With the Republicans about to be fully in control of Congress as a result of the party’s massive victory earlier this month, we can expect a plethora of reheated prescriptions to be trotted out in the form of budget proposals and tax initiatives. And since the current version of the GOP hates any government spending almost as much as it hates taxes (especially the progressive kind represented in the federal income tax tables), we can expect a series of showdowns with President Obama over spending and taxes that might even lead us to the brink of another government shutdown or default on the national debt.
Mitch McConnell is on record as saying that those two things will not happen, and while that is reassuring rhetoric, it remains to be seen whether he can control his caucus. If he is as unsuccessful as John Boehner has been over in the House, he may end up backtracking on that pledge early on in his tenure as Senate Majority Leader.
But while there’s still time, before the Senate leadership switches hands, I want to offer the Republicans, especially those of the tea party wing, a few simple lessons about basic economics. And to do so, I’ll draw on two current examples that, taken together, may give pause to any politician, from the left or the right, who claims to have all the answers when it comes to economic prosperity.
First let’s consider Kansas, where its Republican governor, Sam Brownback, pushed through a massive tax cut in 2012. Brownback was seeking to put into effect the “supply side” theory that was first espoused during the Reagan administration by economist Arthur Laffer. (Laffer is said to have first described it in 1974 to a couple of young Republican staffers named Donald Rumsfeld and Dick Cheney, when both were working in the new administration of Gerald Ford. The story is that he wrote out the graph that illustrates the theory on a cocktail napkin.)
The idea behind the Laffer curve is that you can actually raise tax revenues by reducing tax rates to a certain level because the reduced rates will provide an incentive for increased productivity. Thus the claim is that you can get more net tax revenue from lower rates because everyone will be making more. Yes, I know it sounds too good to be true, and, in fact, it has never been verified or even supported by any experiment at the federal or state level. Reagan, with David Stockman, his young director of the Office of Management and Budget in charge, gave it a serious effort when he took office in 1981. Federal income tax rates were cut significantly in two bills in the first two years of Reagan’s presidency. By 1985, the federal deficit had ballooned to over a trillion dollars for the first time in the country’s history, Stockman was gone, and Reagan was quietly supporting a succession of tax increases that put the death knell to the Laffer-curve hype.
But apparently Governor Brownback didn’t think the Reagan experience with Laffer’s curve was an adequate test. In fact, he was (and purportedly still is) an advocate of it. The result, two years after he pushed massive tax cuts through in his state, is that Kansas is facing a major debt crisis, with some even suggesting bankruptcy might be the only option unless major spending cuts are made. (Brownback was re-elected handily earlier this month, suggesting that Kansans aren’t all that much smarter than he is.)
So, okay, that’s one lesson the new Republican majority in Congress might want to remember as they take control of the institution. Massive tax cuts aren’t a cure-all. But neither are massive tax increases, at least of a certain type, which is what the current Japan experience teaches. There, a major increase in sales taxes has pushed Japan back into a recession as consumer purchasing has slowed precipitously. And, as any non-Laffer economist will tell you, consumer demand is a job creator. Japan’s Prime Minister is now scrambling to avert an economic meltdown in his country. To do so, he will probably need to reverse the sales tax increases he pushed through only two years ago.
These two very real examples of the perils of using tax policy to create a robust economy are clear evidence of what should be obvious: No single factor can control the path of a society’s economy. That fact has been true for as long as humans have studied the matter. All the basic rules only work in a vacuum. Take supply and demand as an example. That rule is supposed to be an indicator of what price can be charged for a particular item. If supply is high and demand low, the theory goes, prices should decline. And to a point they will. But the supply-demand rule can be tempered by the elasticity of a particular product. So, if a product is inelastic (meaning the demand for it is constant), it will be less influenced by excess or diminished supply.
The effect on an economy of income tax rates is similarly variable. At certain levels of income, the rate of taxation can be a disincentive, but there is an element of inelasticity there, too. Everyone has to eat, so even if low income earners are heavily taxed, they will still seek to earn as much income as they can. And those at the upper ends of the earning scale are similarly unimpressed with higher tax rates, since they have so many ways to shield their income (legally) and so much more income than they actually need (or can spend) that they don’t really even think about the matter (except, perhaps, in political dialogues).
In the 2008 campaign, Obama was hit hard for having said that a redistribution of wealth was the result of progressive income tax rates. But political attacks aside, any tax policy redistributes individual finances to the public as a whole. It’s how the society chooses to spend those revenues that more directly impacts the economy.
So much of a society’s economy is uncontrollable and unpredictable. Economics itself is the most inexact of sciences, the study of it fitting much more comfortably in the humanities, alongside psychology and philosophy. In truth, most economic theory is far more likely to be based on political ideology than it is on scientific study. Karl Marx wasn’t an economist; he was a philosopher who decried the injustices he perceived in a wholly capitalistic society. Adam Smith, too, was first and foremost a philosopher. He came to capitalism only through his view of how a society could be most efficient in serving its citizens.
Similarly, most neo-cons are far less schooled in the science (such as it is) of economics than they are in the ideological appeal of free markets. Freedom, not science, was the Reagan catchword. And it’s the same word that conservative economists of the Milton Friedman school have relied on as the linchpin for their supply-side theories. But theories only go so far in directing the course of a nation’s economic vitality. After all is said and done, the cycles will still dominate. Recessions occur for a multitude of reasons and the end for just as many reasons. Rates and forms of taxation, along with government spending, can affect both results but will ultimately dictate neither.
In the end, the Republicans will have to govern. Sam Brownback is learning what that means. His compatriots in DC will, too.