It has become an article of faith among Republicans that cutting taxes on the wealthy always generates economic growth and subsequently increases government revenue. The theory, a subset of trickle-down economics known as the Laffer Curve, holds that tax revenues go down when tax rates go up beyond a certain point. If, for example, the highest marginal tax rate is 91 percent, as it was in the 1950s, then hedge-fund managers hardly have an incentive to make that extra million dollars, what with the government keeping most of it.
And that is the argument Republicans make when advocating for extending the Bush tax cuts on the wealthiest Americans, which are due to expire. As House Minority Leader John Boehner told NBC on Sunday: "The only way we're going to get our economy going again and solve our budget problems is to get the economy moving, get more people back to work where they can care for their own families and begin to expand the tax rolls to bring more revenue to the federal government."
Over at Ezra Klein’s blog, Dylan Matthews recently polled an ideologically diverse group of economists on what tax rate they think would begin to reduce, rather than increase, tax revenue. The answers generally ranged between 60 and 80 percent. There was a broad consensus that the Laffer effect does not kick in at the level of taxes we would revert to, which at the highest would likely be less than 40 percent. (Matthews also asked some members of the Republican congressional leadership, but none responded.)
This punctures a hole in the Republican claim that it is OK to cut taxes without offsetting spending cuts because the increased economic growth will in turn increase tax revenue. To be fair, conservatives worry not only that high tax rates will decrease government revenue, but also that it will slow economic growth. As several conservative economists pointed out to Matthews, the tax rate that maximizes government revenue may be higher than the rate that maximizes economic growth. Thus, if you raise taxes too high, you may increase revenue now but decrease it over the long term.
This is a concern worth being mindful of, notwithstanding the fact that economic growth in the 1950s was fairly healthy. And Republicans are eager to make the case. Boehner again: "You can't raise taxes in the middle of a weak economy without risking a double dip in this recession." But the argument that because of this principle the two highest marginal rates should not be allowed to revert from 33 percent and 36 percent to 35 percent 39.6 percent, respectively, has little relation to macroeconomic reality. The economy performed better under those slightly higher Clinton-era rates than during the Bush era.
Even in the abstract, the claim that increasing by a few percentage points a few rich citizens’ tax rate will harm economic growth is implausible. Outside of yacht manufacturers, Bentley dealers, and real-estate agents on Martha’s Vineyard, not many workers depend on the slight variations in disposable income of the very wealthy for their livelihood.
But wait, what if owners of small businesses reported their income as individuals? Then wouldn’t raising their taxes decrease their desire to expand their business at this precarious juncture in our economic recovery? Perhaps, and that is precisely the argument Republicans have glommed onto. But as The New York Times reports, “Analyses from the Joint Committee on Taxation and the Tax Policy Center, a nonpartisan research organization, show that less than 3 percent of filers with small-business income pay at the top two income tax rates, and many of those are doctors and lawyers in partnerships.” So, when presented with this objective fact that the basis for their arguments are hogwash, presumably Republicans will retract their demand for extending the Bush tax cuts on top earners, right?
Don’t count on it. But doctors and lawyers do buy cars and houses. So if Republicans get their way, maybe at least some Bentley dealers and real-estate agents will be happy.