April 09, 2012
Tax Policy is About Competition, Not Fairness
What John F. Kennedy understood that today's politicians forget.
'The economy is like a regular .300 hitter who only batted .250 and then slumped to .230." So said Walter Heller, chairman of President John F. Kennedy's Council of Economic Advisers, about the U.S. economy in 1961, when growth was anemic and unemployment had hit 7%. He could have said the same after last Friday's disappointing jobs report.
Heller's successful plan to combat the recession of the early 1960s was the Kennedy-Johnson tax cuts, which pushed the unemployment rate below 5% and the growth rate above 5% from 2%. Crucially, the administration's marketing pitch didn't talk about "fairness" but about competition. In the 1963 State of the Union Address, for example, Kennedy spoke about obstacles that "undercut our efforts to compete with other nations." He called "one step, above all, essential" to solve the problem: "the enactment this year of a substantial reduction and revision in federal income taxes."
Heller and Kennedy recognized that taxation (not only growth) is all about competition. Cities compete with cities, counties with counties, states with states, and nations with nations. These natural experiments run in real time.
A few exceptions, such as Massachusetts, show strong growth coexisting with high tax rates. But today as in Heller's day, the trend is overwhelming: At all levels—county, state, federal and international—lower and more stable tax regimes correlate with stronger growth.
The trouble is that lawmakers (especially at the federal level) insist on discussing tax reform in terms of fairness. Tax competition earns a mention from time to time, but only a mention.
Legislators at all levels of government are beholden to data sets that contain little material about states, even less about other countries, and scarcely any easy-to-follow comparisons. Yet while everyone here at home was recrafting the earned-income tax credit or the Alternative Minimum Tax, the United States this month became the country with the highest corporate tax rate in the entire developed world.
In this week before our taxes are due, it is worth reviewing the evidence on tax competition and economic growth. Some of the evidence comes from states; Arthur Laffer and Stephen Moore have shown on these pages that, over the long term, states with no income tax grow faster than those with high income tax rates.
Internationally, as Nobel Laureate Edward Prescott has written, marginal income tax rates correlate to number of hours worked; heavily taxed Europeans work only half the hours of Americans. And smaller government tends to correlate with stronger growth: As scholars Magnus Henrekson and Andrew Bergh showed in analyzing more than 20 countries over a quarter-century, for every 10 percentage points that a country's government expands into its economy, the country loses up to a percentage point per year in economic growth.
To marshal this evidence and present it formally to the public, the George W. Bush Institute is hosting a conference in New York City on Tuesday dedicated to examining tax competition at all levels. Governors and city executives will mix with national leaders and experts in international markets. House Budget Committee Chairman Paul Ryan—whose plan has been scrutinized far and wide for its fairness—will be pressed to show how his plan stacks up in international tax competitiveness.
The next step is to amalgamate data to facilitate such comparisons in the future. Right now, someone who wants to compare Europe to Cook County must compare Organization-for-Economic-Cooperation-and-Development apples to Illinois oranges. But making tax apples like tax oranges is a much lighter task than it once was, and great international tax-competition databases—including all jurisdictions such as states, provinces and cities—are worth developing.
Shifting the American tax debate to the framework of competition feels hard. But there was a president, pre-Kennedy, who made that his cause: Calvin Coolidge, who also thought about prosperity in terms of baseball.
On a 1925 visit to New York, Coolidge stated his (correct) suspicion that his team, the Washington Senators, would soon fall behind the rival Yankees. He preferred the Senators, but Coolidge noted that the intercity rivalry between America's "political center" and its "business center" was healthy, for without it Washington would confront no check. The Framers, he suggested, not only observed but cherished the competition of economic jurisdictions.
Such economic duels remain what Coolidge labeled them—not something to police or ignore, but a "wise dispensation."
Ms. Shlaes, the director of the George W. Bush Institute's Four Percent Growth Project, is author of "Coolidge," forthcoming this year from Harper.
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