Will tax cuts lift up the American economy or cause it to fall even deeper?

One of the pivotal issues at the center of the struggling American economy is whether tax cuts will be beneficial or hurtful for the United States. Firstly, according to the Bureau of Economic Analysis and Tax Policy Center, a Center for American Progress graph shows that higher marginal tax rates lead to a higher average annual growth in real gross domestic product. Since 1950, America has seen average real GDP growth rates of over 4% when the marginal tax rate is over 75% and less than 2.6% growth when the marginal tax rates are below 38.6%. Thus, the graphs display that the positive effects of higher taxes include a higher GDP growth to aid the economy.

On the other hand, raising taxes to help boost GDP growth presents problems. To start, N. Gregory Mankiw makes the excellent point in his New York Times article that he can afford higher taxes that may eventually aid the economy; however, higher taxes influence decisions that people make and lead to a lesser desire to work. Mankiw explains that if he is going to take on a $1000 job so he can put some money away for his children, he is more inclined to take on the job with lower taxes so that the output of his hard work will be greater. Essentially, the negative side of raising taxes is that taxing the American people with a marginal income tax rate of over 40% seems ridiculous in that it will take away the motivation to work if one can only keep around half of the money.

Senior Fellow at the Cato Institute Alan Reynolds said in November 2011 for the CQ Researcher that if Obama allowed the tax cuts enacted in 2001-2003 to vanish on Dec. 31, the top tax on dividends would jump from 15% to 39.6%, “ensuring a stock market crash.” It is correct that the jump from 15% to 39.6% in the top tax on dividends, estate tax jump to 55%, marginal tax rate rise by 3-5% are all rapid changes in tax policy, and perhaps a more gradual change was necessary. But Reynolds was clearly wrong about the stock market crash that has yet to occur. In fact, the stock markets have recently reached their highest points since before the great recession and unemployment rates are dropping despite the higher taxes that Reynolds points out to be catastrophic.

In Reynolds’ defense, he points out that former Obama economic advisor Christina Romer found that a U.S. tax increase amounting to 1% of GDP reduces real GDP by nearly 3% within three years and reduces employment by 1.1%. This evidence contradicts the earlier data found by the Center of American Progress. The difference is that the Center of American Progress focuses on data from past tax policies that may or may not have been successful while the former economic advisor is making future predictions.

In his article for the CQ Researcher, Chuck Marr, an expert on federal tax policy, counteracts Reynolds’s ideas by suggesting that tax policy is one of the best tools to offset the increasing inequality in the social classes. Marr says that according to the Urban Institute-Brooking Institution Tax Policy Center, people making more than $1 mill a year received an average of about $129,000 each year from the Bush tax cut policy. Bush’s tax cuts also had the opposite effect on offsetting economic inequality because they provided larger benefits to people at the top instead of those at the middle and bottom. Overall, the tax policy was counterproductive in redistributing the wealth in the American economy. In addition to making inequality worse, Marr continues to say that the Congressional Budget Office rated tax cuts as the least cost-effective of 11 options for boosting economic growth and job creation. As a solution, Marr extends President Obama’s Making Work Pay tax credit that targets people living paycheck to paycheck. By giving the middle and lower class tax relieve, it can help to solve the “stunning shift in incomes from the middle class to those few at the top” by taking away the larger benefits given to the upper class to use for the lower class.

All these points against tax cuts are very valid; however, in N. Gregory Mankiw’s tax cut article for the New York Times, he contradicts Marr’s anti-tax cut argument by stating that tax cuts might accomplish what spending hasn’t. In the article, Mankiw eludes to a comprehensive analysis carried out by Harvard professors Alberto Alesina and Silvia Ardagna that looked at large changes in fiscal policy in 21 nations in the Organization for Economic Cooperation and Development. By comparing policies that failed with those that succeeded, they found that successful stimulus relies almost entirely on cuts in business and income taxes while failed stimulus relies mostly on increase in government spending. Moreover, that these spending cuts accompanied by no tax increases reduces deficits and is less likely to create recessions. Though the study was conducted on different countries with different economies than America’s economy, Mankiw presents a valid point. He backs up his ideas by showing that a sizable fiscal stimulus passed by Obama and Congress in 2010 to keep the unemployment rate under 8% actually caused it to rise to 10%. The last statement Mankiw makes is that that tax and government spending increases have a strong negative effect on private investment spending; thus, tax cuts are the best tool to combat recession because they influence incentives to invest.

Unfortunately, incentives to invest are not what cause an economy to grow by itself. Even Mankiw admits that government spending has positives in that it reduces credit spreads, increases gross domestic product growth, and diminishes job losses. Although I agree and believe that higher taxes degrade the motivation to work as mentioned by Mankiw, I think that America cannot afford to cut taxes because it would only hurt economic growth. In addition, tax cuts may end up benefiting the top 1% rather than the middle and lower class, and it is essential that with the growing economic equality in America, redistribution of wealth is needed by taxing the rich.

To put the wage gap of America into perspective, the Economy Policy Institute 2009 data states that the average CEO makes 185 times the pay of an average worker.  AFL-CIO calculations go further in stating that in 2010, CEO pay grew from 42 times the average worker’s pay in 1980 to 342 times the worker’s median pay. Despite showing that this is far beyond the pay difference in other countries, there is also the fact that America has some of the largest and most profitable companies in the world. The pay of a CEO is directly proportional to the profits that the company makes, and it is the company’s discretion as to how much they should pay CEOs while still being successful. Even still, these numbers are somewhat ridiculous and display why so many Americans are left jobless and without money.

 When referring to the upper class in America, Stacy Curtin from The Daily Ticker explains that the top 1% owns 40% of the nation’s wealth and contains 24% of the National Income compared to 1976 where they contained only 9% of the national income and less than 33% of the national wealth.

However, the 2007 “Policy Analysis” by Alan Reynolds makes the valid point that this wage gap may owe it sharp increases to changes in tax rules. For example, the top 1%’s share of the national income jumped from 9% to 13% in 1985 and 1986 following a drop in tax rates from 50% to 28%. Reynolds lists capital gains, marginal tax rates, stock options, personal savings, and business income all as possible factors for the changes in the share that the top 1% possesses. Moreover, this analysis explains that business income accounts for much of the perceived share of income that the top 1% has.

Despite Reynolds’ argument, I still think that whether or not changes in economic inequality are due to changes in tax rules, it is essential that action is taken. Ultimately, I think that a 39.6% marginal tax rate is a good balance because it allows the economy to grow while not being too unreasonable. With a 39.6% marginal tax rate, the data from the Bureau of Economic Analysis and Tax Policy Center mentioned earlier stated that America saw an average annual growth rate of real GDP at almost 4% (the highest of any marginal tax rate under 75%) But I don’t think that this is enough to solve economic inequality.

Bernie Kent makes the excellent point in his Forbes article that raising income taxes may not have the desired magnitude of an effect on closing the wage gap. In fact, as Kent suggests, increasing estate or inheritance taxes may be better moves to help distribute the wealth.  This is because wealth and income are not one in the same, and taxing income does not directly affect the top 1%’s wealth. For example, Warren Buffet has a $39 billion net worth but only a $40 million taxable income, so taxing Buffet’s income clearly won’t help the concentration of wealth.

Overall, it seems that tax cuts should be avoided in that they will neither help decrease the wage gap in America nor help increase economic growth. Cutting taxes merely prop up the top 1% and seek to fill their needs. Therefore, high taxes, though disliked, along with government involvement to redistribute wealth to the middle and lower classes are the strongest solutions to fixing the American economy at this moment.