What Conservatives Get Wrong About Taxes
Tax Cuts Very Rarely Raise Revenue - or Starve the Best
(Originally appeared in the Boston Globe)
Related: What liberals get wrong about taxes
US tax policy remains as contentious as ever, with Americans fighting over how much revenue the government should collect, who should pay, and how various taxes affect the economy. These questions will again dominate Washington in 2025 as Congress debates the extension of $4 trillion in expiring tax cuts. Unfortunately, both conservatives and liberals are in the grip of tax policy narratives that have long been undisputed orthodoxy within their own echo chambers yet are clearly contradicted by the tax data. This essay examines conservative tax myths. A companion essay examines persistent liberal myths.
Perhaps the most common and harmful conservative tax fallacy is that most tax cuts entirely pay for themselves with the revenues from expanded economic activity. Indeed, every major Republican tax cut over the past half-century has been sold as a free lunch that will cost the federal government no revenue.
It is true that well-designed tax cuts can increase incentives to work, save, invest, and be productive, thus creating additional income that is subject to taxation. Yet only when starting from exorbitant tax rates will these “economic feedback revenues” cover 100 percent of the static revenue loss of the tax cut. The peak of the Laffer curve — beyond which tax cuts can increase revenues — is typically estimated to be somewhere in between marginal income tax rates of 55 percent and 73 percent (well above current rates), and marginal investment tax rates of 30 percent and 45 percent.
In the current economy, most taxes are not close to their revenue-maximizing rates. At the current average tax rate of 20 percent, each $1 in tax cuts would need to produce $5 in new economic activity to pay for itself. It is rare that tax cuts (or expenditures) can provide such a substantial economic return.
Critics often note that tax revenues have often increased following a tax cut. But such analysis measures the wrong variable. For a tax cut to pay for itself, tax revenues would have to rise as fast as they would have without the tax cut. After all, even a stable tax code will produce rising revenues due simply to inflation, population growth, rising real wages, and growing business profits. If a tax cut reduces revenue growth from 4 percent to 2 percent, then it clearly did not pay for itself. And because government spending also typically rises with inflation, population, and income growth, reducing the rate of revenue growth will expand budget deficits.
The Tax Cuts and Jobs Act of 2017 provides the most recent example. The 2018–2024 federal revenues came in $665 billion below the levels that had been projected by the Congressional Budget Office before the 2017 tax cuts. Some revenues were lost to the COVID-19 pandemic, obviously, while other revenues were increased from new tariffs, tax increases, an immigration surge, and a 2022 capital gains bubble. Before all those intervening factors altered revenues after 2019, tax revenues in 2018 and 2019 came in a combined $432 billion below the CBO’s pre-tax-cut projection. While the Tax Cuts and Jobs Act produced some economic feedback revenues, it did not fully pay for itself.
Another conservative tax fallacy is that tax cuts lead to deficit reduction by “starving the beast” of tax revenue and in turn forcing even larger spending cuts. And while many conservatives fail to observe that the starve the beast theory contradicts the previous fallacy (a tax cut cannot both pay for itself and starve Washington of revenue), it is just as incorrect.
The starve the beast narrative asserts that after Congress enacts large tax cuts, the resulting public backlash over soaring budget deficits will induce the same lawmakers to radically cut spending. Public choice theory says otherwise. Tax cuts lower the price of spending, making voters want more of this free lunch. Persuading voters to oppose spending hikes would require making them pay for that spending with accompanying taxes.
More broadly, it is ahistorical to believe that abandoning all fiscal responsibility on one side of the federal budget will induce Congress and voters to demand even tighter fiscal responsibility on the other side of that ledger. Lawmakers who cut taxes — often while claiming that “deficits don’t matter” — cannot credibly turn around and make a deficit-focused argument to slash popular Medicare benefits or education spending. They have already surrendered any deficit credibility — which is why GOP lawmakers who had focused obsessively on deficits during the early 2010s suddenly stopped talking about them following the 2017 tax cuts.
Instead of starving the beast, tax cuts have been followed by aggressive spending sprees, while tax increases have been followed by spending restraint. This is because tax cuts signal to voters and lawmakers that deficits are no longer a concern, while tax increases reflect an era of deficit-panic and austerity. In other words, fiscal responsibility is practiced on either both sides of the tax and spending ledger or neither side.
This historical record is clear. The 1981 Reagan tax cuts were followed by a defense-driven spending spree. The 2001 Bush tax cuts were followed by a historic spending surge for wars, “compassionate conservative” domestic spending, and new entitlement programs. The 2017 Trump tax cuts came with a GOP-led 13 percent discretionary spending hike in one year.
On the flip side, the 1990 Bush tax hikes contained significant spending reforms and, after the 1993 Clinton tax hikes, were followed by the largest federal spending decline since the 1950s. This fiscal restraint culminated in the 1998–2001 budget surpluses.
Consequently, a full extension of the 2017 tax cuts will certainly reduce tax revenues — and history suggests that significant spending expansions will also follow.