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AEI Argues Against Reagan Economic Adviser Bruce Bartlett on Tax Rates

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The American Enterprise Institute’s James Pethokoukis has put forth an article arguing against Bruce Bartlett’s claim that increasing the highest margin tax rate will not harm economic growth. Of course, Bartlett has history on his side, while the GOP and their funded think tanks have dogma. The nexus of the argument surrounds the Clinton era tax rates and the dynamic growth that ensued throughout the ’90s.

Bill ClintonI’m still not sure what caused the “Clinton Boom.” Democrat economist Dean Baker says Clinton got lucky (coincidence) that the internet boom occurred under this administration. However, since VC capital boomed under those years, I wonder if tax policy – slightly higher rates – didn’t drive more capital into VCs to avoid those higher rates on AGI. When I ran a small (very small) business during the Clinton Administration, I looked for ways to decrease my tax bill. The best way, I discovered, was to invest more money into my business. The result of increased capital investments was lowering my AGI and thus my tax bill.

When you own a business, you consider two things: do I have the customers to sustain my business to make it profitable (demand) and will my taxes (AGI) allow me to make a profit on my business. Under Clinton my income rose, regardless of the higher rates, while under Bush my income declined. Under Clinton my retirement accounts grew; under Bush, they declined steadily year over year.

Of course, we’re in a completely different situation now with globalization where multi-nationals can locate anywhere in the world to avoid paying US taxes and obtain the cheapest labor possible. As a result of this dramatic change, I’ve come to agree with Bruce Bartlett on the need to reduce the nation’s fiscal needs on labor taxation towards more to consumption: a Value Added Tax (VAT). If properly designed – and given Congress’s penchant towards rewarding donors and special interests doing so would be extremely difficult without significant campaign finance and redistricting changes – a VAT could be progressive and moral.

The nation, obviously, needs to three things: 1) increased revenues to pay down the debt/deficit which will signal to the markets that the nation the government is serious about its debt problem; 2) a long term plan to control the costs of health care (bend the cost curve which will reduce costs not just to the federal government but to all health care consumers thereby releasing billions for the nation’s other needs; and 3) a major overhaul of the federal government to bring it fully into the realities and needs of the 21st century rather than maintaining a structure more suitable to the 19th or 20th centuries.

One of the mantras in business during the last two decades was “lean and mean.” What that mantra really meant was reorganizing to create efficiency by reducing duplication, collapsing departments to eliminate roadblocks, and streamline processes towards faster approvals as well as lower costs. Government could take a lesson from the private sector here, but will Congress allow such as change when so many Committee heads gain their power from more rather than fewer committees?

The truly wealthy (those in the 1%) will not be harmed by having their tax rates increase by 3.9% to Clinton rates. They’ll still have more money than they need or can use to create demand; however, if the rates increase on income and short term cap gains, those with enormous incomes will find that investments, in VC or longer held investments, are more profitable than cashing out for lower tax rates. Plus, since the tax system is in part used to to encourage behaviors we like and want, such as marriage and having child, and investments we desire, such as technology, research and design, then why not use the tax system to short term investments and lack of investments rather in favor of lower taxes?

Lastly, it is important to note that the GOP notion of extremely low marginal taxes is relatively new. For example, when JFK advocated reducing the top marginal rate from 90% to 65%, Republicans revolted.They said that reducing the rate would increase the deficit…and since they were deficit hawks, anything that would increase the deficit was anathema. Of course, we know now that the enacted decrease, under Johnson, did not harm the deficit nearly as much as those Republicans claimed it might. On the other hand, we know from the eight years’ experience under the Bush Administration, that rates can be too low – as they are now – which most definitely increases the deficit. The extremely low rates did not unleash the animal spirits of capital. Instead they created a bubble just as Treasury Secretary O’Neill said they would when arguing against Cheney’s push for the 2003 tax cuts. Thus, the happy medium may be about 50% as Bartlett mentioned some years ago in an article for Forbes.

When Cheney argued for the ’03 tax cuts, he said we won the election so we can can do what we want (reward ourselves and our friends). Obviously, Cheney did not care about the deficit or long term health of the nation. Whether his acolytes on Capital HIll have taken up his dogma or are simply opposed to doing anything which may help President Obama, as Republican Congressional leaders stated, in that Capital HIll steakhouse, on the night of Obama’s inauguration, is unknown. Perhaps both.

Nevertheless, what we do know from the Clinton era is that raising the highest marginal rate of taxes by a modest amount, such as the 3.9%, does not harm the economy as the GOP and its funded think tanks proclaim. In fact, raising those rates might be beneficial…especially if combined with long term deficit reduction plan, particularly with regards to bending the cost curve of health care spending for the entire economy (i.e, businesses, families, and government) and reorganization of the federal government as Obama advocated in his last State of the Union address. Nevertheless, the entire tax code must be rewritten at some point in the very near future, not only to clean it up, but to insure the revenues needed for the future. As Bartlett has stated a VAT may well be the way to go.

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