Economy & Budget

Experts Warn: Tax Hikes Would Undercut Economy

The End of Prosperity is a book that presents an abundance of research to give a powerful warning that tax hikes imperil economic growth.

The book is especially relevant in light of the current economic recession, which includes federal deficits reaching record levels, an unemployment rate that the White House cautions could hit 10% by year-end, and planned tax increases to pay for costly new spending initiatives. Three authors, who have combined their expertise in economics and investment advising, advocate the use of supply-side economics rather than federal spending to stimulate growth.  

In addition, the authors cannot be considered political hacks, since they possess laudable credentials that should compel people who have intellectual curiosity to read their conclusions with an open-minded interest in obtaining economic enlightenment. Two of the authors, Arthur Laffer, an architect of President Ronald Reagan’s supply-side economics program, and Stephen Moore, a Wall Street Journal editorial writer, are economists. The third author, Peter Tanous, is an investment specialist who is trained to help people to weather financial storms.  

Together, they cite the failings of federal government stimulus programs previously attempted in the United States and other countries such as Japan. Heightened taxes and government spending typically hamper job creation, business expansion and increased tax revenues for years into the future, the authors explain.

The book forecasts draconian economic fallout if tax rates soar and the tax cuts previously enacted during the administration of President George W. Bush expire. Indeed, the authors argue that the wrong federal policies on taxes could create something akin to a “perfect storm” that would ravage the economy and leave future generations of Americans paying for the profligacy of misguided lawmakers.  

Ironically, history shows that low tax rates generally spur economic growth enough to boost the government’s tax receipts more than can be achieved by raising taxes, the book documents. With support for tax hikes coming from President Obama and key members of Congress, the authors leave no doubt that adopting such a policy would doom the already weak U.S. economy.  

Reversing Supply Side Gains

Rather than single out Democrats or Republicans for criticism, the authors take a bi-partisan view and spread the blame for excess tax-and-spend policies of both political parties. The book’s theme is that a clear connection exists between pro-business federal government policies and economic growth.

For example, the supply-side economic policies championed by President Ronald Reagan preceded an economic recovery that was largely sustained during the succeeding years when the gross domestic product more than doubled from $5 trillion to roughly $12 trillion, the book explains.

Between 1981 and 1989, the U.S. economy produced 17 million new jobs, or roughly 2 million new jobs a year. The U.S. economy created another 20 million jobs in the 1990s. That robust employment growth shows that tax cuts spur hiring, the authors concluded.

During the 1980s, 1990s and early 2000s, obstacles to growth had been winnowed by limiting taxes, tariffs, regulations and inflation. Those policies contributed to stable prices, a dependable and strong U.S. currency, a lower and flatter tax rate, and freer trade. Until the advent of so-called supply-side “Reagonomics,” the Dow Jones Industrial Average suffered one of its worst bear markets in history by falling nearly 8% a year on an inflation-adjusted basis between 1966 and 1982. In the Reagan Administration, the stock market averaged a rise of 12% a year.   

Supply-Side Merits

The authors’ ideas about the merits of supply-side economics are not new. Economist Adam Smith wrote in The Wealth of Nations that high taxes can reduce consumption of taxed commodities and government revenue that otherwise might be drawn from assessing more modest taxes. Opponents of supply-side policies often trumpet the views of British economist John Maynard Keynes, who urged the government to stimulate demand for products and services by deploying idle resources.  

The authors counter that Keynesian economic policies, government planning, and demand-side economics inhibit business investment and economic growth. They warn that, by 2010, America could be the nation with the highest tax rate on investment, savings, corporate profits and stock ownership of any country in the world.  

The result could be economic disaster. The authors cite the example of a 12-year economic slide that began in the 1930s during the Great Depression amid an era of trade protectionism, high taxes, and government-spending growth. The government’s funding of New Deal social programs during that time worsened rather than improved conditions, the authors write. The cold reality then was that one of every four Americans was unemployed, while the combined federal and state tax rates exceeded 80% in certain instances.  

Tax-Caused Recession

The damage inflicted by new taxes also became glaringly apparent in recent decades. When President George H.W. Bush agreed to a compromise with liberal Democrats to raise taxes in 1990 in direct opposition to conservatives, the economy slipped into its first recession in eight years. The policy also failed to reduce federal deficits and increased government spending. Another example of a flawed tax policy cited by the authors occurred when President Bill Clinton and his then-Treasury Secretary Robert Rubin, a former Goldman Sachs CEO, chose to raise taxes in hopes of reducing the budget deficit and spurring investment. The authors say that the resulting fallout may explain why Republicans gained control of the House and Senate in 1994, and President Clinton became a stauncher proponent of free-market policies thereafter.

When free-market policies took hold, tax receipts averaged 10% growth starting in 1995. During the second half of Clinton’s first term, Clinton’s modified policies validated the supply-side economic model by promoting free trade and tight-fisted budgets, signing a capital gains tax cut, appointing Alan Greenspan twice to the Federal Reserve Board, and enacting welfare reform, the authors wrote. In addition, the number of Americans on welfare declined from 4.4 million to 1.9 million — a 58% drop — between August 1996 and December 2005. This dramatic improvement was a domestic policy equivalent to President Richard Nixon going to China, the authors wrote. They also declared that it affirmed a supply-side economics maxim that the best antipoverty program is a job.

Two consumer-focused tax cuts during the administration of Clinton’s successor, President George W. Bush, proved ineffectual. But the latter leader’s supply-side initiatives provided incentives to stimulate the business sector. The supply-side strategies included cutting tax rates on: dividends from 49.5% to 15%; capital gains from 20% to 15%; personal income for the highest earners from 39.6% to 35%; and business investment in plant, machinery and equipment. Stocks climbed about 20% within two years of the Bush tax cuts. Overall asset values rose by $6 trillion between 2003 and 2007. Business spending advanced from declines of 4.8% in 2001 and 6.1% in 2002 to increases of 7.4% in 2004 and 9.5% in 2005 — reflecting a “classic” supply recovery, the authors wrote. Indeed, the economy grew by 8 million jobs between 2003 and the end of 2007, according to the U.S. Bureau of Labor Statistics.

The largest four-year revenue increase in American history took place between 2004 and 2007, after George W. Bush’s tax cuts spurred revenue to rise by $785 billion. Once again, reduced tax rates created a virtual chain reaction of higher economic growth, more jobs, increased corporate profits, and, ultimately, more tax receipts, the authors opined. In 2008, the fruits of the Bush tax cuts preceded a drop in U.S. government interest rates on 10- and 30-year bonds to their lowest level in 30 years.

Excessive taxation is detrimental to the poor and rich, women and men, and old and young, the authors concluded. If the tax cuts enacted during the administration of George W. Bush expire at the end of 2010, tax rates on capital gains, dividends, inheritance, and personal income will increase automatically. The heightened dividend and capital gains taxes would hurt the after-tax return on investment directly and trigger a fall in stock values, the authors warn. Since share prices are based on the stream of future earnings of a company after taxes are paid, the higher the tax imposed on the earnings, the lower the value of stocks. In contrast, when George W. Bush signed legislation to cut taxes on dividends and capital gains, the share value of U.S. stocks rose by 10% to 15% within just weeks of the new law’s enactment. Stock values also rose after the Bill Clinton-led 1997 capital gains tax cut.

Wal-Mart Tops Great Society

The authors’ zealous support of supply-side policies is captured in their conclusion that international trade and discount stores such as Wal-Mart that sell imported goods have done more to alleviate poverty than the combined effect of all of President Lyndon Johnson’s government-funded Great Society programs of the 1960s. The book is especially relevant in light of the record budget deficits that the federal government currently is amassing, coupled with the likelihood that President Obama and the Democrat-controlled Congress will approve tax increases to help pay for a portion of the heightened government spending.

The authors offer a powerful defense of supply-side policies and attack tax hikes as drags on the economy, businesses and people of all income levels. Not every reader may be convinced that supply-side economics is a cure for all that ails the economy, but the book certainly succeeds in offering a formidable argument that is backed both by historical and recent examples to highlight the policy’s merits with unmistakable clarity and conviction.

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