Timothy Smith

Professor Bruce Nuffer

Composition II

November 23, 1993

Taxes and the Economy: Government vs. Industry

A long standing controversy exists on the subject of taxes and the effect they have on

economic growth and federal deficits. Some are in favor of tax hikes in order to solve the

economic woes of both private industry and government offices. Others are convinced

that raising taxes will only add to the problems at hand rather than solving them, and that

lowering tax rates is what is actually needed to generate economic recovery and increase

federal revenues. I propose that the latter group is correct and intend to show why from

the research findings which are contained in this paper.

If anyone should know what makes the system work properly it would be the

founders of our country. From the start, taxation and how to implement it has been a

concern of national leaders. Alexander Hamilton believed that “revenue is the essential

engine by which the means of answering the national exigencies must be procured”

(Rossiter 195). Hamilton also layed out a proposed plan for keeping this “engine” in

good running order. For instance, in order to collect revenue the government must be

empowered to pass legislation giving it a proper measure of authority to collect tax and

enforce tax codes (Rossiter 202-03).

Until the time of the Civil War, such powers were limited to excise taxes

and tariffs on imported goods. As an emergency measure the income tax was first

enacted to generate revenue to cover expenses incurred during the war. In 1872 the
income tax law was repealed because of massive public outcry against it (Waltman 3).

The war had been over for several years and citizens saw no reason for hard earned

money going into the government treasury.

In the 1890s, the Populist party brought the issue into hot, debate by attaching an

income tax amendment to a tariff bill. “Cries of ‘confiscation’ were heard throughout the

land to which populist replied ‘these huge incomes were ‘stolen’ anyway’” (Waltman 4).

In a ruling handed down by the Supreme Court in 1895 the income tax law was declared

unconstitutional because it did not levy the burden in proportion to the population of each

state.

Although its inception came during the Civil War, the Internal Revenue Service as

we know it did not exist until 1913. Stemming from an uproar in Congress four years

earlier, the Sixteenth Amendment to the United States Constitution received the necessary

votes for ratification, giving Congress the power to levy an income tax (Waltman 5-6).

With the Republican party still weak from a split in 1912, Democrats were in

control of Congress and wasted no time in enacting the first rates by which income

should be taxed (Waltman 104). The struggle of the have-nots against the haves was

entering a whole new era. The industrial revolution of the late nineteenth century had

created many successful families whose wealth was now seen as unfair and unjust. Thus,

just as the populist had done in 1894, Democrats in 1913 now hungered to tax the rich.

Many of the founding fathers warned against such a practice. Alexander

Hamilton was one of them. His reasoning suggested that if “revenue should be restricted

to particular objects, it would naturally occasion an undue proportion of the public burden

to fall upon those objects” (Rossiter 216-17). Hamilton also stated that those who
possess a full and complete understanding of political economy would have the least

tendency “to resort to oppressive expedients, or to sacrifice any particular class of

citizens to the procurement of revenue…the most productive system of finance will

always be the least burdensome” (Rossiter 216-17).

An interesting twist in this commentary on the history of taxation is the stance of

the two main political parties. Since Abraham Lincoln first defined the Republican party

by his own example of governing, Republicans have maintained that the upper class

citizens are paying more than their share by investing in land, business and industry, and

in the employment of the people in such industry. Therefore the “wealthy should not pay

much <in taxes>” (Waltman 118-19).

Thomas Jefferson, considered to be the founder of the Democratic party, would

surely dinstance himself from the Democrats of tday, for they have distanced themselves

from their beginnings. Since the opening of this century Democrats in Congress have

“had their cake and eaten it too” (Waltman 118-19). They have been able to do this by

representing themselves as the champions of compassion by urging the enactment of laws

which use government funds “to help the disadvantaged. However, at the same time,

they have been prone, in many of their own upper middle class interests, to make sizable

holes in the tax law” (Waltman 118-19).

A brief exception to this rule came in the person of John F. Kennedy who favored

the idea of slashing tax rates in order to spur the economy and reduce the federal deficit.

In his speeches to Congress Kennedy emphatically stated that higher tax rates “invite

recurrent recessions, depress federal revenues, cause chronic budget deficits” (Month 33-
34). Kennedy also said that higher marginal rates produce lower income for both

individuals and the Treasury department (Kenndy’s 83-87).

More recently, Reagan in his address to Congress in early 1981 succeeded in

putting into action the Republican belief that less taxes on wealth is a key factor to

economic growth. Reagan in his address to Congress in early 1981 expalined that when

people make more they have an incentive to work more which results in an expanding

economy. “Higher output in the economy also leads to increased revenues to the

government” (President’s 166-68).

The results were exactly the same as what Reagan predicted. While many in

Congress, (in both the 1960s and the 1980s), had argued that tax cuts would only make

things worse for the government, the outcome was anything but negative. An $11 billion

cut in personal taxes was eneacted in 1964 when the budget deficit was at $6 billion. One

year later, the economy was growing, inflation was down, and the increased amount in

federal revenues reduced the budget deficit to $1 billion (Malkin 34).

On the other hand, in a capitalistic environment such as ours raising taxes to

“help” the economy and reduce the deficit always results in slower growth and larger

government indebtedness, especially when such tax hikes are aim at the rich. In 1990,

Congress, with the reluctant agreement of President Bush, enacted a tax plan which was

“supposed to yield $150 billion over the next five years.” The actual figures add up to a

staggering $487 billion in projected revenue losses by 1996 (Reynolds 407).

As Dan Quayle has so aptly stated, “You don’t build economic strength by taxing

economic strength. If you tax wealth, you diminish wealth. If you diminish wealth, you

diminish investment. The fewer investments, the fewer the jobs” (Pater 107). Less jobs
results in a lesser amount being collected in federal taxes. A second result of higher tax

rates is that of less investment and trading. For instance, in 1986, when Congress raised

the capital gains tax from 20% to 28% they did so to “help balance the budget by

increasing revenues” (Fletcher A8). Since then the amount received from taxes on capital

gains has declined by more than 20% (Fletcher A8). “Tax hikes, because they dampen

economic activity, never seem actually to raise tax revenues” (Tobias 184).

As noted earlier, many Democrats in Congress have either failed to learn this

lesson or simply don’t care to remember it. The current administration is now proposing

more “tax the rich” ideas in order to try and generate more incentives for those less

fortunate and also to reduce the deficit. Some Democrats, however, have voiced

opposition to Clinton’s tax hike proposals, along with their Republican counterparts, such

as Dick Armey: “Your plan won’t work. It is based on a faulty economic model which

assumes higher taxes will reduce the deficit and doesn’t recognize they will slow the

economy” (Dunham 82).

Not only does the government loose needed revenues which are lost due to higher

taxes being imposed on individuals and businesses, the effects of such nonsense make the

federal deficit and the national debt rise even higher.

In 1986, when Congress decided real estate should no longer be a tax shelter the

result was not $30 billion more in revenue because of higher capital gains taxes. Rather,

the government induced a real estate the harvest of which is almost $500 billion being

spent to prop up the already anemic Savings and Loan industry (Roberts 32-33). The

moral of this story is that politicians who believe that capital is only good for the rich are

likely to end up hurting the poor. For it is “capital <that> creates jobs, and it is capital
that makes workers more productive, thus raising their wages. When you hear a

politician say that he is going to tax the rich to help the poor, you know that you are

listening to a dangerously uniformed person” (Roberts 32-33).

The World Bank did a study of twenty countries and the relation between tax rates

and economic growth. Evidence strongly supports the argument that lower tax rates not

only increase economic growth but aid in bringing in more for government spending

purposes. In fact, “the lowest tax rates brought in the highest revenues” (Gilder 160).

Two examples can be given to lend to the reader the real effect of raising taxes in

order to stimulate the economy and reduce the deficit. Number one is the state of

Connecticut which since 1989 has tried to tax its way out of recession. More than a

billion dollars in tax increases have been enacted by the state legislature. Again the

supposed result was that more revenues would be brought into the state treasury (Adams

44-49).

Actual happenings include a virtual extinction of defense industry which accounts

for a large portion of the more than 200,000 jobs which have been lost during the current

recession. Five years ago Connecticut was number one in the nation concerning per

capital income. It is now last place in income growth. “Connecticut has become one of

recent memory’s more dramatic examples of a tax-induced disaster” (Adams 44-49).

A second and more well-known illustration is California. After more than two

decades of continuous growth and expansion the west coast state faltered a bit because of

defense cut backs due to the end of the Cold War. The state legislators took it upon

themselves to solve the economic downturn. California’s governing body increased taxes

on everything from income to alcoholic beverages and consumer goods (by way of more
sales taxes). “This tax hike…was supposed to bring in $7 billion in additional revenues”

(Bengs A14). The real outcome of these “deficit reduction” taxes included more layoffs,

no per capita income groeth, weak retail sales, “and the most severe economic recession

since the Great Depression of the 1930s” (Bengs A14).

Even with evidence puring in from all sides, many of the Honorables on Capitol

Hill seem intent on trying out the same experiment on a national level. Do those in

Congress really think more taxes will lower the deficit and help the economy or are they

falling prey once again to what Alexander Hamilton described as “sacrificing a class for

the procurement of revenue,” more commonly known as envy and jealousy? “Such taxes

would mainly be vindictive, not economically useful. Wealth is antidote to depression,

not its cause. A wealth tax…would do nothing to stop a depression or strengthen the

overall economy” (Davidson 407).

Even if Congress passed tax codes requiring every single person of wealth to fork

over every dollar they earned in a year the federal government would be out of money in

less than a month. Of those with incomes of $1 million or more per year the combined

total of their earnings in 1987 was $75.5 billion. This amount is equal to about 26 days

of government operational expenses (Cunniff 151). Monetary amounts of descending

order can be pieced together in the same fashion until you finally arrive at the same

meager percentages of the annual federal budget. All too soon, the government’s thirst

for spending would turn a “soak the rich” tax into a shower for all levels of society. Once

again, “the effect would be the opposite of that intended. Take most of a person’s

income, and see how long he continues to work” (Cunniff 152).

 Contrary to popular belief, the poorer segment of society has a lot more

understanding of economic issues than we might think. They realize that if it becomes

more difficult for the affluent to profit from their ventures then how can those who have

no resources or options to fall back on possibly increase their standard of living?

One must also look at the other side of this issue of understanding economics.

Many of today’s wealthy were yesterday’s poverty-stricken and more than a few of them

can still empathize with the working man who is trying to support a family. Ronald

Reagan is just such an example. His policies concerning taxes and economic growth

were derived from another small man who became great—Abraham Lincoln. “You

cannot strengthen the weak by weakening the strong. You cannot help the wage-earner

by pulling down the wage payer. You cannot help the poor by destroying the rich” (Text

11).

Many people say they really don’t care about making it big or becoming wealthy.

But, somewhere in the recesses of their minds is a glimmer of hope, a dream, a spark

which given the right conditions will burst into a flame of ingenuity that will create more

products, more jobs, more wealth, more revenues.

The survival of the United States over the past 217 years has occurred not from

the ramblings and actions of those in Congress or the White House but from the likes of

entrepreneurs such as Ben Franklin, Samuel Morse, Thomas Edison, Henry Ford, and

yes, Sam Walton. These five men together have contributed more to the growth of the

economy and the federal budget than most, if not all of the men who have graced (or

disgraced) the halls of Congress for the past 200 years combined. Sam Walton’s Wal-

Mart stores employ more than 400,000 people and bring in billions of dollars from
millions of consumers each year, a healthy percentage of which the government benefits

from.

Without exception, recessionary periods in our history have ended when

incentives for spending and investing were brought into play as a result of lower marginal

rates on income and a smaller capital gains tax. Therefore, it is not an increase in the tax

burden that will accomplish economic growth and deficit reduction. Nicholas Brady,

former Secretary of theU.S. Treasury states that the solution is a”a freeing up of assets

and an opportunity for small and middle-income people to make a profit…it’s the private

economy that gets things done” (Pater 85). In other words, it is really an issue of who

will spend our money and what, where, and why—the government or each individual.

At present, federal agencies and their activities make up twenty percent of our

annual economic picture (Dent 24). However, as Dent also points out, it’s not really

government money. It’s our money that we paid out in taxes. “So, the government does

not drive the economy-it doesn’t even drive itself-we do. That is, we fund the

government with our taxes and we fuel the economy with our spending” (Dent 24-25).

The more fuel we have available, the further our economy, and our government, will be

able to travel down the road to lasting prosperity.

 WORKS CITED

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44-49.

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Yourself in the Coming Depression. New York: Simon & Schuster, 1993.

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1993.

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33.

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