Ever since the financial collapse of 2008 — and perhaps since the dawn of time — Democrats have argued that a struggling economy needs more government spending and more taxes, while Republicans have fought tooth and nail for less government spending and lower taxes. This has gone on so long that I got drawn to the ancient mystery of it. Which side is right?
According to Joseph J. Thorndike, director of the Tax History Project at Tax Analysts, tax rates aren’t nearly as important to economic growth as people think.
In the 1950s, taxes were high, but the economy still hummed at an impressive rate. In the early 1980s, Reagan cut taxes and took credit for ending a recession. But by the mid-1980s, he raised rates again to combat a growing deficit. The economy continued growing. Then George H. W. Bush and Bill Clinton raised taxes even more. Business kept booming.
“The economy will do what the economy will do, thanks largely to non-tax factors,” Thorndike said.
But one thing that does seem to matter, perhaps more than the tax rate itself, is the frequency with which the tax rates change. In the 1930s — during the Great Depression — tax rules shifted constantly, as the government reacted to the crisis. Since investors could never predict what taxes would be, they delayed new investments rather than make big decisions with too many unknowns. That prolonged the Depression.
Today’s investors are in the same boat. The crash of 2008 prompted a host of new policies, literally overnight. An unpredictable presidential election raises more questions about what tax policy will be.
And even after November, uncertainty looms as both sides vow to fight on to undo whatever the other side has already done. It is no wonder that companies would rather wait for the dust to settle, instead of investing big now.
So this leads to another idea that has been gaining currency lately: That our ailing economy is not due to Democratic or Republican policies, but rather to the epic failure to agree on any policy at all; that the biggest obstacle to an economic recovery is the interminable struggle over how to bring a recovery about.
Last year, three economists — Scott Baker and Nicholas Bloom of Stanford and Steven Davis of University of Chicago — set out to quantify the feeling of uncertainty, and measure its impact on the economy. Using a combination of inputs, such as mention of the word “uncertainty” in news reports and how widely economic forecasts vary, they created an “uncertainty index.” Their findings? Economic policy uncertainty hit a historic high last year.
In an interview last week in Cambridge, Baker showed me his latest “uncertainty chart,” which reached its jagged apex last August during the debt ceiling debate.
He said the psychological weight of uncertainty over taxes might have an ever bigger impact than the taxes themselves. Take the health care bill. “The effect on many businesses might be small, but the hysteria over it makes a large impact,” he said.
Another reason for so much uncertainty these days is the new fad in Congress for passing temporary tax cuts that expire in a matter of years. In 2000, there were 22 such laws, worth about $90 billion. Last year, there were nearly 100, worth more than $4 trillion.
The temporary measures are popular because they are easier to pass, and they look deceptively affordable because budget estimates assume they will not be extended. But they carry an invisible pricetag: far greater uncertainty. Baker and his colleagues estimated that as many as 2.5 million jobs would be created within 18 months if uncertainty dropped back down to what it was in 2006.
Who knows when our leaders will see fit to bring back some kind of clarity? Right now they have left us on the precipice of the economic unknown. But we have been here before, and we’ll be here again. That is just the nature of politics.
“Most economists say, ‘We need more stability. If we could just leave the tax code alone for awhile, governments could plan; businesses could plan,’ ” Thorndike told me. “But they have been saying that for 50 years. That’s just not how American democracy works.”
Politicians always tinker with the tax code. They just can’t help themselves.
NOTE: In response to a recent column about Taiwanese opposition leader Annette Lu, the office of President Ma Ying-jeou asserted in a statement that he never served as an agent for the Kuomintang party when he was a student at Harvard and that he never spied on Lu, as she claimed: “Ms. Lu’s allegations are baseless and strictly the work of her imagination.”