NCPA - National Center for Policy Analysis

Lower Taxes vs. Lower Deficit

February 5, 2004

Are we better off having lower taxes on interest, dividends and capital gains (and other taxes on capital) or having a lower deficit? Obscure as it may seem, this is the central economic debate being fought in the political arena, says Richard W. Rahn (Discovery Institute).

There are costs involved whether the government obtains its funds from taxing or from borrowing. Yet the extraction costs of borrowing are far less costly than taxing. This is because the capital markets are very efficient. It only costs the government a few cents on the dollar to issue notes or bonds, and the effect of additional government borrowing on interest rates tends to be small (provided, of course, federal debt remains below 50 percent of GDP).

According to Rahn:

  • The failure of the deficit hawks to understand that high taxes on capital are more damaging to the economy than a modest deficit led them to embrace a budget surplus.
  • While they received almost universal acclaim for this action, in effect, what they were doing was a costly drain on high-value, private-sector capital for the sake of reducing low-cost government debt.
  • If in 2000, instead of running a surplus, the Clinton administration had enacted a tax cut to reduce the highest marginal tax rates, the corporate income tax and the double taxation of dividends, we probably would have avoided the most recent recession and all the misery, unemployment and hardship it caused.

Reducing the growth in government spending has many benefits, including less misallocation of resources and less need for both borrowing and taxes to keep the deficit within manageable range. Missing from the deficit debate, however, are serious proposals to substantially reduce the growth in spending, says Rahn.

Source: Richard W. Rahn, "The Deficit Bugaboo," Wall Street Journal, February 5, 2004.

For WSJ text (subscription required),,SB107594313736821311,00.html


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