Are Lower Taxes Good the for the Economy and How Do We Know?

Lower taxes increase a country's economic health if certain other conditions are met. As desirable as it would be for economies to be simple cause and effect systems that change when only one other variable is changed, they do not appear to be this simple. While cause and effect relationships are a pattern in economies, an economy is more like a diverse interrelated web of relationships, actions, regulations and incentives and other important variables. Taxes are one of these 'other variables' and they do play a significant role in economics, but the question is not only do they improve a country's economic health when lowered, but by how much? and in what ways? This article will engage these questions with the aim of discerning how much lower taxes increase a country's economic health and under what conditions.

Depending on what resources are consulted and what evidence is presented an argument can be made to prove tax cuts are bad for the economy just as an argument stating tax cuts are good for the economy. Theorists like Karl Marx and Friedrich Engels saw the needs of social human beings as being a more dominant force of human nature than the will to compete and the power of self interest. (www.worsleyschool.net) Milton Friedman and Adam Smith would probably have disagreed with the former two on several key principles. Thus in order to make an argument tax cuts are beneficial to an economy we must first side with either the socialist concept of human nature, or the capitalist. There is evidence supporting both models but in the United States the bias is clearly capitalist so we'll run with that ball since the economic momentum in the United States is capitalist.

In an article by Mike Moffatt of www.about.com he states "A tax cut does not necessarily help or hurt an economy. You must consider what the revenue from those taxes is being spent on before you can determine the effect on the economy." (http://economics.about.com) This comment seems rather obvious but confirms the point an economy consists of a web of relationships. If a tax cut is used to subsidize a mega-competitive donut industry that may be great for donut businesses but not necessarily the economy as a whole. Thus, when a tax cut is made it should be made with the concept of optimization in mind i.e. what is the most amount of industries a tax cut will benefit and to what extent. The tax cut that intensely maximizes its affect across industry is better than a tax cut that marginally boosts a single sector of the economy.

Other writers and commentators do little to discuss theoretical principles of tax cuts and cite real political examples to support their case. In an article by Jack Kemp of www.freedomworks.org Kemp cites tax cuts made by John F. Kennedy and Ronald Reagan as occurring during periods of international tension and economic expansion. According to Kemp, Regan's tax cuts of the 1980's coincided with an improved economy while defense spending also increased. The end result to which the tax cut contributed was a better economy and the collapse of the Soviet Union. This sentiment is issued by the Cato Institute where in an article on taxation they cite 10 years of research and even more politicians who's tax cuts led to alleged economic priming, job growth, and increased business and consumer income. "Our research indicates that over the past decade, the 10 states that cut taxes the most created about twice as many new jobs and enjoyed about 27% more income growth than the 10 states that raised taxes the most." (www.cato.org)

It is easy to draw parallels from the policies of political administrators to events that occur during their time in office. However, what many of these claims do not do is refer to principles of reason and science and perform due diligence experiments to test the hypothesis tax cuts do improve the economy. In other words what absolute proof exists between tax and economic benefits? Does such evidence exist or is it all theoretical pseudo-science? It is probably very difficult or next to impossible to perform a set of control experiments i.e. tests where all variables are held constant except one, on an economy because it just too huge a laboratory. For this reason a purely scientific diagnosis of tax incentives would have to be held in a micro-environment of some kind, but even then a bounty of psychological variables play roles making the whole study of the economy somewhat a social science.

As in business, the next best thing to science is statistics. Statistics measure degrees of relationship through correlations, variable clustering, demographic patterns and the like. Thus to provide evidence confirming the widely held belief taxes improve economies it is useful to look at the statistics in addition to changes that occur after Governor A, implements tax proposition B. Statistics refine the scenario from educated opinions and observations to recorded patterns and have the potential to more accurately demonstrate beyond a historical context which countries have lowered their taxes in history and what effects followed thereafter. Over time, the more of this data is gathered, the more of a pattern and relationship seems to gain the status of 'truth'.

So, what statistics are there to illustrate what the Mike Moffat, Jack Kemp and the Cato Institute seem to suggest? One example is a document published by The Republican Policy Committee entitled 'New Numbers Support Tax Relief'. It attempts to 'cite' commerce department economic data and 'provide' supporting the notion higher taxes do increase the economy. The following quote illustrates this point: "Record tax burdens, record regulatory rulemaking, and excessively tight monetary policies are bad for any economy. Last month's Commerce numbers show how they hurt the U.S. economy much sooner and harder than previously believed." (http://rpc.senate.gov)

The lesson of this article is simple, always take what you hear with a grain of salt and dig for the facts supporting any claim even if the argument sounds very good. Facts are the substance of any argument and if the argument has none it more akin to educated opinion, hypothetical rhetoric or theoretical appeal. When it comes to lower taxes, there is ample 'evidence' to demonstrate the beneficial affects on an economy but there are also many factors to consider such as which sectors the tax relief assists and how vast the tax incentive's affects actually are. To describe the vastness of an economic nexus through the lens of a single a variable is cross sectional at best. While correlations can often be drawn between economic variables the consequent relationships are not necessarily absolute fact and should therefore be viewed with some degree of contemplation.

Sources:

http://www.worsleyschool.net/socialarts/marxengels/page.html
http://economics.about.com/cs/taxpolicy/a/taxing_growth.htm
http://www.brookings.edu/comm/events/20031216_Slemrod.pdf
http://www.cato.org/dailys/02-12-01.html
http://www.freedomworks.org/informed/issues_template.php?issue_id=1945
http://rpc.senate.gov/_files/ECONPOLICYbr082102.pdf

Disclaimer: Any opinions and/or views expressed in this article are not necessarily those of the author.