August 13, 2016 will be the 35th anniversary of the largest tax cut in American history: The Economic Recovery Tax Act of 1981 (ERTA), sometimes referred to as the Kemp-Roth Act. This law is generally credited with beginning the economic boom which carried through the 1990s. Why should we take note of this? Because in an election year economic theory, history, and promises get thrown about like fish at Seattle’s Pike Place Fish Market.
To help you avoid getting hit in the head by some rhetorical fish in the next 100 days, I’ll provide in the next few paragraphs the historical importance of this act, some observations on economics, and ways to learn more about economic and other issues raised by the election.
It Started on a Napkin
In 1974, a young economics professor, Arthur Laffer, sat down to dinner with Jude Wanniski, Associate Editor for the Wall Street Journal; Donald Rumsfeld, President Ford’s Chief of Staff; and Dick Cheney, Rumsfeld’s deputy and a former classmate of Laffer’s. They discussed President Ford’s economic plans and when the subject turned to taxation, Laffer grabbed a napkin to make a point.
The graph he drew, dubbed the Laffer Curve by Wanniski in an article four years later, illustrated Laffer’s belief about the relationship between tax rates and government revenue.
One might think that the higher the tax rate, the more money the government would receive. Laffer held that this is true only to a certain point, at which raising the tax rate discourages investment, savings, and growth, leading to reduced revenue.
The counter-intuitive corollary of this suggests that reducing a too-high tax rate will increase the amount of revenue. This was the logic behind the ERTA, the cornerstone of Ronald Reagan’s plan to rescue the nation from the Jimmy Carter malaise. The act reduced the top tax rate from 70 to 50 percent, cut the lowest tax rate from 14 to 11 percent, and also reduced inheritance and gift taxes.
This left, undeniably, more money in consumers’ hands, which they could spend, increasing demand and spiking business activity, or save, making more money available for business investment and mortgage loans. Increased productivity and investment yield more economic activity which will create taxable growth. Lowering the tax rate, in this scenario, creates more tax revenue.
Unfortunately, economics, like other social sciences, is not a “hard science” like chemistry or physics. You can’t put two identical economies in separate test tubes and subject them to different tax rates and measure the results. Water always boils at 212 degrees at sea level. What is the optimum tax rate to enhance government revenue? It depends.
Thus, the ERTA is praised by some as the most important legislation of the late 20th century and dismissed by others as showing the failure of supply-side economics. People tend to pick and choose facts to support political objectives (e.g., big government is the cause of our problems) and others ignore facts based on emotional predispositions (e.g., rich people are evil.)
Also, changes in economic or taxation policies do not have immediate results like applying heat to a pan of water. It takes time for a tax rate change, for instance, to create ripple effects in an economy. While waiting for that effect, other factors such as crop failures, new inventions, migrations, fads, and financial panics can enhance or overwhelm the influence of the rate change you are trying to measure.
Where to Research
Bottom line: In order to evaluate the economic arguments of the candidates you have to do your homework.
Two good places to start are this article on government-driven economics and, at the opposite extreme, this series of essays and videos on freedom-driven alternatives.
A third approach to learning about economic as well as other political issues can be found at ProCon.org. This site lines up pro and con arguments on a wide range of issues, attempting to treat all sides with fairness. It does not go in-depth, but is a great place to start your research or clarify who is saying what about an issue.
For instance, Hillary Clinton has recently spoken in favor of raising taxes on both middle-income and top wage earners. Donald Trump has suggested that taxes are too high and has put forth a proposal to simplify and lower tax rates across the board, including for corporations. Here is a link to a ProCon.org page exploring the issue of whether lowering corporate tax rates will create jobs.
Good luck on your research and watch out for the fish flingers.