Beneath the Surface

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Since the late 1970s, a powerful antitax movement has advocated a reduction in the portion of national income that goes to fund government. What has it accomplished?

Tax cuts, then and now

To answer that question, I found that I had to distinguish between two very different periods of tax-cutting. The first began with the Reagan tax cuts of 1981, and the second with the Bush tax cuts of 2001.

Most tax-cutters wanted to both reduce tax rates and shrink the size of government by cutting spending. (A few argued that reducing the federal budget would not be necessary, because the tax cuts would pay for themselves.) What is interesting about the period from 1981 to 2000 is that the antitax forces succeeded a little more in cutting spending than in lowering taxes. Government outlays went down from 20.7 percent of GDP in 1980 to 17.5 percent in 2000, while government revenue went up from 18.1 percent to 19.8 percent. As a result, the budget went from a deficit of 2.6 percent of GDP to a surplus of 2.3 percent. Why? Because when faced with the high deficits resulting from the Reagan tax cuts, political leaders got serious about balancing the budget. They accomplished this both by raising taxes and cutting spending.

The fiscal trends in the second period, 2001 to 2023, were the opposite: The Bush and Trump tax cuts really did bring federal revenue down, while federal spending went up. That’s because the country cut taxes in both good times and bad, while also spending to address the national emergencies of the War on Terror, the Global Financial Crisis, and the Covid pandemic. The budget went from a 2.3 percent surplus in 2000 to a 6.2 percent deficit in 2023.

For much of the nation’s history, taxes were increased to fund wars and new entitlement spending, such as for Social Security and Medicare. In the twenty-first century, however, commitments not to raise taxes meant that massive spending to fund the wars following the terrorist attacks on September 11, 2001, to add prescription drug coverage to Medicare, to keep the economy afloat during the global financial crisis, and to respond to the Covid pandemic all went unfunded.

Low taxes and the economy

The effect of low taxes and federal deficits on the economy is a difficult and controversial topic. A tax cut is not a controlled experiment, since the economy is changing in other ways all the time. Some ideas do stand the test of time. The old Keynesian idea that tax cuts and deficit spending can stimulate the economy during recessions remains alive and well, thanks to the experience of the Great Recession of 2007-2009 and the Covid recession of 2020. The idea that low taxes accelerate growth any time finds less support, since the economy grew faster in the high-tax postwar era and in the 1990s than in the recent period of lower taxes. Graetz says that “the most robust economic growth since 1978 occurred during years following Bill Clinton’s 1993 tax increases. Tax reductions at the top have spurred neither great increases in domestic investment nor bursts of increased productivity.”

Lower taxes have been a contributing factor to economic inequality. The main beneficiaries of tax cuts have been the wealthy, who are disproportionately impacted by cuts in income taxes, estate taxes, capital gains taxes, and corporate taxes (as shareholders). They also have ways of living off their existing wealth while paying hardly any taxes at all.

Rich Americans borrow cheaply against their stock and bond portfolios to fund their lifestyles without paying any income taxes. Increases in the values of assets are not taxed as income until the assets are sold, and the tax law forgives any income tax on a lifetime of gains if assets are held until death.

Low taxes and government

Low taxes and high deficits may hamper the government’s ability to respond to new crises, such as climate change, global political threats like Russian or Chinese expansionism, demographic changes increasing the costs of Social Security and Medicare, economic dislocations caused by new technologies, and new demands for human capital development. The national debt is now so large that the country spends about as much on interest payments as it does on national defense.

This year’s presidential election is, among other things, a choice between two different fiscal approaches. President Biden wants to raise taxes on individuals with incomes over $400,000, raise the corporate rate from 21 percent to 28 percent, and create a wealth tax on people with over $100 million in assets. Former President Trump wants to make permanent his 2017 tax cuts favoring the wealthy.

I began with John Marshall’s observation, “The power to tax involves the power to destroy” and Graetz’s addendum, “So, it turns out, does the power not to tax.” I agree with Graetz’s suggestion that low taxes may now be a bigger threat to national greatness than high taxes.

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The antitax movement was encouraged by President Reagan’s partial success in cutting taxes. The antitax forces were also disappointed, but certainly not deterred, by his failure to reduce total federal spending or balance the budget. They continued to claim that cuts in tax rates could generate increases in tax revenue by encouraging saving, investment and economic growth. And if tax revenue did fall, that would eventually force government to rein in spending, whatever the cost to popular domestic programs.

Antitax warriors

Graetz’s book features three noteworthy figures who mobilized the antitax movement in the late 1980s and 1990s. They led the way in making tax-cutting the central mission of the Republican Party.

Grover Norquist founded Americans for Tax Reform and served as its first president. He had a radically hostile view of the federal government, often saying that he wanted “to get government down to the size where you can drown it in the bathtub.” As for taxes, he proclaimed, “There is no such thing as a just tax—it is a contradiction in terms. We just want the government to steal less of our money.” Apparently he thought that citizens owe their government nothing for whatever benefits they receive from it. In 1986, Norquist began urging politicians to sign a pledge that they would “oppose any and all efforts to increase the marginal income tax rates for individuals and for businesses…” Over the next few years, almost every Republican president, governor, Congressional representative and senator did.

Newt Gingrich was elected to the House in 1978 and served as Speaker from 1995 to 1999. He championed the most radical form of supply-side economics, claiming that tax cuts would actually increase federal revenue by stimulating growth. He did not hesitate to attack any president, even of his own Republican Party, who dared to raise taxes. He co-authored the “Contract with America,” the agenda Republicans ran on in 1994. It called for tax cuts, a balanced budget, and the requirement of a three-fifths majority to pass any future tax increases.

Rush Limbaugh was a talk-show host who became nationally syndicated in 1988. His antitax message was eventually heard on 650 radio stations and 200 TV stations. Graetz describes Limbaugh’s role in right-wing media as “the granddaddy of them all, untroubled by factual accuracy, often bigoted, feasting on outrage.”

“Read my lips”

In 1985, during Reagan’s second term, Congress passed the Balanced Budget and Emergency Deficit Control Act, also known as Gramm-Rudman-Hollings. It called for a phased reduction in the federal deficit until a balanced budget was achieved in 1990. (That date was later pushed back to 1993.) The bill mandated automatic spending cuts divided equally between defense and non-defense spending, if Congress failed to meet the annual targets on its own. At the end of the Reagan presidency, the Congressional Budget Office estimated that without tax increases, these cuts would have to be substantial, like a 42 percent cut in defense spending.

Nevertheless, Reagan’s successor, George H.W. Bush, ran with the campaign slogan, “Read my lips: No new taxes.” Two years into his presidency, over the vociferous objections of House Republicans like Gingrich, Bush bowed to necessity and signed the Omnibus Budget Reconciliation Act of 1990. This law raised the top income-tax rate from 28% to 31%. It also raised payroll taxes and taxes on gas, tobacco and alcohol.

When Bush was defeated for reelection in 1992, Republicans blamed his loss on his failure to keep his “no new taxes” pledge. They were determined not to make the same “mistake” again, regardless of the fiscal circumstances. No Republican president has agreed to a tax increase since.

Political polarization

When Bill Clinton took office in 1993, Democrats controlled Congress and the presidency for the first time since 1979. Clinton’s original hope had been to cut taxes for the middle class and increase some domestic spending, especially for his health-care initiative. He too was induced to shift his focus to deficit reduction. Federal Reserve Chair Alan Greenspan warned him that the government’s demand for loans to finance the deficit would eventually raise interest rates and hurt the economy. (For a less pessimistic view, see my summary of Stephanie Kelton’s The Deficit Myth, especially part 2.) Under Democratic leadership, Congress passed the Tax Reform Act of 1993, which reduced the deficit with a combination of tax increases and spending cuts. The top income-tax rate went up again, from 31% to 39.6%.

The Democrats suffered a major defeat in the 1994 midterms, losing the House for the first time in 40 years. Republicans ran on their Contract of America, which promised no tax increases. Newt Gingrich became Speaker of the House. The following year, House Republicans wrote much of their Contract with America into legislation. In addition to tax cuts, it included:

…a budget proposal to restructure and sharply limit Medicare and deeply cut Medicaid, welfare, job training, student loans, farm subsidies, and a host of other programs. It also proposed eliminating the commerce, education, and energy cabinet departments.

Clinton vetoed the Republican budget and stood by his more moderate plan. Republicans then shut down the government temporarily rather than pass the president’s budget. When public opinion turned against them, they finally gave in.

Clinton was reelected in 1996, but Republicans retained control of the House. In 1997, the two sides reached a compromise in which Republicans got some reductions in estate taxes and capital gains taxes (both mainly benefiting the wealthy), and Clinton got a $500 tax credit for families with low-to-middle incomes. In the following year, Republicans nearly succeeded in passing the Tax Code Termination Act, which called for ending all taxes except for payroll taxes. (It passed by 10 votes in the House but lost by one vote in the Senate.) The bill contained no plan for funding most of the government, given that payroll taxes normally go to fund Social Security, Medicare and Medicaid.

In the end, the tax breaks adopted in Clinton’s second term were not large enough to keep the government from achieving a balanced budget in 1998. Clinton’s moderate policy of combining tax increases with spending cuts had prevailed over the Republican agenda of radical tax cuts and draconian cuts in federal programs. For several years starting in 1998, the budget ran surpluses, but they were the last budget surpluses the country would see for a long time.

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Michael J. Graetz. The Power to Destroy: How the Antitax Movement Hijacked America. Princeton: Princeton University Press, 2024

The title of this book comes from the classic statement by Chief Justice John Marshall in 1819, “The power to tax involves the power to destroy; the power to destroy may defeat and render useless the power to create.” Graetz ends his book by adding, “So, it turns out, does the power not to tax.”

Over the past half-century, advocates of low taxes have had some success in cutting taxes, especially taxes on high incomes and great wealth. Taxes in the United States are generally lower than taxes in other economically advanced democracies. “In 2021, counting state as well as federal taxes, U.S. taxes as a share of the economy were 7.5 percentage points lower than the average of the 38 OECD member countries.” Graetz is a tax lawyer, not an economist, so he describes the legislative and political accomplishments of the antitax movement more than he analyzes its economic consequences. Nevertheless, he is obviously skeptical that the benefits of low taxes outweigh the costs to society.

Sources of antitax sentiment

Graetz begins by saying that Americans have complained about taxes for a long time, but only since the late 1970s have so many joined together in an organized antitax movement. One reason for that is the unusual combination of income stagnation and inflation during that decade. Taxes were easier to tolerate when government seemed to be delivering strong economic growth without inflation. As times got tougher, the clamor for tax relief grew louder.

However, the reasons for antitax sentiment go deeper than that. Graetz argues that support for government programs to benefit the needy is lower in racially heterogeneous countries. The antitax movement was preceded by a time when the federal government was promoting civil rights legislation and funneling public money into a “war on poverty.” Since Blacks and Latinos were disproportionately poor, many whites felt that too many of their tax dollars were going to help people who were different from themselves, people who were often looked down upon. Southern whites especially left the Democratic Party in droves after it embraced civil rights. “The modern antitax movement rose and gained strength within the Republican Party alongside the party’s “Southern Strategy,” an electoral effort explicitly linked to racial division.”

Racial issues were also entwined with religion. Evangelical Christians were drawn to the antitax movement when the IRS was threatening to withdraw tax-exempt status from racially segregated religious schools. Republican activist Paul Weyrich, founder and first president of the Heritage Foundation, claimed that this issue enabled him to mobilize Christian conservatives more than abortion or school prayer. As president, Ronald Reagan sided with the churches against the IRS, saying that its effort to enforce racial integration “threatens the destruction of religious freedom itself.” He lost that battle when the Supreme Court ruled in favor of the IRS, but he won the hearts of many white Christians.

Another source of antitax sentiment was the increasing popularity of libertarian views, which were previously out of step with the pro-government sentiment of the New Deal and World War II era. The novels of Ayn Rand and the economic theories of Friedrich Hayek were dusted off and popularized. Their thinking celebrated the freedom to work and to enjoy the rewards of one’s own effort, not so much the obligation to support the collective good through government. Taxation was increasingly regarded as a threat to personal liberty and work incentive.

Many economists were turning away from Keynesian thought and rediscovering the glories of the unencumbered free market. Previously, economists had seen tax cuts as one tool that could stimulate a sluggish economy by increasing the demand for goods and services. But stimulating demand was not as clearly desirable when a sluggish economy was accompanied by double-digit inflation. Milton Friedman attracted attention and support by calling for tight monetary policy—high interest rates—to curb inflation. He also supported tax cuts, but for non-Keynesian reasons, to force government to cut spending and thereby reduce demand. In theory, cutting taxes would also give people more money to save and invest, which would stimulate the economy from the supply side, easing inflation. Cutting taxes for the wealthy should be especially effective, since they could afford to save and invest more.

The best-known supply-side economist was Arthur Laffer. He reasoned that if government taxes too little, it loses revenue. But if it taxes too much, it also loses revenue by discouraging people and businesses from producing as much as they could. There must be a happy medium, an optimal tax rate that produces the maximum revenue. Laffer always insisted that current tax rates were above the optimal rate, so that tax cuts would pay for themselves by actually increasing revenue. Few economists agreed, but Laffer’s argument became a major talking point in the antitax movement.

Graetz identifies three myths that motivated antitax crusaders:

(1) cutting taxes will increase government revenues, or, at the extreme, cutting taxes is the only way to raise government revenues; (2) lowering taxes will necessarily “starve the beast” by cutting government spending; and (3) reducing taxes at the top is the best way to grow the nation’s economy no matter the circumstances. These claims have been repeatedly debunked, but for more than four decades they have never disappeared from antitax advocates’ playbook.

One influential proponent of these ideas was The Wall Street Journal under the leadership of Robert Bartley.

Finally, the prospect of lower tax rates for the wealthy thrilled large political donors. They stood to gain the most from lower individual tax rates, lower corporate tax rates (which increased profits and shareholder dividends), lower capital gains rates (whenever they sold appreciated assets), and lower estate tax rates (when they left their fortunes to their heirs). Wealthy donors like Richard Mellon Scaife, Joseph Coors, and Charles Koch poured money into conservative think tanks like the Heritage Foundation and CATO Institute, which heavily promoted the antitax philosophy. “Money to organize meetings, produce favorable polls, generate supporting research by friendly experts, and contribute to political campaigns is more readily available to those who want to reduce their taxes than it is to their opponents.”

Proposition 13

The antitax movement began with a revolt against property taxes in California. The inflation of the 1970s had dramatically raised housing prices and property tax bills. But as with tax issues at the federal level, more was involved.

Property taxes financed public schools, but changing demographics and efforts to equalize spending across different kinds of districts undermined support for education funding. In the Los Angeles public schools, Black and Latino students were increasing in number, while many white students were leaving. In 1976, the California Supreme Court placed a limit on how much spending per pupil could vary from district to district across the state. The state legislature responded by redistributing some funds from wealthier districts to poorer ones.  Now richer homeowners could complain that their high property taxes were going to support someone else’s schools.

Proposition 13 was a referendum to amend the California state constitution in 1978. It called for limiting local property taxes to 1 percent of a property’s assessed value. It also required a two-thirds vote of the legislature to raise any state or local taxes. The amendment passed with most white voters supporting it and most black voters opposing it.

Graetz describes some of the results:

California ranked fourth among the states in per capita income, but after the enactment of Proposition 13, the state dropped to thirty-first in public school spending per child. Other services also suffered: community colleges, police departments, public hospitals and health programs, public works, local parks, and welfare and social services.

California was the first, but within the next four years, thirty-four other states cut property taxes too.

Reaganomics

The antitax movement soon targeted federal taxes. In the 1980 presidential election, Ronald Reagan campaigned on the promise that he could cut taxes, increase military spending, but still balance the federal budget by cutting other spending. President Reagan fulfilled the tax-cutting part of his promise with the Economic Recovery Act of 1981. This act immediately reduced the top bracket income tax rate from 70% to 50% and phased in cuts for lower brackets over the next two years. It created large tax savings for businesses and real estate investors by allowing them to deduct the cost of new investments more quickly. “New tax benefits for business were so generous that corporate tax receipts declined from about 15 percent to less than 9 percent of federal revenues.” The law provided additional benefits for the wealthy by cutting estate taxes and creating new ways for them to shelter income from taxation.

To assess the fiscal impact, I supplement the book with Federal Reserve Economic Data (FRED) from the Federal Reserve Bank of St. Louis. Between 1980 and 1983, federal receipts fell from 18.1 percent of GDP to 16.5 percent, while federal outlays rose from 20.7 percent of GDP to 22.2 percent. That means that the federal deficit rose from 2.6 percent of GDP to 5.7 percent, the highest since World War II.

The ink was hardly dry on the 1981 tax bill when pressure began to build in Congress for a change of direction. The Tax Equity and Fiscal Responsibility Act of 1982, which passed with bipartisan support, recouped some of the lost revenue by cracking down on underreported income. Reagan wasn’t happy, but he signed it in order to hold the deficit down.

The Tax Reform Act of 1986 also recovered some revenue by placing limits on tax shelters. But this time much of the gain in revenue was offset by another rate reduction for high earners. The bill replaced the many tax brackets ranging from 11 to 50 percent with just two rates, 15 and 28 percent. Taxpayers with high incomes got another windfall, while those with low incomes were protected from a tax hike by increases in the standard deduction and personal exemption.

By the end of Reagan’s administration, moderation of tax cutting and reductions in domestic spending brought the deficit down from 5.7 percent of GDP to 3.0 percent. Still, over the course of his eight years, “President Reagan added nearly twice as much to the federal debt as was accumulated during all of the presidencies that preceded him.” His tax cuts had neither paid for themselves nor forced equivalent cuts in spending.

In the 1980s, Congress still included many Republican moderates like Bob Dole, who were willing to raise taxes in order to keep the gap between receipts and outlays from growing too large. Over the next few years, positions would harden, so that Republicans united to resist any tax increases, regardless of economic or fiscal conditions.

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