Chicago School Needs Practicum

If free-market economist Milton Friedman could see what is happening at the University of Chicago—his home base for many years—the late Nobel laureate would probably turn over in his grave several times.

Recently, the Booth school at U-Chi held a forum in which top academic economists from around the country weighed in on a host of issues. On one of these, all of the economists surveyed agreed that a small increase in marginal tax rates would lead to corresponding revenue gains by the federal government.

Even those few professors who worked in Republican administrations signed onto this view, despite primary evidence indicating the opposite is true. “During the summer of 1981 the central focus of policy debate was on the Economic Recovery Tax Act (ERTA) of 1981, the Reagan tax cuts,” economist Christopher Frenze wrote in a report from the Congressional Joint Economic Committee (JEC) in 1996. “The core of this proposal was a version of the Kemp-Roth bill providing a 25 percent across-the-board cut in personal marginal tax rates.”

“By reducing marginal tax rates and improving economic incentives, ERTA would increase the flow of resources into production, boosting economic growth. Opponents used static revenue projections to argue that ERTA would be a giveaway to the rich because their tax payments would fall.”

“The criticism that the tax payments of the rich would fall under ERTA was based on a static conception of human behavior. As a 1982 JEC study pointed out,[1] similar across-the-board tax cuts had been implemented in the 1920s as the Mellon tax cuts, and in the 1960s as the Kennedy tax cuts. In both cases the reduction of high marginal tax rates actually increased tax payments by ‘the rich,’ also increasing their share of total individual income taxes paid. Unfortunately, estimates of ERTA by the Democrat-controlled CBO continued to show falling tax payment by upper income taxpayers, even after actual IRS data had become available showing a surge of income tax payments by affluent taxpayers.”

Now back to the future. This year, the Booth School at U-Chi asked 45 Ivory Tower economists  if they agreed with the proposition that, “All else equal, permanently raising the federal marginal tax rate on ordinary income by 1 percentage point for those in the top (i.e., currently 35%) tax bracket would increase federal tax revenue over the next 10 years.” All 45 economists polled said aye.

Only two of the respondents offered significant caveats.  “Some activities will change little, such as labor supply, but some will increase tax avoidance efforts,” Kenneth Judd of Stanford averred. “My guess is a weak revenue increase.”

“Revenue would rise, but the important question is what happens to growth, not revenue,” Stanford’s Edward Lazear predicted. “The goal is not to maximize the size of government.” Lazear chaired the President’s Council of Economic Advisors during the last Bush Administration.

Most of the surveyed economists saw no negative consequences to such a rate hike. The Berkeley contingent (7/45) didn’t think the rate hike was high enough.

As the above comments indicate, all were making predictions, rather than drawing on evidence of what has happened in the past when tax rates were raised or cut. They would do well to observe the guiding principle of academic research espoused by Mr. Friedman. “The only relevant test of the validity of a hypothesis is comparison of its predictions with experience,” Friedman stated.

Malcolm A. Kline is the Executive Director of Accuracy in Academia.

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