Paul

Ibrahim

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June 22, 2009

Low Taxes Worked for Peter the Great, Worked for Reagan . . . and Will Always Work

In a history of Peter the Great, author Jacob Abbott writes about Peter seeking to increase exchanges between Russia and Western Europe:

“The tariff of duties on the products and manufactures of foreign countries was greatly reduced. (…) The new system greatly increased the revenues of the empire. It is true that the tariff was reduced, so that the articles that were imported paid only about half as much in proportion after the change as before. But then the new laws increased the importations so much, that the loss was very much more than made up to the treasury, and the emperor found in a very short time that the state of his finances was greatly improved.”

Fast-forward a couple of hundred years, and jump to the other side of the globe. In 1980, when the top income tax rate in the U.S. had for several years been at an unbelievable 70 percent, American taxpayers making $200,000 or more paid $19 billion in taxes. However in 1988, when the top tax rate had been reduced to 28 percent, that same group of taxpayers, which had greatly increased in number thanks to the economic activity generated by the tax cuts, paid nearly $100 billion in taxes – nearly five times the number from only eight years earlier.

The identical result observed in two unrelated historical instances is no coincidence. It is explained by an economic principle: When government increases taxes beyond a certain point, it drastically chokes the economy and eliminates incentives for people to generally engage in commerce, start businesses, grow existing businesses and even get jobs. When these high taxes are cut, however, the tax base itself grows because people regain the incentive to engage in commerce and make money (they get to keep more of it). When this occurs, the government brings in more tax revenues than it did when its tax rate was higher.

It is no surprise that the same exact phenomenon was observed in two very different societies during two very different points in history. The economic principle that explains these events, like other economic principles, is reminiscent of a hard science: It has been proven and it is timeless.

During the political debates with which we are most familiar, people tend to point to, say, a president, and proclaim “oh yeah this guy did great things with the economy,” or “that guy failed to ‘fix’ the economy.”

The problem with such debates is their implication that economic health depends on how smart a certain politician is, or how timely a government’s policies are. They imply that government should always “do something” to “stimulate” the economy, and that the options come down to, say, knowing which industries to bail out, as opposed to whether or not to bail out any industries at all.

Yet the reality is that economic principles are full of facts that have been proven and observed: It is a fact that free trade benefits the globe more than any combination of protectionist measures. It is a fact that beyond taxing for things like roads and law enforcement, taxes are harmful to the economy. It is a fact that price controls hurt the economy. We know exactly the solutions to economic problems, and we do not need a “smart” politician to “manage” the economy.

Thus it should not matter who is in office, as long as these known and tried principles are pursued. Any other “creative” economic actions or policies are by definition harmful to the economy. The only difference between the hundreds of “creative solutions” that are designed by politicians and teleprompters in Washington is how harmful they exactly are.

Indeed, economic principles have always been the same (as they proved to be with Peter the Great) and will always remain the same. One cannot reasonably suggest that “tax cuts worked during the Reagan years, but we need a different policy for a different time.”

No. That would be like asserting that although there was gravity in the 19th Century that made things fall to the ground, we’re not sure there is gravity today. It is factually incorrect. Free trade, tax cuts and privatization have always worked because of the laws of economics – and these laws, after proving true in every single century to which we have historical access – will always continue to be true.

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