Nov 22, 2017

Concerned about the debt? Here’s how tax relief can help.

Post by Freedom Partners

As Congress moves ahead on tax reform legislation, one question that continues to come up is how cutting taxes squares with concerns over the debt and deficit. After all, many of today’s proponents of lower taxes also strongly opposed the policies that led to trillion-dollar deficits during the Obama administration.

If the federal government takes less in direct taxes from Americans, revenue would decrease, right? Actually, history shows the opposite is true. And the reason is economic growth.

Bold tax relief enacted by presidents Kennedy, Reagan and Bush resulted in lower tax rates, millions more jobs, greater economic growth, thousands of dollars more in after-tax income for individuals, and hundreds of billions more in federal revenue—not less. The chart below shows the increases in federal revenue, GDP, disposable income, and jobs in the five-year window following each tax cut.

The full report can be viewed here.

Still, for some, that’s not enough. One argument that tax relief opponents like to focus on is that debt grew as a percentage of GDP following the Reagan cuts. But this argument is flawed. Looking at debt to GDP tells you that debt increased relative to the growth of the economy, but it doesn’t tell you why. The truth is, our deficits and debt are too high, but it’s not because of tax cuts – it’s because of overspending.

If you want to know whether the tax cuts added to deficits, don’t just look at debt to GDP, look at the revenue. Then, look at the spending. Here’s what you’d find (laid out in our past blog post: Correcting the Record: The Truth About Tax Reform & Debt):

When President Reagan first began cutting taxes in 1981, revenues did dip initially. However, much of that can be attributed to the economic downturn that took place as a result of tighter monetary policy to fight inflation. By 1984, revenues had turned around and began increasing by billions of dollars each year. 5 years after the cuts were fully phased in, the federal government was collecting more than $300 billion in additional revenue each year. The debt and deficit growth during this time period was not due to a lack of funds—rather due to out of control spending. In fact, from 1981-1985 federal spending was 22.1 percent of GDP—well above the post-WWII average of 19.3 percent. Keep in mind that economic growth during this time period averaged 3.4 percent annually, so this heightened level was not the result of a sustained economic slowdown.

Spending is the true driver of deficits and the national debt. To ensure lasting, positive effects from tax relief, these efforts must also be paired with spending restraints, as well as continued regulatory relief like we’ve seen from the Trump administration. There is no question that much more work must be done over the long-term to rein in spending and reform the key drivers of our debt like Medicare, Medicaid, and Social Security.

Tax cuts aren’t a silver bullet, but they are a crucial piece of the puzzle that have consistently led to increased revenue to the federal government. Lawmakers are right to be concerned about increasing debt and deficits, but the economic growth that would come from tax relief would be a step towards addressing those problems.

A 2012 report from the left-leaning Tax Policy Center found that in order to reduce the national debt to just 60-percent of GDP by 2035 it would require increasing the then-top two tax rates to over 100-percent. In other words, no tax increase is going to be enough to offset our staggering deficits. Robust economic growth is the only way America can begin to close the gap.