Art Martinez de Vara had a dream: To build a whole new kind of city, one with as few taxes and regulations as possible. That city is Von Ormy—a one-exit kind of place on the outskirts of San Antonio, Texas.
On today’s show, how Von Ormy went from being an unincorporated stretch of land, to a so-called “Liberty City.”
The advocates of tax cuts are relentless, even fanatical. An indication of the movement’s fervor — and of its political power — came during the Iraq war. War is expensive and is almost always accompanied by tax increases. But not in 2003. ”Nothing is more important in the face of a war,” declared Tom DeLay, the House majority leader, ”than cutting taxes.” And sure enough, taxes were cut, not just in a time of war but also in the face of record budget deficits. Nor will it be easy to reverse those tax cuts: the tax-cut movement has convinced many Americans — like Tinsley — that everybody still pays far too much in taxes.
.. A result of the tax-cut crusade is that there is now a fundamental mismatch between the benefits Americans expect to receive from the government and the revenues government collect. This mismatch is already having profound effects at the state and local levels: teachers and policemen are being laid off and children are being denied health insurance. The federal government can mask its problems for a while, by running huge budget deficits, but it, too, will eventually have to decide whether to cut services or raise taxes. And we are not talking about minor policy adjustments. If taxes stay as low as they are now, government as we know it cannot be maintained. In particular, Social Security will have to become far less generous; Medicare will no longer be able to guarantee comprehensive medical care to older Americans; Medicaid will no longer provide basic medical care to the poor.
.. The reason Tinsley’s comic strip about the angry taxpayer caught my eye was, of course, that the numbers were all wrong. Very few Americans pay as much as 50 percent of their income in taxes; on average, families near the middle of the income distribution pay only about half that percentage in federal, state and local taxes combined.
.. In fact, though most Americans feel that they pay too much in taxes, they get off quite lightly compared with the citizens of other advanced countries. Furthermore, for most Americans tax rates probably haven’t risen for a generation. And a few Americans — namely those with high incomes — face much lower taxes than they did a generation ago.
.. In the United States, all taxes — federal, state and local — reached a peak of 29.6 percent of G.D.P. in 2000. That number was, however, swollen by taxes on capital gains during the stock-market bubble.
By 2002, the tax take was down to 26.3 percent of G.D.P., and all indications are that it will be lower still this year and next.
This is a low number compared with almost every other advanced country. In 1999, Canada collected 38.2 percent of G.D.P. in taxes, France collected 45.8 percent and Sweden, 52.2 percent.
.. Meanwhile, wealthy Americans have seen a sharp drop in their tax burden. The top tax rate — the income-tax rate on the highest bracket — is now 35 percent, half what it was in the 1970’s. With the exception of a brief period between 1988 and 1993, that’s the lowest rate since 1932. Other taxes that, directly or indirectly, bear mainly on the very affluent have also been cut sharply. The effective tax rate on corporate profits has been cut in half since the 1960’s. The 2001 tax cut phases out the inheritance tax, which is overwhelmingly a tax on the very wealthy: in 1999, only 2 percent of estates paid any tax, and half the tax was paid by only 3,300 estates worth more than $5 million. The 2003 tax act sharply cuts taxes on dividend income, another boon to the very well off. By the time the Bush tax cuts have taken full effect, people with really high incomes will face their lowest average tax rate since the Hoover administration.
.. Yet a significant number of Americans rage against taxes, and the party that controls all three branches of the federal government has made tax cuts its supreme priority. Why?
3. Supply-Siders, Starve-the-Beasters and Lucky Duckies
It is often hard to pin down what antitax crusaders are trying to achieve. The reason is not, or not only, that they are disingenuous about their motives — though as we will see, disingenuity has become a hallmark of the movement in recent years. Rather, the fuzziness comes from the fact that today’s antitax movement moves back and forth between two doctrines. Both doctrines favor the same thing: big tax cuts for people with high incomes. But they favor it for different reasons.
One of those doctrines has become famous under the name ”supply-side economics.” It’s the view that the government can cut taxes without severe cuts in public spending. The other doctrine is often referred to as ”starving the beast,” a phrase coined by David Stockman, Ronald Reagan’s budget director. It’s the view that taxes should be cut precisely in order to force severe cuts in public spending. Supply-side economics is the friendly, attractive face of the tax-cut movement. But starve-the-beast is where the power lies.
.. So the standard view of economists is that if you want to reduce the burden of taxes, you must explain what government programs you want to cut as part of the deal. There’s no free lunch.
What the supply-siders argued, however, was that there was a free lunch. Cutting marginal rates, they insisted, would lead to such a large increase in gross domestic product that it wouldn’t be necessary to come up with offsetting spending cuts.
.. The other camp in the tax-cut crusade actually welcomes the revenue losses from tax cuts. Its most visible spokesman today is Grover Norquist, president of Americans for Tax Reform, who once told National Public Radio: ”I don’t want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.” And the way to get it down to that size is to starve it of revenue. ”The goal is reducing the size and scope of government by draining its lifeblood,” Norquist told U.S. News & World Report.
.. Edwin Feulner, the foundation’s president, uses ”New Deal” and ”Great Society” as terms of abuse, implying that he and his organization want to do away with the institutions Franklin Roosevelt and Lyndon Johnson created. That means Social Security, Medicare, Medicaid — most of what gives citizens of the United States a safety net against economic misfortune.
.. The starve-the-beast doctrine is now firmly within the conservative mainstream. George W. Bush himself seemed to endorse the doctrine as the budget surplus evaporated: in August 2001 he called the disappearing surplus ”incredibly positive news” because it would put Congress in a ”fiscal straitjacket.”
.. to starve the beast, you must not only deny funds to the government; you must make voters hate the government. There’s a danger that working-class families might see government as their friend: because their incomes are low, they don’t pay much in taxes, while they benefit from public spending. So in starving the beast, you must take care not to cut taxes on these ”lucky duckies.” (Yes, that’s what The Wall Street Journal called them in a famous editorial.) In fact, if possible, you must raise taxes on working-class Americans in order, as The Journal said, to get their ”blood boiling with tax rage.”
.. The supply-side movement likes to present itself as a school of economic thought like Keynesianism or monetarism — that is, as a set of scholarly ideas that made their way, as such ideas do, into political discussion. But the reality is quite different. Supply-side economics was a political doctrine from Day 1; it emerged in the pages of political magazines, not professional economics journals.
.. That is not to deny that many professional economists favor tax cuts. But they almost always turn out to be starve-the-beasters, not supply-siders.
.. And they often secretly — or sometimes not so secretly — hold supply-siders in contempt. N. Gregory Mankiw, now chairman of George W. Bush’s Council of Economic Advisers, is definitely a friend to tax cuts; but in the first edition of his economic-principles textbook, he described Ronald Reagan’s supply-side advisers as ”charlatans and cranks.”
..Douglas Holtz-Eakin .. his conclusion was that unless the revenue losses from the proposed tax cuts were offset by spending cuts, the resulting deficits would be a drag on growth, quite likely to outweigh any supply-side effects.
.. since the 1970’s almost all of the prominent supply-siders have been aides to conservative politicians, writers at conservative publications like National Review, fellows at conservative policy centers like Heritage or economists at private companies with strong Republican connections. Loosely speaking, that is, supply-siders work for the vast right-wing conspiracy.
.. What gives supply-side economics influence is its connection with a powerful network of institutions that want to shrink the government and see tax cuts as a way to achieve that goal. Supply-side economics is a feel-good cover story for a political movement with a much harder-nosed agenda.
.. Irving Kristol, in his role as co-editor of The Public Interest, was arguably the single most important proponent of supply-side economics. But years later, he suggested that he himself wasn’t all that persuaded by the doctrine: ”I was not certain of its economic merits but quickly saw its political possibilities.” Writing in 1995, he explained that his real aim was to shrink the government and that tax cuts were a means to that end: ”The task, as I saw it, was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority — so political effectiveness was the priority, not the accounting deficiencies of government.”
.. In effect, what Kristol said in 1995 was that he and his associates set out to deceive the American public. They sold tax cuts on the pretense that they would be painless, when they themselves believed that it would be necessary to slash public spending in order to make room for those cuts.
.. But one supposes that the response would be that the end justified the means — that the tax cuts did benefit all Americans because they led to faster economic growth. Did they?
.. skeptics say that rapid growth after 1982 proves nothing: a severe recession is usually followed by a period of fast growth, as unemployed workers and factories are brought back on line. The test of tax cuts as a spur to economic growth is whether they produced more than an ordinary business cycle recovery. Once the economy was back to full employment, was it bigger than you would otherwise have expected? And there Reagan fails the test: between 1979, when the big slump began, and 1989, when the economy finally achieved more or less full employment again, the growth rate was 3 percent, the same as the growth rate between the two previous business cycle peaks in 1973 and 1979. Or to put it another way, by the late 1980’s the U.S. economy was about where you would have expected it to be, given the trend in the 1970’s. Nothing in the data suggests a supply-side revolution.
.. Does this mean that the Reagan tax cuts had no effect? Of course not. Those tax cuts, combined with increased military spending, provided a good old-fashioned Keynesian boost to demand.
.. While the Reagan tax cuts didn’t produce any visible supply-side gains, they did lead to large budget deficits. From the point of view of most economists, this was a bad thing. But for starve-the-beast tax-cutters, deficits are potentially a good thing, because they force the government to shrink. So did Reagan’s deficits shrink the beast?
.. In response to these deficits, George Bush the elder went back on his ”read my lips” pledge and raised taxes. Bill Clinton raised them further. And thereby hangs a tale.
.. Clinton did exactly the opposite of what supply-side economics said you should do: he raised the marginal rate on high-income taxpayers. In 1989, the top 1 percent of families paid, on average, only 28.9 percent of their income in federal taxes; by 1995, that share was up to 36.1 percent.
Conservatives confidently awaited a disaster — but it failed to materialize. In fact, the economy grew at a reasonable pace through Clinton’s first term, while the deficit and the unemployment rate went steadily down. And then the news got even better: unemployment fell to its lowest level in decades without causing inflation, while productivity growth accelerated to rates not seen since the 1960’s. And the budget deficit turned into an impressive surplus.
.. By the end of the 1990’s, in other words, supply-side economics had become something of a laughingstock
.. the most striking example of what skillful marketing can accomplish is the campaign for repeal of the estate tax.
.. the estate tax is a tax on the very, very well off. Yet advocates of repeal began portraying it as a terrible burden on the little guy. They renamed it the ”death tax” and put out reports decrying its impact on struggling farmers and businessmen — reports that never provided real-world examples because actual cases of family farms or small businesses broken up to pay estate taxes are almost impossible to find. This campaign succeeded in creating a public perception that the estate tax falls broadly on the population. Earlier this year, a poll found that 49 percent of Americans believed that most families had to pay the estate tax, while only 33 percent gave the right answer that only a few families had to pay.
.. the public rationale for tax cuts has shifted repeatedly over the past three years.
.. During the 2000 campaign and the initial selling of the 2001 tax cut, the Bush team insisted that the federal government was running an excessive budget surplus, which should be returned to taxpayers. By the summer of 2001, as it became clear that the projected budget surpluses would not materialize, the administration shifted to touting the tax cuts as a form of demand-side economic stimulus: by putting more money in consumers’ pockets, the tax cuts would stimulate spending and help pull the economy out of recession. By 2003, the rationale had changed again: the administration argued that reducing taxes on dividend income, the core of its plan, would improve incentives and hence long-run growth — that is, it had turned to a supply-side argument.
.. So what were the Bush tax cuts really about? The best answer seems to be that they were about securing a key part of the Republican base. Wealthy campaign contributors have a lot to gain from lower taxes, and since they aren’t very likely to depend on Medicare, Social Security or Medicaid, they won’t suffer if the beast gets starved. Equally important was the support of the party’s intelligentsia, nurtured by policy centers like Heritage and professionally committed to the tax-cut crusade. The original Bush tax-cut proposal was devised in late 1999 not to win votes in the national election but to fend off a primary challenge from the supply-sider Steve Forbes, the presumptive favorite of that part of the base.
.. the selling of the tax cuts has depended heavily on chicanery. The administration has used accounting trickery to hide the true budget impact of its proposals, and it has used misleading presentations to conceal the extent to which its tax cuts are tilted toward families with very high income.
.. The most important tool of accounting trickery, though not the only one, is the use of ”sunset clauses” to understate the long-term budget impact of tax cuts.
.. But, of course, nobody expects the sunset to occur: when 2011 rolls around, Congress will be under immense pressure to extend the tax cuts.
.. the administration has carried out a very successful campaign to portray these tax cuts as mainly aimed at middle-class families. This campaign is similar in spirit to the selling of estate-tax repeal as a populist measure, but considerably more sophisticated.
.. the 2001 tax cut, once fully phased in, will deliver 42 percent of its benefits to the top 1 percent of the income distribution.
.. It might seem impossible to put a populist gloss on tax cuts this skewed toward the rich, but the administration has been remarkably successful in doing just that.
.. One technique involves exploiting the public’s lack of statistical sophistication. In the selling of the 2003 tax cut, the catch phrase used by administration spokesmen was ”92 million Americans will receive an average tax cut of $1,083.’‘ That sounded, and was intended to sound, as if every American family would get $1,083. Needless to say, that wasn’t true.
.. About half of American families received a tax cut of less than $100; the great majority, a tax cut of less than $500.
.. David Stockman famously admitted that Reagan’s middle-class tax cuts were a ”Trojan horse” that allowed him to smuggle in what he really wanted, a cut in the top marginal rate.
.. If a couple had multiple children, if the children were all still under 18 and if the couple’s income was just high enough to allow it to take full advantage of the child credit, it could get a tax cut of as much as 4 percent of pretax income. Hence the couple with two children and an income of $40,000, receiving a tax cut of $1,600
.. But while most couples have children, at any given time only a small minority of families contains two or more children under 18 — and many of these families have income too low to take full advantage of the child tax credit. So that ”typical” family wasn’t typical at all. Last year, the actual tax break for families in the middle of the income distribution averaged $469, not $1,600.
.. through a combination of hardball politics, deceptive budget arithmetic and systematic misrepresentation of who benefits, Bush’s team has achieved a major reduction of taxes, especially for people with very high incomes.
.. Alan Auerbach, William Gale and Peter Orszag, fiscal experts at the Brookings Institution, have estimated the size of the ”fiscal gap” — the increase in revenues or reduction in spending that would be needed to make the nation’s finances sustainable in the long run. If you define the long run as 75 years, this gap turns out to be 4.5 percent of G.D.P. Or to put it another way, the gap is equal to 30 percent of what the federal government spends on all domestic programs. Of that gap, about 60 percent is the result of the Bush tax cuts. We would have faced a serious fiscal problem even if those tax cuts had never happened. But we face a much nastier problem now that they are in place. And more broadly, the tax-cut crusade will make it very hard for any future politicians to raise taxes.
So how will this gap be closed? The crucial point is that it cannot be closed without either fundamentally redefining the role of government or sharply raising taxes.
.. Politicians will, of course, promise to eliminate wasteful spending. But take out Social Security, Medicare, defense, Medicaid, government pensions, homeland security, interest on the public debt and veterans’ benefits — none of them what people who complain about waste usually have in mind — and you are left with spending equal to about 3 percent of gross domestic product. And most of that goes for courts, highways, education and other useful things. Any savings from elimination of waste and fraud will amount to little more than a rounding-off error.
.. Let’s assume that interest on the public debt will be paid, that spending on defense and homeland security will not be compromised and that the regular operations of government will continue to be financed. What we are left with, then, are the New Deal and Great Society programs: Social Security, Medicare, Medicaid and unemployment insurance. And to close the fiscal gap, spending on these programs would have to be cut by around 40 percent.
.. It goes almost without saying that the age at which Americans become eligible for retirement benefits would rise, that Social Security payments would fall sharply compared with average incomes, that Medicare patients would be forced to pay much more of their expenses out of pocket — or do without. And that would be only a start.
.. All this sounds politically impossible. In fact, politicians of both parties have been scrambling to expand, not reduce, Medicare benefits by adding prescription drug coverage
.. I think within a decade, though not everyone agrees — the bond market will tell us that we have to make a choice.
In short, everything is going according to plan.
.. Some supporters of President Bush may have really believed that his tax cuts were consistent with his promises to protect Social Security and expand Medicare; some people may still believe that the wondrous supply-side effects of tax cuts will make the budget deficit disappear. But for starve-the-beast tax-cutters, the coming crunch is exactly what they had in mind.
.. In Norquist’s vision, America a couple of decades from now will be a place in which
- elderly people make up a disproportionate share of the poor, as they did before Social Security. It will also be a country in which
- even middle-class elderly Americans are, in many cases, unable to afford expensive medical procedures or prescription drugs and in which
- poor Americans generally go without even basic health care. And it may well be a place in which only
- those who can afford expensive private schools can give their children a decent education.