Romney Wrong on Tax Cuts: 3 Reasons Why Supply-Side Economics Has Failed

Recently, on “Face the Nation,” Republican presidential candidate Mitt Romney stated, “One of the absolute requirements of any tax reform that I have in mind is that people who are at the high end, whether you call them the 1%, or 2%, or 0.5%... will still pay the same share of the tax burden they’re paying now.” He later went on to say that “For me, this is all about creating good jobs.”

Obviously, Romney is alluding to supply-side economic theory which claims that tax cuts for the wealthy increases domestic investment which creates jobs and spurs economic growth. In classical economic theory, this policy has merit and should lead to desirable results. However, empirically, this economic policy has not been effective and has actually negatively affected the U.S. economy. Here are three reasons why supply side economics has failed:

1) High-income earners spend a smaller percentage of their incomes after tax cuts. According to a 2010 study by Moody’s Analytics Inc., the rich saved more of their income after the 2001 and 2003 Bush tax cuts than spent it. This increased savings rate comes from the rich’s low marginal propensity to consume. As a result, wealthy tax cuts prove ineffective to bolster consumer spending. Instead, Moody’s research found that spending by the wealthy is influenced by the business cycle rather than marginal tax rates. Increased savings, of course, is not a bad thing. More savings tends to lead to increased investment which benefits the economy. The rich, however, are not always investing in the U.S. economy.

2) One in five wealthy families has more than half their investments overseas. According to a 2011 survey by the Institute for Private Investors, families with $30 million or more of investable assets have one-third of their assets overseas. One-fouth of wealthy respondents are moving away from the U.S. dollar by managing foreign currencies and hedging against currency risks. A study by Spectrum Group showed that more than 60% of investors with $25 million or more are investing overseas. This is not surprising since investment usually flows towards economic growth which is taking place in emerging economies such as China, Brazil, and India. Again, this evidence proves the ineffectiveness of wealthy tax cuts on investment and job creation in the U.S.

3) Tax cuts do not lead to increased tax revenues. One of the greatest misconceptions of supply-side economics is that lowering tax rates actually increases revenues. This theory agrees with the Laffer Curve which claims that increasing tax rates beyond a certain point is counterproductive for raising revenues, since it damages the economy. A 2005 Congressional Budget Office study, however, debunked this theory after analyzing the effects of a hypothetical 10% across-the-board marginal tax reduction. They found that only 28% of the lost revenue would be recouped over a 10-year period and that the federal government would have to spend an extra $200 billion in interest charges to cover the deficit spending. This is why the Bush tax cuts added $1.6 trillion to the national debt during Bush’s presidency instead of “paying for themselves” as many Republican leaders originally thought.

I agree that tax cuts have some economic benefits, especially for middle class and low income earners. But with income inequality at its highest point in recent history, national debt almost topping $16 trillion, and the need for government investment in infrastructure, health care, research, and education, the benefits of increasing taxes clearly outweighs the costs. Hopefully, Romney and other Republican leaders can eventually come to this conclusion.