The Case For The Tax Cut

Policy Reports | Taxes

No. 226
Sunday, August 01, 1999
by Bruce Bartlett

Tax Rate Reduction

"Each tax rate would fall by one percentage point."

The congressional tax bill would deliver the bulk of its tax relief in the form of an across-the-board reduction in statutory tax rates. Each rate, from 15 percent at the bottom to 39.6 percent at the top, would fall by one percentage point. This means that the new rate structure would go from 14 percent at the bottom to 38.6 percent at the top. It also means that those in the bottom bracket get a larger percentage reduction, almost 7 percent versus a 2.5 percent reduction for those at the top.

While one might have hoped for an equal percentage reduction in each tax rate, as Ronald Reagan's tax plan provided back in 1981, nevertheless it is significant that all tax rates will fall under the congressional plan. This means that every taxpayer will get some relief regardless of his or her circumstances. In recent years too much of tax policy has involved gimmicky tax credits that give big rewards to some taxpayers, while giving nothing to others. Cutting each bracket by 1 percentage point is at least a welcome move back in Reagan's direction and away from the tax gimmick approach that characterized the 1997 tax bill.6

Tax rate reduction is not only the fairest way to give tax relief, it is also the one that promises the most "bang for the buck." Economic theory is clear that high marginal tax rates are very costly in terms of reduced labor, saving and investment, ultimately leading to lost output and lower government revenues.7

"The tax bill leaves the existing distribution of taxes virtually unchanged."

The Clinton Administration, however, maintains that tax rates are not that high and that it is inappropriate to give the wealthiest Americans - those in the top bracket - a tax cut. Also, it contends, reductions in statutory tax rates do nothing to help those at the very bottom of the economic scale because they pay no taxes. There are several responses to this charge.

  1. In 1986, the federal government struck a deal with taxpayers. Deductions and other tax preferences, many of which were used primarily by the wealthy, were curtailed in return for lower tax rates. This led to a reduction in the top rate from 50 percent to 28 percent. In 1993, however, Clinton reneged on the deal and raised the top rate back up to 39.6 percent without restoring any of the deductions that were lost in 1986.
  2. Mr. Clinton justified the higher tax rates exclusively on the need to get the budget deficit under control. Higher revenues from those most able to pay them were essential, he argued. However, in 1998 the budget moved into surplus and is expected to remain in surplus for some time to come. Therefore, it is appropriate to begin rolling back the Clinton tax increase, since its basic justification no longer exists.
  3. Historically, higher tax rates on the rich have led to higher taxes on the middle class. When the top rate goes up, it is often easier to raise rates on those well below the top. Also, inflation and real growth push taxpayers up into higher brackets once reserved exclusively for the rich. Therefore, a reduction in the top rate helps ensure that those below that rate are protected from tax increases.8

"Clinton justified higher tax rates exclusively on the need to get the budget deficit under control."

Finally, it is important to remember that tax policy cannot help everyone, at least not directly. The only way a tax cut can help someone who pays no taxes is to send that person a government check and call it a tax cut, even though it is really government spending.9 However, keeping the tax burden down ultimately benefits everyone because it leads to higher growth and more jobs in the long run. In the end, full employment and high wages are the best way to help those at the bottom of society. It is short-sighted and counterproductive to oppose a tax cut that contributes to this end simply because it does not directly put more dollars into the pockets of those who pay no taxes now.

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