In December of 1962, President John Kennedy, about one month after the Cuban missile crisis had the world on edge, delivered what has to be one of the most brilliant economic speeches ever delivered by an American president (no, I haven’t read them all, nor would I subject myself to such barbarity!)
Speaking before the Economic Club of New York, Kennedy spelled out the case for the economically transformative benefits of lower tax rates on businesses and individuals. What I wouldn’t give for both political parties to accept this as conventional wisdom.
I thought of Kennedy’s speech recently amid the political uproar over whether the state’s relatively new combined reporting tax has brought Harley-Davidson to the brink of moving its manufacturing operations out of Wisconsin, raising the alarming prospect that Wisconsin could lose one of its most iconic companies.
Until 2009, Wisconsin corporations used separate entity reporting, which allowed the state franchise or income tax to apply to each separate corporation doing business in the state. In contrast, combined reporting requires that two or more related entities engaged in businesses inside and outside of Wisconsin calculate their tax burden as a single or combined unit under an apportionment formula — meaning the state can tax the percentage of an out-of-state subsidiary’s profits that can be attributed to a firm’s in-state operations.
Groups like Wisconsin Manufacturers and Commerce pointed out that combined reporting would be a radical departure from the way corporate income taxes were statutorily calculated, but Harley-Davidson executives have not said the tax has harmed the company’s cost structure, only that the recession has whacked its sales.
Assembly Minority Leader Jeff Fitzgerald, a Republican, is having none of that. He puts the Harley’s unified reporting damage at a stunning $22.5 million.
Wherever the truth lies, there were ample warnings about the economic impacts of applying this or any new tax during a recession. Yet here we are, one side claiming that it has closed a tax loophole that has resulted in $200 million in additional state tax collections; the other side countering with the pejorative label “job-killer” while noting that if Harley leaves, you can kiss significant tax base, family supporting jobs, and positive image good-bye.
This brings me to an applicable paragraph in Kennedy’s 1962 speech. It reads as follows:
“In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the rates now. The experience of a number of European countries and Japan have borne this out. This country’s own experience with tax reduction in 1954 has borne this out. And the reason is that only full employment can balance the budget, and tax reduction can pave the way to that employment. The purpose of cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus.”
I always tell my liberal/progressive friends that if they want more tax money out of the rich, make them richer. I know it sounds counter-intuitive; I thought the same thing at first, but that’s part of the paradoxical truth Kennedy referred to. We’re really talking about an equation with two different factors, the income tax rate and income. The product of those two factors is the tax revenue an individual or company sends to the federal and/or state government.
When tax rates are cut, it places more money in the pockets of the people who really make the economy go: namely, consumers, investors, and the people who put their wealth at risk to start companies. That’s why each time we have cut tax rates — under Kennedy, Reagan, and George W. Bush — we stimulate the economy as more businesses — and therefore jobs — are created. This not only creates more tax-paying entities, it creates more taxable wealth.
Ask yourself this: Who pays more taxes? A relatively wealthy person who earns $1 million a year paying at a 40% income tax rate, or that same wealthy person whose annual pre-tax income has risen to $1.5 million (as part of an expanding economy) after his income tax rate was reduced to 35%? Let’s do the math.
$1 million multiplied by 0.40 = $400,000.
$1.5 million multiplied by 0.35 = $525,000.
It would appear then that raising income is a more effective revenue generator. So which approach — higher tax rates or lower tax rates — is more likely to help balance the budget and meet whatever spending obligations the government enacts? Which approach is more likely to produce a higher level of business activity?
Think of it this way. Lowering tax rates makes the rich richer, but that’s just another way of increasing the tax base — just like a municipality or state does when it woos a company from another city or state.
True, the budget deficit is likely to go up initially as the tax rate cuts work their economic magic (some long overdue spending discipline would help), but in the long run more wealth equals more taxes paid. I would hasten to note that the national economy is starting to gain some traction while the Bush tax rate cuts are still in place. When they expire at the end of 2010, I hope the rebound is strong enough to overcome this and other tax increases.
Tax rate cuts are the classic win-win scenario, but it’s hard to explain this without giving people a headache. Even some pro-growth politicians don’t know how to break this down, as most use the term “tax cuts” instead of “tax-rate cuts.” Tax cuts imply less revenue to the government, which is not the desired result.
In his 1962 speech, Kennedy would go on to describe the desired result, and it has to do with expanding the incentives and opportunities for private expenditures, consumption, and investment:
“The final and best means of strengthening demand among consumers and business is to reduce the burden on private income and the deterrents to private initiative which are imposed by our present tax system …”
If we could ever get bipartisan consensus on this point, Republicans and Democrats could confine their fiscal argument to how the tax revenue should be spent once it comes flowing in. That alone should keep their debate going 24/7.
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