The benefits of helping the Gulfstream crowd

Recent US history shows that those on average incomes gain from fiscal regimes that initially seem to favour the rich

Scarcely had President George W. Bush introduced his plans for tax cuts when his critics did what critics of tax cuts usually do: they accused him of pandering to the rich.

Mr Bush's assailants sought to damn the Bush programme by likening it to previous Republican tax cuts. Several observers labelled Mr Bush's programme a "Trojan horse". This was a reference to the "Trojan horse" criticism of President Reagan's tax cuts by David Stockman, his rebel budget director.

Mr Stockman, a Republican, made headlines in the early 1980s when he turned on his party with the charge that the equitable-sounding Reagan plan was secretly designed to line the pockets of the wealthy. The Grand Old Party, the number-cruncher alleged, was merely pretending to help the rest of the country. In reality, their plan was disreputable "trickle-down economics" aimed at plutocrats.

Of course, the tax sceptics are not content with invoking Mr Stockman. They are also producing the usual distribution tables to reveal the Bush plan as a scheme to keep the venture capital crowd in Gulfstreams.

The Bush response should be: and so what if they do? Whatever is wrong with "trickle down"?

For while class warfare by tax cut opponents has not changed much since Mr Stockman's days, the world has. The American fiscal experience of the 1980s and 1990s has revealed a few truths about taxes and growth.

Cuts to top rates do indeed benefit the wealthy - in the short run. They may even widen income disparities. But in the long run lower rates for society's more productive members also tend to fuel overall growth. And strong growth does more for the nation's poor than the most generous federal redistribution. The tax game is not zero-sum: gains at the high end do not come at a cost to the poor.

This rule has also tended to hold true for democracies outside the US that derive their economic wealth from something other than a single, and hoggable, commodity such as oil.

But the US is perhaps the best example, for it was tax cuts that helped to engender the technology-led growth of the 1990s. As economist Bruce Bartlett relates in his book Reaganomics, the story started in the mid- and late-1970s. In that period, venture capital was weak, initial public offerings dried up and capital investment was rising at only half the rate of previous expansions. The nation's prospects as an economic leader of the world looked questionable.

William Steiger, a congressman from Wisconsin, proposed the solution of cutting the tax on capital gains to 28 per cent from 49 per cent, to boost the entire economy.

As today, the class warriors attacked. Michael Blumenthal, President Jimmy Carter's Treasury secretary, dubbed the proposal the "Millionaire's Relief Act of 1978". Indeed, a government report indicated that four-fifths of the bonus would go to households earning above $100,000. But the bill became law and Mr Steiger was vindicated. Venture capital investments expanded by 10 times that year, with a good share of the increase coming in the fourth quarter, when the cut became certain.

Among the beneficiaries of the capital infusion were technology innovators such as Steve Jobs of Apple. The scale of the investment was tiny: hard as it is to imagine now, total venture capital investment nationally was only $300m (yes, million). But the new money helped plant the seeds for the flowering of Silicon Valley and other technology centres, generating jobs at all salary levels.

Then there was the "Lobbyists Relief Act", as its opponents called Ronald Reagan's tax cut of 1986. Even after its loopholes were dropped, the legislation was still lampooned because it reduced the top marginal rate of income tax to 28 per cent. Ignoring the growth that followed, the critics focused on the widening deficit - even though that deficit was arguably due more to fresh spending than to revenue shortfalls. Today, many observers argue that the 1990s showed that tax rates do not affect growth. They say the fact that a boom could follow tax increases in the 1990s showed that deficit slashing, not taxation, is the paramount factor.

But this view overlooks the international picture. The lower taxes of the 1986 law gave America a strong competitive advantage. America's friendly rates helped to ensure that the technology industry did not migrate to Japan, as many were certain it would. Thanks in part to its low taxes, the US became the headquarters of the technology expansion.

What is more, the most controversial aspect of the 1986 cut - the radical reduction of the top rate to 28 per cent - proved the most valuable. The rate put America so far ahead in the tax competition that, even after two rises in the 1990s, the country's tax burden remained light next to its competitors' when measured as a share of gross domestic product. That played a part in reducing unemployment to almost 4 per cent.

Finally there is the most recent target, the Clinton administration's 1997 reduction in capital gains tax. As usual, there were the hostile headlines, such as: "The rich will benefit while the deficit balloons". But the deficit did not balloon. As Larry Kudlow of ING Barings notes, capital-gains-linked tax receipts tripled after the cut became law, fuelling the new surplus. Such new revenue streams made it possible for Congress to contemplate socially oriented projects such as new drug benefits for pensioners.

Given this tax record, the surprise is that class attacks on tax cuts continue to garner as much respect as they do. It is telling that many of those who produced the 1980s anti-wealth sound-bites have themselves moved to the for-profit sector. Mr Stockman himself was in the news this winter. The old whistleblower surfaced, not to rail against the Bush plan but to publicise his new private investment fund.

© Copyright 2001 Financial Times

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