Tax Increases to Reduce Deficit Will Help, Not Hurt, Growth

Economic growth and job creation were much stronger after the Clinton tax increases than after the Bush tax cuts.

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Chad Stone is chief economist at the Center on Budget and Policy Priorities.

Significant tax increases have been critical to past successful deficit reduction deals. Most notably, the historic 1990 budget agreement, which paved the way for President Clinton and Congress to achieve budget surpluses less than a decade later, was possible only because President George H.W. Bush relented on his "no new taxes" pledge.

President Bush won no friends among conservatives at the time, and, if anything, conservative intransigence on taxes has hardened since then. The basis for it is claims that tax cuts are always good, and tax increases always bad, for growth. But as my Center on Budget and Policy Priorities colleague Chye-Ching Huang's review of the evidence on the impact of tax hikes on high-income households shows, that claim doesn't hold water.

[ See a collection of political cartoons on the budget and deficit.]

Let's start with the obvious circumstantial evidence that there's no simple relationship between taxes and growth. In 1993, President Clinton and a Democratic-controlled Congress enacted deficit-reduction legislation (with no Republican support) that raised income tax rates for high-income taxpayers. In 2001, President Bush and a Republican-controlled Congress cut income taxes. As the chart shows, economic growth and job creation were much stronger after the Clinton tax increases than after the Bush tax cuts. The respective effects on the budget deficit are well-known.

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Moreover, this impressionistic conclusion is strongly supported by the systematic evidence that the new Center on Budget and Policy Priorities report reviews, as summarized in these blog posts. Here's the bottom line:

"Findings from the research literature stand in contrast to assertions of extensive economic damage from increases in tax rates on high-income households, which are repeated so often that many policymakers, journalists, and ordinary citizens may simply assume they are solid and well-established. They are not.

[ Read the U.S. News debate: Is Obama's Corporate Tax Plan A Good Idea?]

But we can go even further. In a conference call about this report with journalists last week (you can listen to it here), Urban-Brookings Tax Policy Center codirector William Gale acknowledged, as most economists do, that changes in tax rates affect behavior, "but they also have effects on the deficits, and those deficits' impact on growth can be far larger than the incentive effects that are created."

To date, the mantra on taxes has been "tax reform," interpreted to mean broadening the tax base by closing loopholes so that tax rates can come down without losing revenue. But in our current situation, revenue neutrality is too weak a standard. We need to recognize the substantial economic benefits of reducing long-term budget deficits in a sensible way, compared with the effect of lowering tax rates on incentives. As the center report points out,

Raising revenues by broadening the tax base can in fact improve the efficiency of the tax code. And, because a cleaner tax code offers fewer opportunities to evade taxes, base broadening can reduce the economic cost of any rate increases also needed to achieve fiscal sustainability.

Sustainable policies to reduce long-term deficits require a balanced approach that combines spending cuts, tax reform that on balance also raises revenue, and investments in infrastructure and people that increase our future productive capacity. People truly interested in achieving that goal should not be influenced by false claims that higher taxes always have dire effects on economic growth.