax cut provisions will undoubtedly be associated with revenue losses.)