NTLF Tax Colloquium
August 18, 2017
NTLF Tax Colloquium
August 18, 2017
Thank you for organizing this discussion on tax reform.
I believe the most important mandate given to this administration and this Congress is to revive our economy. Our success or failure will largely be determined on achieving this objective and will be judged by the answer every American gives to Ronald Reagan’s question in both 1980 and 1984: “Are you better off than you were four years ago?
In order for this answer to be a resounding “YES,” our economic reforms have to be enacted this year for them to have time to improve the economy and most importantly, the daily lives of individuals, by next year.
The good news is that we know how to do this because we’ve done so many times before. When Ronald Reagan took office in January of 1981, we suffered double digit unemployment, double digit inflation and double digit interest rates. Reagan diagnosed the challenge with these words: “In this great economic crisis, government is not the solution to our problems – government IS the problem.” He rolled back the tax and regulatory burdens that were crushing the economy. He slashed the top federal income tax rate from 70 percent to 28 percent and cut federal spending by one percent of GDP. He produced one of the most prolonged economic expansions in our nation’s history and because of that growth, our revenues nearly doubled.
This wasn’t a uniquely Republican policy. John F. Kennedy did the same thing in the early 1960’s with the same result. Harry Truman abolished the excess profits tax in 1945, reduced income tax rates and slashed federal spending from $85 billion down to $30 billion in FY 1946. The result was the post-war economic boom.
After his drubbing in 1994, Bill Clinton announced that the era of big government was over. He approved what amounted to the biggest capital gains tax cut in American history, overhauled entitlement spending – in his words, ending welfare as we know it – and cut federal spending by 4 percent of GDP.
The efficacy of these policies should be beyond reproach. But I would like to offer a few caveats.
FIRST, we DO need to worry about debt. Tax reductions without spending restraint simply shifts taxes to the future and crowds out investment capital that would otherwise be available for economic expansion as government borrows to cover the difference. Reagan’s one percent cut in spending relative to GDP still increased debt relative to GDP -- but our debt was less than $1 trillion. Today it is over $20 trillion. Clinton cut spending by 4 percent of GDP and was successful in reducing debt relative to GDP. The budget pending before the House starts that process, but we have a long way to go, and we can’t safely count on economic growth to fully offset lost revenue.
SECOND, (with apologies to the Bill Clinton campaign) IT’S THE SPENDING, STUPID. The European experience with austerity programs in the 1990’s illustrates this nicely. Austerity was a combination of tax increases and spending cuts. Those countries, such as Spain, Italy and Portugal that relied on tax increases did poorly. Those countries, such as Sweden, Finland, Denmark and Norway, which relied on spending cuts did very well. Between 1993 and 1997, Sweden reduced spending from 71.5 percent of GDP to 51 percent and its economic growth rate doubled relative to the prior decade.
THIRD, flattening and broadening the tax base is just as important as lowering rates. The Mercatus Center at George Mason University estimates that tax compliance costs the economy $1 trillion annually including capital misallocation caused by political preferences littering the tax code. The more we flatten and broaden that code, the fewer distortions in the flow of capital and the greater the productivity of capital allocations.
FOURTH, lowering rates does matter. In the last sixty years, the top income tax rate has been as high as 92 percent and as low as 28 percent, but income tax revenues have stayed remarkably steady at between 13 and 20 percent of GDP. Indeed, some of the lowest income tax revenues came when the top tax rate was at its highest. Some of the highest revenues came when the top rate was quite low. But although the tax rate within this envelope has remarkably little effect on revenues relative to GDP, it has a huge impact on the growth of GDP, and thus the growth of total revenues.
Finally, what are the prospects of getting this done? The good news is that past performance is not (necessarily) an indicator of future results. I am still optimistic that we will be able to get the tax bill done this fall for three reasons. First, reconciliation was poorly adapted for policy reform like health care but is very well adapted for tax reform. Second, the thorniest matter, the Border Adjustment Tax, has been dropped from the discussion. And third, this HAS to be done and every one of my colleagues fully understands this.