US Politics Analysis: The Republicans' Damaging Myth of Lower Taxes = More Employment

With just three weeks to go before America faces possible default on some of its fiscal obligations, the stances of both political parties have only become more entrenched.

Last week, President Obama finally showed some of the leadership over the issue that his critics have demanded. But his new engagement with the debt limit talks, and his desire for a long-term deal, have run headlong into the brick wall of the Republican insistence that spending cuts are the only acceptable means for cutting America's deficits. Even though virtually every moderate media observer is demanding some revenue increases as part of any meaningful deal –-- see, for example, the editorial in The Washington Post –-- and even though there is reason to doubt tax increases would be as harmful to the economy as conservatives maintain, Republicans seem prepared to hold this position to the point of breakdown.

On Saturday night, House Speaker John Boehner (R-Ohio), after several weeks of apparently productive discussions with Obama over a long-term debt-reduction deal, announced that he would be concentrating his efforts on securing a short-term solution to the problem. Citing the President's insistence that tax hikes must be included in the agreement, Boehner indicated that he would pursue a policy of cutting spending. Boehner's change of course prompted a spokesman for Senate GOP leader Mitch McConnell (R-Kentucky) to remark, "Like the Speaker, Sen. McConnell has consistently said that we should cut Washington spending without raising taxes on job creation, particularly in the middle of a jobs crisis."

Thus, once more the Republicans' standard argument that an increase in taxation, for individuals or businesses, damages job creation. Conversely, they maintain, lowering tax rates encourages consumer demand, and investment in employment increases.

At face value, this "trickle-down" theory of economics, with the idea that cutting taxes leaves companies with more more capital to invest in jobs, makes sense. The raw numbers on job creation compared to tax rates, however, suggests otherwise; especially when you look at some of the figures from the last decade when the Bush tax cuts of 2001 and 2003 were in effect.

On Friday night, CBS News noted US unemployment rose slightly to 9.2% after only 57,000 jobs were created in June (the net increase, after layoffs, was 17,000). These weak statistics, which economist Mark Zandi blamed on a stalling economy caused by high gas prices, introduced the recent history of job creation in America. The headline conclusion was: “In the 1970's, 80's and 90's, the U.S. economy created more than 18 million jobs during each decade. But from 2000 to 2007, the economy added only 7 million jobs.”

To put that stark rebuttal of the notion that tax cuts automatically stimulates new jobs into context –-- the 2003 cuts passed under the title of the Jobs and Growth Tax Relief Reconciliation Act –-- CBS quoted economist Heidi Shierholz's analysis, "The seven years before the great recession hit marked the worst business cycle we have on record as far as job creation goes."

Last month the Center for American Progress published two "charticles" which gave an even more damning assessment. Written by Michael Linden, the Center's Director of Tax and Budget Policy, the survey of marginal income tax rates for the wealthiest since 1950 contended, "Cutting taxes for the wealthy has become conservatives’ one, and often only, response to any economic problem. Just one problem: History doesn’t bear them out. Not at all.”

Linden concluded, “Growth was actually fastest in years with relatively high top marginal tax rates....Back in the 1950s, when the top marginal tax rate was more than 90 percent, real annual growth averaged more than 4 percent. During the last eight years, when the top marginal rate was just 35 percent, real growth was less than half that.”

In a parallel article, "Rich People's Taxes Have Little To Do With Job Creation", Linden offered another claim, "In years when the top marginal rate was more than 90 percent, the average annual growth in total payroll employment was 2 percent. In years when the top marginal rate was 35 percent or less—which it is now—employment grew by an average of just 0.4 percent.”

So the years of the Bush tax cuts are not an historical anomaly. Taking into account the progressive bent of economist Paul Krugman, his description of the effect of tax cuts in the 1980s bears repeating:

The Reagan economy was a one-hit wonder. Yes, there was a boom in the mid-1980s, as the economy recovered from a severe recession. But while the rich got much richer, there was little sustained economic improvement for most Americans. By the late 1980s, middle-class incomes were barely higher than they had been a decade before — and the poverty rate had actually risen.

Martin Feldstein, a conservative professor of economics at Harvard and chairman of President Reagan's Council of Economic Advisors from 1982 to 1984, has made the case repeatedly that the deficit problem can be partially addressed by increasing tax revenues; without touching marginal income tax rates. In May, he argued in The New York Times, “Reducing the budget deficit and stopping the explosion of our national debt will require more tax revenue as well as reduced government spending,” and contended that instead of hiking tax rates “tax revenues can be increased substantially by limiting the deductions, credits and exclusions that are essentially government spending by another name.”

The elimination of some tax deductions, or in Feldstein's proposal capping the amount that can be deducted, forms part of nearly all the deficit-reduction plans that are calling for a "shared sacrifice" to solve the debt problem. As President Obama said in his weekly address on Saturday:

I believe we need a balanced approach. That means taking on spending in our domestic programs and our defense programs. It means addressing the challenges in programs like Medicare so we can strengthen those programs and protect them for future generations. And it means taking on spending in the tax code – spending on tax breaks and deductions for the wealthiest Americans.

But Republicans are refusing to back down from their insistence on any new revenue increases, even in exchange for some cuts to entitlement programs, and the chances of a compromise in Congress over America's debt appear to be waning. As the deadline for a deal to forestall the possibility of default approaches, possibly as early as Friday, the reaction of the markets deserves watching. It is the sudden change in the confidence of investors, rather than sense over taxes and spending cuts, that may force politicians to adopt a deal they previously rejected as unthinkable.