February 2009

The Case for Tax Cuts

By John Hendrickson

In the current economic recession lawmakers should push for tax reductions in order to stimulate the private sector and create jobs. President Barack Obama and many Democrats in Congress are pushing for a massive, $850 billion-$1trillion, Keynesian style stimulus package to fight unemployment and the recession by focusing on infrastructure projects. Unemployment has hit 7.2 percent nationally and the federal government is facing a $10.6 trillion national debt and a deficit of $1.2 trillion for 2009. The most effective way to revive the economy is to allow the private sector to work, that is, the best way for government to help in a recession is to demonstrate fiscal prudence and reduce taxation and allow the private sector to grow.

Part of President Obama’s economic recovery plan does contain a tax cut. The stimulus plan includes “a proposal for a $3,000 tax credit for companies that hire or retain workers.”[1] In addition, “about $300 billion of Obama’s package would be for tax cuts or refunds for individuals and businesses.”[2]  The proposal also calls for a “$500 tax cut for most workers and $1,000 for couples, at a cost of about $140 billion to $150 billion over two years.”[3]

It is yet to be determined what role Congress will take in offering tax reductions as an economic solution for recovery, which would also include making President George W. Bush’s tax cuts permanent. As The Heritage Foundation scholars J.D. Foster and William Beach noted:

Extend the 2001 and 2003 tax reductions for as long as possible—certainly through at least 2013 to prevent a tax increase. Better yet, make the tax reductions permanent; and reduce tax rates on individuals, small businesses, and corporations through 2013 by lowering the top rate by 10 percentage points and reducing rates by similar amounts for lower level taxpayers.[4]

Economist Larry Kudlow argues that “a reenergized economy cannot occur without lower marginal tax rates.”[5] As Kudlow wrote:

Right now the top federal tax rate for C-corps is 35 percent. Small businesses, which pay the individual rate, also are taxed at 35 percent. These rates should be 20 percent for both C-corps and S-corps (including LLCs). ..It would be a boon for our global competitiveness; since companies in the U.S. (as well as Japan) are taxed way above the rates of other advanced countries…Republicans also could promote a middle-class tax cut that would reduce the 28 percent and 25 percent brackets down to 15 percent. And of course the GOP should work hard to maintain the Bush tax cuts on capital gains, dividends, inheritance, and top individual rates.[6]

In order to be effective any tax policy must go beyond tax rebates or redistribution schemes. Serious tax relief must occur in order for the economy to turn around. “By far the most effective means of helping the economy recover is to improve the incentives that drive economic activity, and that means reducing tax rates on work, savings, investment, risk taking, and entrepreneurial activity,” noted Foster and Beach.[7]

“Prescribing the wrong medicine for an illness can make a patient still sicker,” noted South Carolina Governor Mark Sanford.[8] The economic recovery package, even with some tax reductions included, is not as effective as a market-based approach. “What’s worse is that the bailout approach undermines what has historically been the ultimate source of economic stimulus—the American worker and entrepreneur,” noted Governor Sanford.[9]

Tax reductions, when used correctly in combination with fiscal prudence such as reducing spending and balancing the budget have proved successful. The most notable example being the economic policies of President Warren G. Harding and President Calvin Coolidge, but also an examination of the Kennedy and Reagan administrations will demonstrate the effectiveness of proper tax policy on the economy.[10]

Perhaps the current economic situation will foster a new atmosphere for a serious debate on the need for tax reform. Lawmakers need to seriously consider replacing the current tax code with either a national sales tax, the Fairtax proposal, or a flat tax. “The market-based economy of our country, responsible for creating 200 years of wealth, is now threatened as never before in our Republic,” wrote Governor Sanford.[11] The solution to this crisis must not come from government, but rather returning back to the principles of our Constitution. As Sanford noted: “Furthermore, history shows issuing debt on top of debt, to solve a problem created by too much debt, threatens both the financial strength and sustainability of our government, given its impact in countries across time.”[12]

The case and need for tax cuts is crucial, but more crucial is the need to change our philosophy of government—not by embracing new solutions or philosophies, but by following the Constitution bestowed on us by our Founding Fathers.

John Hendrickson is a Research Analyst at Public Interest Institute. 

The views expressed herein are those of the author and not necessarily those of Public Interest Institute or Tax Education Foundation. They are brought to you in the interest of a better-informed citizenry.  

[1]“Obama tax plan runs into opposition in Senate: Democrats especially critical of $3,000 business tax credit,” Associated Press, January 8, 2009, <http://www.msnbc.msn.cm> (January 8, 2009).

[2] Ibid.

[3] Ibid.

[4] J.D. Foster and William W. Beach, Economic Recovery: How Best to End the Recession, WebMemo No. 2191, January 7, 2009, The Heritage Foundation, p. 1.

[5] Larry Kudlow, “Time for a Choice—Not an Echo,” National Review Online, December 30, 2008, <http://www.nationalreview.com> (December 31, 2008).

[6] Ibid.

[7] Foster and Beach, p. 3.

[8] Mark Sanford, “Bad Beltway Medicine: Bailouts are the wrong prescription for the U.S. economy,” National Review Online, January 9, 2009, <http://www.nationalreview.com> (January 10, 2009).

[9] Ibid.

[10] For more on the historical success of tax cuts, please read Public Interest Institute’s October 2006 edition of Iowa Economic Scorecard.

[11] Sanford.

[12] Ibid.