These results shouldn’t be a surprise. The power of tax cuts to incentivize economic output has been apparent at least since the Reagan tax cuts, which ended the stagflation of the 1970s and ignited a quarter-century of strong growth. Before the economy revived in the 1980s, government coffers were filled by inflation, which pushed families into higher tax brackets in a process known as bracket creep. As a result, tax collections rose almost 50% faster than inflation, enriching government while impoverishing workers. The inflation-driven tax spike was so relentless that federal revenues rose even as the economy contracted, producing what the CBO called “a significant fiscal drag on the economy” and helping to trigger the double-dip recession of 1980-82.
Fed Chairman Paul Volcker’s tight monetary policy helped choke off inflation, and the Reagan tax cuts reduced rates and indexed tax brackets to inflation, ending bracket creep. Remarkably, the surge in economic growth after the full implementation of the Reagan tax cuts produced real revenue growth of 5.7% a year from 1984-87, exceeding the bracket-creep revenues, which grew 4.4% a year during the high-inflation period from 1978-81. Strong growth was a windfall for both the government and the governed, while inflation enriched the government at the expense of the people.
As the American tax code has become more progressive, the collection of revenues at the federal, state and local levels all are increasingly dependent on strong economic growth. The top 10% of U.S. households earn 33.5% of all income but pay 45.1% of all income-based taxes, including income, Social Security and Medicare taxes. The top 10% of American earners pay 1.35 times their share of income in income taxes. In France, Germany and Sweden—supposed progressive paradises—the top 10% of earners pay just 1.1, 1.07 and 1.01 times their respective shares of national income.
With the most progressive tax code in the developed world, the U.S. government relies increasingly on a small proportion of higher-income families to pay a larger share of taxes. Because the income of the top 10% of earners is tied closely to business profits and capital gains, slow growth now decimates federal revenues.
Today changes in economic growth overwhelm the direct effects of policy changes. After President Obama raised income taxes in 2013, expecting to collect an additional $650 billion over 10 years, the CBO had predicted annual growth would average 3.7% through 2016. When the actual growth rate for 2014-16 was 40% lower, the CBO revised its revenue estimate down by $3.1 trillion: 4.7 times the amount the tax increase was supposed to collect. The CBO also cut its growth estimate for 2016 by $524 billion, $6,475 of GDP for every family of four in America.
Conversely, when economic growth in 2018 came in higher than the 2% the CBO had projected in the previous year, the windfall added $4,740 of GDP for every family of four and prompted the CBO to increase federal revenue projection for the next decade by $1.2 trillion.
A strong economy simultaneously fills federal coffers and the family purse. It is a great paradox of modern America that those who support more government programs generally espouse economic policies that impede growth and deny government the very revenues that could fund their agenda. Democrats and Republicans alike should always remember that if your income comes from milking the cow, you need to keep the cow healthy.
Mr. Gramm, a former chairman of the Senate Banking Committee, is a visiting scholar at the American Enterprise Institute. Mr. Solon is a partner at US Policy Metrics.