The Pros and Cons of the Bush Tax Cuts. Do they really favor the wealthy or is that a myth? What will help the...

Those who favor the continuation of the Bush tax cuts argue that these cuts are needed to encourage investment which, in turn, will result in a stronger economy and more job creation.

As I pointed out in my Hub entitled How Tax Cuts Work, this is true to the extent that the cuts are made to the rates in the higher tax brackets of a progressive income tax system (our Federal and State income tax systems are progressive systems) and that the rates are such that they are discouraging work and investment to some extent.

The famous Laffer Curve (named after the economist Arthur Laffer who first publicized it) shows how increasing tax rates result in increased tax revenues up to a point - after this point increasing marginal tax rates (the rates in the higher brackets) result in lower revenues for the government. You will notice that the only numbers on curve are found on the horizontal axis and these are zero at the starting point of the curve and 100 where the curve intersects the axis on the right side. Point "t" on the horizontal axis shows the point where the slope of the curve ceases to increase and begins decreasing indicating that, at these points on the curve to the right of the "t", government revenues collected with the tax will be decreasing as the rate increases.

The reasons there are no numbers is that, first, we don't know at exactly what rate the slope of the curve will become negative thereby reflecting reduced tax revenue collection from increased rates, and, second, even if we could determine the point precisely, it is subject to change.

During a national crisis, like World War II in which almost the entire nation was united behind the President in fighting what was perceived by most as a war that threatened our existence as a nation (many nations in Europe and Asia had already been conquered by the Axis powers so the perception was very real) people willingly turned most of their earnings over to the war effort in the form of high taxes and the purchase of War Bonds (today's Savings Bonds). However, today the point at which the slope of the curve turns downward is considerably to the left of the World War II era point.

While we cannot pinpoint the rate at which taxes cause work and investment to decline, there are plenty of antidotel examples of this occurring.

The 1978 Steiger Capital Gains Tax Cut (named after Representative Bill Steiger of Wisconsin) measure which reduced the tax rate on the gains resulting from the sale of assets resulted in many people suddenly selling stocks and other assets whose price had increased noticeably since the purchase of the asset (with most of the increase being due to the government's continued inflating of the money supply rather than any gain in the real value of the assets). Much of this money, which had been invested in assets associated with the old industrial economy which was not growing, was reinvested in the new high tech economy and contributed greatly to the high tech boom of the 1980s and 1990s (this boom was further fueled by the Reagan cuts in income taxes during the 1980s).

Former President Ronald Reagan used to tell the story of his experiences as an actor in the high tax era of the 1950s. He found that his income from being the lead actor in five feature film productions each year left his family with a comfortable income. However, if he made a sixth movie the additional income earned from that movie would push him into a higher tax bracket (which was in the 90% range in those days) which, after paying the higher tax on that portion of his income, left him and his family with very little additional income for that year. The 90% tax on his income earned by making more than five movies per year was the same as having his pay for additional movies cut by 90%. Faced with the choice of spending time home relaxing with his family or working on location for a few weeks for 10% of his normal pay, he choose to limit himself to five films. This, of course meant that many of the other workers on the set whose jobs and income were tied to Reagan's movies were also limited to five films per year and, since they were in lower tax brackets, they suffered a cut in income due to less work.

My Hub entitled Rolling Stones Prove Tax Cuts Work contains numerous other examples of entertainers and other high income people choosing to live and work abroad, thereby reducing work opportunities in their home countries for others who would normally be hired as support workers, in an effort to avoid burdensome high taxes.

Keeping the tax cuts in place will help keep America competitive in the global market by encouraging more investment which will result in more jobs and greater output by the economy.

The most common arguments against the Bush tax cuts are that they favor the wealthy and that we cannot afford them as they are depriving the government of needed revenues.

The tax cuts do favor those with higher incomes. But this is because, under our progressive income tax system, the only people who pay the high marginal rates (the term marginal here refers to the tax bracket in which the last dollars of income are taxed - the progressive nature of the tax system is such that, as one's income rises, the additional increments of income are taxed at progressively higher rates) are high income people. Since the incomes of lower income people are below the threshold at which the higher rates kick in, they are not being penalized by the tax cuts.

If the high tax rates in the upper income brackets actually generated significant tax revenues for the government and the cutting of these rates resulted in a reduction in total tax revenues which had to be made up with an increase in the rates in the lower brackets then we could argue that the tax cuts were shifting some of the tax burden from higher income taxpayers to lower income tax payers. However, this is not the case as history has shown that reducing high marginal rates encourages higher income people to work and invest more thereby creating a larger income pool on which to levy the tax. For example, if the total income available to tax in the 90% bracket is one billion dollars ($(1,000,000,000 - the actual number is much higher but I will try to keep this example simple) then the government will collect nine hundred million dollars ($900,000,000) in taxes on incomes in this bracket. If we cut the top rate from 90% to 50% and, due to higher income people deciding to work and invest more (such as former President Reagan deciding to make six or seven films per year rather the five), income available for taxation in the now 50% bracket increases to two billion dollars ($2,000,000,000) the government's take in taxes rises to one billion dollars ($1,000,000,000) or one hundred million ($100,000,000) more than at the previous 90% rate. Since the tax cut resulted in the government collecting more revenue from the high income brackets than previously, there is no need to raise more money from lower income people by increasing the taxes in the lower brackets. Further, the tax cut only applies to rates in the top brackets which only affect the last dollars of income earned by high income people, leaving high income people to continue to pay the same rates as everyone else on income taxed in the lower brackets.

This situation is no different than if the government had enacted at one time a special fifty cent per cup tax on tea sold by the cup over the counter but had no tax on coffee sold by the cup. If the government then reduced the tea tax to twenty-five cents it would clearly be a tax cut favoring tea drinkers but one would be hard put to argue that coffee drinkers had been slighted or harmed by this in any way.

The income tax cuts enacted during the administrations of Calvin Coolidge in the 1920s, Kennedy-Johnson in the 1960s, Ronald Reagan in the 1980's and the current administration of George Bush have all resulted in total tax revenues increasing as there is not only more income available to tax in the top brackets, but the fact that additional jobs created are created for people in the lower tax brackets means that the number of new workers in the lower brackets have increased the pool of income subject to taxation in these brackets as well .

However, politicians are addicted to spending and, in each of the recent tax cuts, Congress has gone on a spending binge every time the revenues from tax cuts increased. This is where we are getting the warnings about growing deficits as the opponents of tax cuts first project spending increasing at the current rate and then project how much more income could be raised by reversing the tax cuts and restoring rates to the old levels while assuming, incorrectly, that the amount of taxable income will remain the same. Of course, income will go down as people, when faced with higher taxes on the extra income, will cut back on working and investing.

As I have pointed out in comments in my previous Hubs dealing with tax cuts, there is another, less articulated, reason why some on the left oppose tax cuts.

The late economist Kenneth Galbraith and, more recently Paul Krugman, have come out in opposition to tax cuts on the grounds that spending decisions in the economy should be made by central authorities rather than by individuals. Galbraith, even though he was a member of the Kennedy Administration, opposed the Kennedy-Johnson tax cuts on the grounds that people would get used to taxes being cut and would demand more cuts.

Galbraith was not so much concerned with the government's revenue needs as he was with the idea that the government, rather than individuals, should make the decisions as to how much and what types of products people should consume. In some of his writings (such as the Affluent Society), Galbraith actually called for the establishment of a special system of schools to attract and train people for careers in government involving the micro-management of the economy and making decisions as to what products would be produced for people including things like the types of books, movies and other entertainment available to people in their leisure time. Galbraith envisioned taxing away most of people's discretionary income and using it to produce goods selected for them by elitist bureaucrats - meaning that things like Monday Night Football would be replaced with entertainment like Masterpiece Theater.

Books like Aldous Huxley's Brave New World and George Orwell's Animal Farm offer a glimpse into the regimented society ruled by bureaucratic fiat that elitists like Galbraith envisioned and wished to see created.

In the final analysis the tax cut debate is really about individual freedom of choice vs bureaucratic dictate.