Do tax cuts stimulate the economy? - Jonathan Smith
When President Ronald Reagan began
his first term in 1981,
the US economy was struggling.
Unemployment rates were high
and getting higher,
and in 1979, inflation had peaked
at an all-time high for peacetime.
In an effort to combat these issues,
Reagan's administration introduced
a number of economic policies,
including tax cuts for large corporations
and high-income earners.
The idea was that tax savings for the rich
would cause extra money
to trickle down to everyone else,
and for that reason,
these policies are often referred
to as trickle-down economics.
From the 80s to the late 90s,
the US saw one of its longest
and strongest periods
of economic growth in history.
Median income rose,
as did rates of job creation.
Since then, many politicians have invoked
trickle-down theory
as a justification for tax cuts—
but did these policies actually work,
either in the sense of stimulating
economic growth,
or in terms of improving circumstances
for Americans?
Would they work in other circumstances?
To answer these questions,
the main things to consider are whether
the impact of the tax cut
on the government’s tax revenue
is harmful,
whether the money saved in taxes actually
stimulates the economy,
and whether stimulating the economy
actually improves people’s lives.
The idea behind tax cuts is
that if taxes are too high,
people will be less willing to work,
which would ultimately
decrease tax revenue.
So at a lower tax rate, the government
might actually gain more tax money
that it can theoretically put
towards improving life for its citizens,
because people will work more when they
get to keep more of their earnings.
Of course, there’s a limit to how much
the government can cut taxes:
at a zero tax rate there is no tax revenue
regardless of how much people are working.
So while cuts from a very high
tax rate might be fine,
cuts from a lower tax rate might
be counterproductive,
hampering the government's ability
to accomplish crucial things.
Tax rates were extremely high
when Reagan took office.
His administration cut the highest income
tax bracket from 70% to 28%
and corporation tax from 48% to 34%.
By comparison, as of early 2021,
those rates were 37% and 21% respectively.
When tax rates are lower, tax cuts
for the wealthy can be harmful.
For example, in 2012 to 2013,
lawmakers cut the top tax-rate in the
state of Kansas by almost 30%
and reduced some business
tax rates to zero.
As a result, the government’s balance
sheet immediately fell
into negative territory
and did not recover,
implying that wealthy individuals
and companies did not invest
back into the economy.
In short, the money did not trickle down.
This appears to be a trend:
in a study over multiple periods
of history and across 18 countries,
The London School of Economics
found that cutting taxes
increased the wealth
of the top 1% of people,
but had little effect
on the economy as a whole.
In order for tax cuts for the rich
to truly stimulate the economy,
they would have to spend the saved money
putting it back into, for example,
local businesses—
but this isn’t what happens in practice.
No economic policy operates in isolation:
each time and place is unique with
multiple policies in place simultaneously,
so there is only ever one test case
for each set of scenarios.
This makes it difficult to deliver
definitive rulings on whether
an economic policy worked,
whether something else might
have worked better,
or whether it would work
in a different situation.
And yet, rhetoric
around trickle-down economics,
both during the Reagan era and since,
often promises something definitive:
that spending by society’s richest members
on things other than taxes
directly improves the financial
circumstances of the less wealthy.
And there’s not
much evidence to support that.
