Why Tax Cuts Work

Economists, philosophers and politicians have understood this simple bit of common sense throughout the ages -- and so should you. It's a practical lesson that defies political parties, demagoguery and dictatorship. It is intuitive, understandable -- and provable. Yet it is forgotten in the heat of the moment, and must be relearned by every generation -- a very costly lesson: Raising tax rates above a certain level actually reduces tax revenues.

President John F. Kennedy said it clearly on Nov. 20, 1962: ''It is a paradoxical truth that tax rates are too high and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the rates now. . . . Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus.''

Under Kennedy, the top personal tax rate was cut from 91 percent to 70 percent. He didn't live to see the so-called "Kennedy boom" that followed. But in the four years following the Kennedy tax cuts, federal tax revenues grew at 8.6 percent, four times the rate of the four years preceding the tax cuts.

The idea of collecting more tax revenues from lower tax rates has its roots in antiquity. In the 14th century, the Muslim philosopher Ibn Khaldun wrote in "The Muqaddimah":

"It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments."

And the great economist, John Maynard Keynes, wrote in 1972 about the British economy:

"Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget."

By the time the Laffer Curve was popularized by economist Arthur Laffer during the Reagan administration, the commonsense idea that the way to increase tax revenues is to cut tax rates had been demonstrated, but was still decried.

Then, the 1981 Reagan tax cuts (Kemp-Roth) cut marginal tax rates 25 percent across the board, over a three-year period. The top tax rate immediately dropped from 70 percent to 50 percent. Allowing for the delayed impact of the tax cuts, in the four years before 1983, federal tax revenues had fallen at an annual rate of 2.6 percent. Continued...