I harp enough on Democratic policies and economic claims that cannot be supported by facts, so I thought I’d do the same for the other side of the aisle, people like Sean Hannity that parrot the Republican argument repeatedly that tax cuts increase revenues, no matter when or where they occur. They point to the Reagan tax cuts, where the highest marginal tax rate on income was reduced from 70% to 35%. They look at the fact that tax revenues doubled from 1980 to 1990, and therefore use a simple “post hoc ergo propter hoc” analysis to say that one caused the other. But what’s worse is that they use that example and apply the logic to any and all tax cuts, as John McCain did in an interview with the National Review, where he said that tax cuts “as we all know, increase revenues.”

I’m reading the latest version of Naked Economics by Charles Wheelan and I highly recommend it. I’ve read other books like it (The Accidental Theorist, the Armchair Economist, etc.) and I think this one is the best. In discussing the effects of taxation, Dr. Wheelan includes the following footnote:

There is a subtle but important analytical point here. Those who argue that tax cuts increase government revenues often point out, correctly, that government revenues are higher after a major tax cut than before. But this is not the appropriate comparison to make. The question we should ask is whether government revenues after the tax cut are higher than they would have been if there had not been a tax cut.

Dr. Wheelan is correct to point this out, as it is often overlooked. Yes, tax revenues went up during the 1980s when we cut tax rates. They also went up in the 1990s when we increased tax rates. And they went up in the 2000s after the Bush tax cuts. If you look at any 10-year period in which the economy doesn’t tank (which Republicans always do to make their case), they’ll ALWAYS go up because of a) population growth, and b) inflation.

But let’s get back to Dr. Wheelan’s point. It relies on a counterfactual: what would tax revenues have been in 1990 if Reagan had not lowered tax rates in 1981? The simple answer is: we’ll never know. And the reason we’ll never know is that the relationships between economic variables depend on the institutions and rules that are in place: change the laws and taxes and you change how people respond. And you can’t use the relationships from the 1970s because many other things changed from the 70s to the 80s, not just tax rates.

The same counterfactual-based argument is made by President Obama, who says that, despite the fact that his stimulus bill was supposed to keep unemployment below 8% and create millions of jobs, unemployment went above 10% (and is still at 9.7%) and we lost millions of jobs, the stimulus was a success. This analysis is based on the behavior of an economy that no longer exists, multiplier estimates based on years when people were confident in spending and people borrowed more money than they do now. It’s all based on improvable assumptions about a world that does not exist.

So just as Obama should be careful about claiming success when his numbers are down, so should Republicans be careful about claiming that tax cuts increase revenues. They may increase economic activity and create jobs, but if they’re small they won’t do enough of that to offset the loss in tax revenue from the rate cuts. If you want to cut the budget deficit, grow the economy through smarter regulation, and cut wasteful government spending (and not just so you can add another entitlement program).

And while we’re debunking tax myths, here’s another one. For those who say the Bush tax cuts and Reagan tax cuts benefited the rich, I would invite you to look up the facts. Obviously, any tax cut is going to benefit the people who pay the most in taxes, just as a decrease in the price of a good is going to benefit those who actually buy the good and have no impact on people who don’t. (That’s your economics no-brainer for the day.)

But how did they affect the distribution of taxes paid? After both of those tax cuts, the share of federal income taxes paid by the highest 1% of income earners increased. From 1981 to 1988, the share increased from 17.6 to 27.5, while the amount of income tax paid by the bottom 50% fell from 7.5% to 5.7%. In 2007, the share of federal income taxes paid by the highest 1% of income earned was 40.4% (almost double their share of income earned, 22.8%). In 2000, before the Bush tax cuts, these people paid 37.4% of taxes. To wealthy people benefit from tax cuts? Yes, because they pay the most in taxes. But they actually make the distribution of tax liability more skewed in favor of the poor, not less.

*See Virginia Postrel’s analysis of the 1986 tax cut.