An agenda for inclusive growth

US capitol building
Editor's note:

This piece originally appeared in Real Clear Policy. 

A president who wants to boost economic growth should avoid ideology and focus instead on “evidence-based policies.” Unfortunately, lots of policy in Washington is based on what people hope will work, not what actually works.

The standard, but failed, approach often advocated by conservatives is to cut taxes for high-income households.  Ever since the 1970s, when Jude Wanniski and Arthur Laffer came up with what’s become known as supply-side economics, conservative politicians have found it difficult to resist the notion that tax cuts for high-income households are good for all and will “trickle down” to the rest of the economy.  In the extreme versions that thrived through the beginning of the Reagan Administration, some supply-siders argued that tax cuts would pay for themselves by substantially increasing overall economic growth.  Decades of experience make that claim impossible to support, so advocates now make the more modest claim that tax cuts will spur enough growth to make up a large enough share of the revenue losses to still be good economic policy.

But the record is clear that deficit-financed tax cuts on high-income households and businesses have failed to boost growth at the federal or state level in the U.S., or in other countries.  For example, when growth is (appropriately) measured from peak to peak of the business cycle, the vaunted Reagan tax cuts produced a period of only average growth.  Indeed, research by Martin Feldstein, President Reagan’s former chief economist, and Douglas Elmendorf, the former Democrat-appointed Congressional Budget Office Director, concluded that the 1981 tax cuts had virtually no net impact on growth.  Instead, the post-recession recovery of the early 1980s benefited primarily from the Fed’s decision to reduce interest rates.

The record is clear that deficit-financed tax cuts on high-income households and businesses have failed to boost growth at the federal or state level in the U.S., or in other countries.

Nor did the 2001 and 2003 Bush tax cuts stimulate much, if any, growth. Despite cuts in tax rates on ordinary income, capital gains, dividends and estates, the economy grew sluggishly after 2001.  Moreover, even that lackluster growth is generally attributed to the Fed’s expansionary monetary policy (and to a housing boom that unfortunately went bust and triggered the Great Recession of 2008-9).

States have not fared better with high-income tax cuts.  On the advice of Donald Trump’s economic advisor Stephen Moore and others, Gov. Sam Brownback (R-KS) argued in 2012 that an income tax cut would be “like a shot of adrenaline into the heart of the Kansas economy.” Alas, the tax cuts coincided with an economic decline that continues to this day.  In the wake of faltering revenues, the state has cut education and raised more regressive taxes.  Other states that enacted tax cuts have similar stories to tell.

Top tax rate cuts fare no better in cross-country comparisons. There is no relationship  between changes in top marginal tax rates and growth between 1960-2010.  For example, the United States cut its top rate by over 40 percentage points and grew just over 2 percent annually per capita over that period. Germany and Denmark, which barely changed their top rates at all, experienced about the same growth rate.

Thus, high-income tax cuts have not magically improved economic growth.  Instead, the next president should focus on building economic capacity with new investments in infrastructure, research and development (R&D), education, and anti-poverty programs.

Research from a wide variety of sources broadly supports the notion that public infrastructure and R&D investments increase private sector productivity and GDP.  The impacts of public investment are greatest during periods of low growth.  Federal investments in R&D have aided the rise of modern medicine (such as the human genome) and technology (the microwave, the internet).  Public R&D policies can boost private R&D and increase productivity by generating knowledge that leads to new goods and services and improvements in existing ones. Investments in R&D can also drive down the price of new technologies, making them available to more people.

Research from a wide variety of sources broadly supports the notion that public infrastructure and R&D investments increase private sector productivity and GDP.

Federal investments in education lead toward a more skilled workforce, raising earnings and spurring innovation. Workers with only a high school education are twice as likely to be unemployed as those with at least a bachelor’s degree. Looking outside the U.S, an extra year of school is associated with a significant increase in per capita income.

There are also gains to investments in early childhood education: the earlier the intervention, the more cost-effective, which is why policymakers have been focused on pre-school.  Children who attend early high-quality care and education programs are less likely to engage in criminal behavior later in life and more likely to graduate from high school and college.  Reducing the cost of preschool effectively increases a mother’s net wage, making it more likely she will return to the labor market.

Spending on effective social programs provides immediate benefits to low-income families and can improve long-term economic growth. For example, the Earned Income Tax Credit provides a critical tax break to low-income families and contributes toward a number of economic benefits: the increased income security contributes to better health; much of the credit’s benefit structure encourages work; and the credit can lead to increased college enrollment, which leads to higher wages.  Nutrition assistance programs improve beneficiaries’ health and also increase economic independence, while housing assistance programs such as portable vouchers can improve educational attainment and future earnings by allowing families to relocate from housing projects with concentrated poverty to areas with more diverse incomes  and higher levels of upward mobility.  Spending for low-income health programs such as Medicaid and the Children’s Health Insurance Program (CHIP) can improve economic outcomes; improved children’s health leads to a healthier future adult population, and better health leads to work stability and increased education completion.

A significant investment – say, 1 percent of GDP per year – could be made in the programs above and would spur broad-based, inclusive growth.

Added growth would boost revenues, but not by enough to pay for this new spending, thus raising the public debt.  The effects of debt cannot be ignored.  Fueled by rising Social Security, Medicare, and Medicaid obligations, our growing debt will eventually become a drag on economic growth.  We have plenty of tools that could deal with this problem – including a carbon tax, a value-added tax, a reduction in income tax expenditures, and judicious Social Security and Medicare reforms.  We just need the political will to implement them.

But it isn’t the time for debt reduction yet.  The current priority should be to establish more robust growth.  Research has shown that federal investments can lead to better future economic outcomes. The evidence on supply-side tax cuts is simply not supportive.  It is time for a pragmatic growth agenda, not magical thinking.

This piece originally appeared in Real Clear Policy.