Tax Hikes Will Slow Growth, Kill Jobs--But Won't Reduce the Debt
Tax increases are not the way to combat the deficit
July 31, 2012
Last week, the Senate voted in favor of the Democrats's tax plan to extend the Bush tax cuts for Americans earning less than $200,000 and against the Republicans' tax plan for extending the cuts to all Americans. This would mean a tax hike for high-income Americans.
While neither bill is expected to become law, the political posturing is intended to portray a stark divide between the two parties before the November elections. The Democrats, in particular, want to depict the Republican Party as beholden to the rich, while creating the image that their own party—President Barack Obama's party—represents the true interest of the poor and middle class. Hopefully, voters will see past this façade, and understand that the real choice is not between rich and poor, it's between growth and stagnation, and it's between having a successful debt reduction and a failed one.
Basic economics suggest that higher tax rates reduce the benefit of working and therefore cause people to work less. They also dampen consumption because people with lower after-tax incomes consume less. This holds for people of all income classes—those earning more than $200,000 and those earning less. The additional impact of high tax rates on small business owners is that they are left with insufficient capital to invest in their businesses and have less money to hire new workers. Empirical research in economics widely documents these effects on small business owners.
What's more, tax hikes are not even very effective at reducing long-run debt. Research by several economists, including a recent paper coauthored with one of us, indicates that strategies for reducing deficits and debt that rely on tax hikes are much less likely to succeed than those that rely on reductions to government spending, particularly entitlement programs. If these cuts would occur they might also dampen consumption, but the bulk of that effect would come in many years when the economy is stronger.
Obama argues that the rich need to pay more to "pay their fair share." You may agree or disagree depending on your ideology. But what should be obvious is that now is not the time to raise taxes—on anyone. When economists place the chance of the United States entering another recession at a non-trivial 20 percent, unemployment is stagnant at 8.2 percent, and the Congressional Budget Office predicts that debt as a share of GDP will double in less than 20 years, it is surprising that any party would support a policy that will slow growth, kill jobs, and ineffectively reduce debt in the long run. Unless, of course, attacking the rich wins votes.