Merkel defends income tax cuts

In advance of a two day closed door cabinet meeting in Meseburg (described as a bit of much-needed marriage counseling by the newspaper Spiegel), Angela Merkel defended her center-right government's planned income tax cuts.  The Wall Street Journal reports:

Speaking at a conference organized by German magazines, Merkel said there is no alternative to the government's growth promotion plans, which include tax reliefs in 2010 and tax cuts from 2011 and amount to a total of €24 billion ($36 billion) in relief. Her comments come as the cabinet meets in Meseberg Tuesday for a two-day, closed-door meeting to discuss the new government's program.

"If the global economic conditions don't improve, it will be a very difficult path for us," said Ms. Merkel. "That's why the government... has opted for growth. I indeed face very critical treatment, as does the whole government, regarding the course that we have chosen." [snip]

"But I just want to say, don't forget there has never been such an economic slump in the 60-year history of the Federal Republic of Germany. The question how quickly we will manage to get of this will be decisive for a lot," Ms. Merkel said. "It is in our all interest "that we make progress quickly," she added.

Speaking ahead of the meeting, Ms. Merkel told reporters that the cabinet aims "to solve the difficult problems that our country is facing, such as overcoming the economic crisis and the quick drawing up of the budget."

That sounds almost like good old-fashioned Ronald Reagan/Margaret Thatcher leadership.  In the Reagan years, tax cuts actually increased tax revenue though you would have to be a world class hypnotist to convince a liberal of that.  Why, just yesterday, Kevin Hassett at Bloomberg mentioned the Laffer curve:

The problem is that the U.S. income tax, a primary source of federal revenue, is very progressive, and has high rates. When rates are already high, it becomes harder and harder to raise money by lifting them more. This is, of course, the observation that made economist Arthur Laffer famous, and for the U.S. it is a real concern.

First, our corporate tax rate is the world’s second highest, and a number of recent studies have found that such rates don’t lead to more revenue. This version of the Laffer curve is now fairly widely acknowledged.

But what is less commonly understood is that our graduated income tax also probably has reached the point where higher rates raise little new revenue, at least given the political landscape. President Barack Obama has pledged to only increase taxes on those with incomes higher than $250,000. But lifting only that top marginal rate can have perverse revenue effects.

Here is why. When tax rates go up, wealthy individuals have many options to reduce their tax bill. They can work a little less, they can purchase municipal bonds that pay tax-free interest, and they can take a vast number of other similar steps.

If you want to learn more about the Laffer curve, there is an expositive analysis from the Heritage Foundation from 2004 which still holds up well today.  Here is one of its major conclusions:

Over the past 100 years, there have been three major periods of tax-rate cuts in the U.S.: the Harding-Coolidge cuts of the mid-1920s; the Kennedy cuts of the mid-1960s; and the Reagan cuts of the early 1980s. Each of these periods of tax cuts was remarkably successful as measured by virtually any public policy metric.

In his review of the book The End of Prosperity, Paul Dykewicz reminds us of the effects of tax cuts during the Reagan years:

For example, the supply-side economic policies championed by President Ronald Reagan preceded an economic recovery that was largely sustained during the succeeding years when the gross domestic product more than doubled from $5 trillion to roughly $12 trillion, the book explains.

Between 1981 and 1989, the U.S. economy produced 17 million new jobs, or roughly 2 million new jobs a year. The U.S. economy created another 20 million jobs in the 1990s. That robust employment growth shows that tax cuts spur hiring, the authors concluded

During the 1980s, 1990s and early 2000s, obstacles to growth had been winnowed by limiting taxes, tariffs, regulations and inflation. Those policies contributed to stable prices, a dependable and strong U.S. currency, a lower and flatter tax rate, and freer trade. Until the advent of so-called supply-side “Reagonomics,” the Dow Jones Industrial Average suffered one of its worst bear markets in history by falling nearly 8% a year on an inflation-adjusted basis between 1966 and 1982. In the Reagan Administration, the stock market averaged a rise of 12% a year.

Now that was some change that America really could believe in.