A Brief Review of the Success of Tax Cuts

IT IS FAIR TO SAY THAT as a nation we do not like taxes, but we accept them as a necessary burden to run our country based on the rule of law. The social contract requires some form of taxation, but as King George III learned, it is unwise to be irresponsible when it comes to tax policy.

The citizen response to taxation is often complex and confusing. Citizens do not like high taxes, yet they expect much from all levels of government and complain when deficits grow. How does government keep taxes low, keep revenues coming in, and yet keep the economy growing? The solution is to cut taxes and government spending, in addition to reviving the fiscal aspects of the Constitution.

The Constitution specifically lists the responsibilities and powers of the national government. Article I, Section 8 states the powers of Congress, and the Tenth Amendment establishes state jurisdiction or Federalism. The Tenth Amendment explicitly limits the scope of the federal government.

The 20th century saw three important periods where tax cuts stimulated the economy: the Harding/Coolidge cuts of the 1920s, the Kennedy cuts of the 1960s, and the Reagan cuts of the 1980s. All three substantially improved economic conditions and raised government revenues during their respective years.

The Harding and Coolidge Tax Cuts

President Warren Harding represented fiscal conservatism at its best. In 1921 when he took office, he faced a severe economic recession from his predecessor President Woodrow Wilson. Harding, along with Treasury Secretary Andrew Mellon, resolved the recession by slashing taxes and government spending. Historian Paul Johnson writes: “Harding and Mellon had done nothing except cut government expenditure by a huge 40 percent from Wilson’s peacetime level, the last time a major industrial power treated a recession by classic laissez-faire methods, allowing wages to fall to their natural level.”

President Calvin Coolidge, upon the unfortunate death of Harding, continued the tax- and budget-cut policies of the Harding administration. “The Coolidge-Mellon team,” says veteran political reporter Robert Novak, “took dead aim at a steeply graduated federal income tax.” According to historian Robert Sobel, Coolidge’s “goal was to hold the line on spending, and if possible roll it back, while at the same time reducing taxes, for he expected that this would result in greater personal freedom, continued prosperity, and a more moral population.”

The economic policies of the 1920s created more revenues and ushered in economic expansion. “Between 1922 and 1929,” writes fiscal policy scholar Veronique de Rugy, “real gross national product grew at an annual average rate of 4.7 percent and the unemployment rate fell from 6.7 percent to 3.2 percent.” According to columnist Cal Thomas, “[Coolidge] cut taxes four times and reduced the national debt by one-third while maintaining a surplus every year in office.”

The Kennedy Tax Cuts

President John F. Kennedy is not known for his “conservatism,” but he did understand the benefit of sound fiscal policy. “Recognizing that high tax rates were hindering the economy,” writes tax expert Dan Mitchell, “President Kennedy proposed across-the-board tax rate reductions that reduced the top tax rate from more than 90 percent down to 70 percent.” In a speech before the New York Economic Club, Kennedy explained the reason for his policy: “In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise revenues in the long run is to cut the rates now.” Walter Heller, chairman of the Council of Economic Advisors, described the Kennedy tax cut as a “major factor that led to our running a $3 billion surplus by the middle of 1965 before escalation in Vietnam struck us.”

The Reagan Tax Cuts

President Ronald Reagan in 1981 inherited an economic malaise marked by inflation, high taxes, and a general feeling that capitalism had reached its capacity. Reagan understood that less government and tax cuts were necessary to reverse the past economic trend. In 1981 Reagan signed into law the Kemp-Roth tax cut, which slashed income and capital gains tax rates. “Total federal revenues,” writes Heritage Foundation policy analyst Peter Sperry, “doubled from just over $517 billion in 1980 to more than $1 trillion in 1990.” Reagan followed his tax cut up with another series of cuts in 1986, which added to the economic recovery and expansion into the 1990s.

According to Christopher Frenze of the Joint Economic Committee, “the Reagan tax cuts, like similar measures enacted in the 1920s and 1960s, showed that reducing excessive tax rates stimulates growth, reduces tax avoidance, and can increase the amount and share of tax payments generated by the rich.”

The Benefit of Tax Cuts

Arthur Laffer, the father of the Laffer Curve and Supply-Side economics, writes:

Lower tax rates change economic behavior and stimulate growth, which causes tax revenues to exceed static estimates. Under some circumstances, tax cuts can lead to more—not less—tax revenue. The exact opposite occurs following tax increases, and revenues fall short of static projections.

The tax cuts outlined above were significant because all three examples ushered in significant economic growth. The best economic policy can be summed up by tax cuts, budget cuts, and limited government, or to phrase it in simple terms: constitutional government.

Mr. Hendrickson is a research analyst at the Public Interest Institute, an Iowa-based nonpartisan public policy research organization. This article is adapted with permission from Iowa Economic Scorecard, October 2006, published by the Public Interest Institute.