Tax cuts history and optimal taxation levels
One statement frequently heard from Republican politicians is that tax cuts always create prosperity. That has not been shown to be true by recent history.
Tax cuts created prosperity when Kennedy did it because at that time the taxes were ridiculous, with the tax on the highest incomes in 1950s being 92%. The result of the Reagan tax cuts was more ambiguous. Economy registered strong growth under Reagan; however the federal debt tripled during that time. When Bush cut taxes in 2001, the result was an unmitigated disaster. Debt swelled by $6 trillion during the eight years of Bush; the economy did not grow, no jobs were created, living expenses rose, and at the end of the Bush administration the economy sustained its worst crisis since the Great Depression.
What this shows is that the Republican line on this matter is a lie. The results of the three major tax cuts in American history - under Kennedy, under Reagan and under Bush Jr. - shows that there are situations when tax cuts are appropriate and situations when the tax cuts are inappropriate. Indeed, based on this evidence, it is possible to come up with a fairly common-sense conclusion: That there is an optimum level of taxation, and that either raising or lowering taxes from that level does more harm than good.
Of course many would say that the optimal taxation level is zero. Tell that to the folks in Mogadishu. Let's face it, the government is necessary and does a wide variety of important tasks. Everything from protecting the country to law enforcement to education to scientific research that is at the root of all that business sells to infrastructural projects such as the Interstate and the Internet that vastly increase prosperity. The fact that the government does these tasks, and the importance of these tasks for the economy as much as for national security, demands that there be taxation. Of which there can be - more than needed; less than needed; or an optimum.
One important perspective in economics is known as the game theory. In the game theory scenario, the different participants seek to advance their benefit, and the solution is seen as pareto-optimal when the benefit is at the level where adding to any party can only be done by taking more away from another party. In matter of public sector and private sector, given the recent history, there is such an optimum, where either taking more from the private sector or taking more from the public sector can only be done at a greater expense to the other and thus to result in economic damage. And to optimize the situation it is necessary to find this optimum.
This optimum was reached under the Clinton administration. The result was a vast economic boom and an achievement of fiscal sanity in the government. By slightly increasing taxes on highest incomes while cutting a number of unneeded programs, Clinton was able to convince the investors that the federal debt was being brought under control and that it was safe to invest in America. American economy under Clinton created 23 million new jobs, and the budget went from $300 billion a year deficit in 1992 to $250 billion surplus in 2000. The optimum was achieved; the private sector grew strongly, while the government had fiscal sanity; and American economy was the envy of the world.
This great economic accomplishment was destroyed by Bush cutting the taxes below their optimum level, resulting in needlessly vast accumulation of debt and economic failure. And while Obama has been catching much flack for too much deficit spending, Obama's economic bailout package was a one-time deal to prevent the crisis from getting much bigger than it has, whereas vast deficits under Bush were consistent from year to year and were totally unnecessary. The problem was made bigger by the fact that the taxes stayed at the level they had been under Bush; which means that the deficits under Obama were what the deficits had been under Bush plus the cost of the stimulus package. Not under Bush, nor under Obama so far, have we seen prosperity.
With spending, we also see that there is an optimum level, and that taking spending either significantly above that or significantly below that has negative results. Federal spending at the end of Clinton administration was $1.8 trillion. At the end of Bush, it was $2.9 trillion. With the expiry of the stimulus package, we are going to see a return of federal spending to the level it was at the end of Bush. That level however is also too high for comfort.
The solution to the present economic downturn is far from cutting taxes further below their optimum level. That's what caused the problem in the first place. The solution to the present crisis is restoring taxes to the way they were when America had a strongly growing economy and fiscal sanity, while also limiting the spending to what it was at that time. To improve the economic situation - both economic prosperity and fiscal sanity - it is necessary to restore taxation and spending to this optimal level. And then will it be possible to realize both economic growth and fiscal sanity, as these existed under Clinton and as they were destroyed by Bush cutting the taxes below their optimum level.