The fallacy of the Tax Fairy

Tom Maertens
Mankato Free Press
August 24, 2010

In his 1841 classic, “Extraordinary Popular Delusions and the Madness of Crowds,” Charles Mackay wrote about the alchemists who believed that it was possible to turn lead into gold. If he were writing about today’s popular delusions, he could point to claims by Republican tax-cut-cultists that tax cuts “pay for themselves.”

Paul Waldman in the American Prospect called this “the return of the Tax Fairy, the absurd belief, depressingly widespread in Republican circles, that cutting taxes increases revenue.” Greg Mankiw, chairman of George W. Bush’s Council of Economic Advisers, called those who believe this fiction “charlatans and cranks.” If tax cuts pay for themselves, how did the Bush administration run up over five trillion in new debt, despite repeatedly cutting income taxes, capital gains taxes, and inheritance taxes?

According to the Center on Budget and Policy Priorities, Bush-era tax cuts account for more than $700 billion — or nearly 55 percent — of the currently-projected deficit for 2019. Former Fed Chairman Alan Greenspan was asked on NBC’s Meet the Press whether tax cuts pay for themselves by generating revenue and productivity among recipients. “They do not,” said Greenspan. He added that the push by congressional Republicans to extend the Bush tax cuts without offsetting the costs elsewhere could end up being “disastrous” for the economy.

Both the Congressional Budget Office and the Joint Committee on Taxation agree with Greenspan that large tax cuts financed by borrowing can harm the economy over the long term rather than help it. According to the Center on Budget and Policy Priorities, just two policies dating from the Bush Administration — tax cuts and the wars in Iraq and Afghanistan — accounted for more than $500 billion of the deficit in 2009 and will account for almost $7 trillion in deficits from 2009 through 2019, including associated debt-service costs. The prescription drug benefit enacted in 2003 accounts for further substantial increases in deficits and debt, which they were unable to quantify due to data limitations; other analysts have put the costs over $1 trillion. If the Bush tax giveaways are allowed to lapse, the deficit outlook would improve by about $4 trillion over the next 10 years — and more after that.

The Congressional Budget Office recently reported that without spending reductions, higher taxes, or both, “growing budget deficits will cause debt to rise to unsupportable levels.” David Stockmann, Ronald Reagan’s budget director, pointed out the “Emperor’s New Clothes” Aug. 1 in The New York Times: “Republicans used to believe that prosperity depended upon the regular balancing of accounts — in government, in international trade, on the ledgers of central banks and in the financial affairs of private households and businesses, too … The new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance…which have crippled our economy.” He added, “If there were such a thing as Chapter 11 for politicians, the Republican push to extend the unaffordable Bush tax cuts would amount to a bankruptcy filing.”

Treasury Secretary Geithner recently said “there is no credible argument that the purpose of government is to borrow from future generations of Americans to finance an extension of tax cuts for the top 2 percent … That would be a $700 billion fiscal mistake,” he said.

Obama has proposed making most of the tax cuts permanent, keeping a 2008 campaign pledge, but only for Americans making less than $250,000 a year. Even that is a bad idea, one that would cost $700 billion of borrowed money over 10 years. As for the campaign pledge, Obama already fulfilled that with one of the largest tax cuts in U.S. history as part of the stimulus package, alas, also paid for with borrowed money.

Republicans have claimed that our highest priority is to decrease budget deficits immediately or interest rates will go sky-high. Then, in their best Orwellian doublethink, they claim that tax cuts for the rich must be extended no matter how much red ink they create. Treasury estimates the cost for extending all the tax cuts, as Republicans are advocating, at $199 billion in fiscal year 2011 and $3.7 trillion over 10 years.

Their second argument is that we can’t “raise” taxes during a recession, that tax cuts stimulate the economy. The Congressional Budget Office recently assessed 11 different potential ways of stimulating the economy. The most effective, they found, would be increasing unemployment benefits (the unemployed quickly spend whatever money they get, putting the money directly into the economy).

The least effective? Extending the Bush tax cuts.

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