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Tax Cuts Won’t Rebuild America

Supply-side economics is a spent force, and we are already in debt.


When Liz Truss became prime minister one year ago today, conservatives on both sides of the pond thought she might herald a new era of tax-cutting to unleash prosperity. Since the Tories’ landslide of 1979 presaged Ronald Reagan’s triumph in 1980, ushering in the Anglo-American era of free-market supply-side economics, American conservatives have looked to their British cousins as hopeful harbingers. But the would-be heiress to Lady Thatcher resigned in 49 days after her tax-cut plan triggered a gilt market crisis. While the Wall Street Journal rallied to her Reagan-Thatcher program in belief it could still work wonders 40 years later, might the Truss fiasco signal another kind of harbinger for this agenda: the end?

Before the era of globalized capital markets, production, and supply chains, scaling back high tax rates under both Presidents Kennedy and Reagan delivered sustained GDP growth. Back then, newly freed capital was invested productively at home in American companies and domestic industry. Neither president implemented his respective tax reductions in a vacuum, but as corollaries of their industrial policies, from JFK’s visionary moonshot to Reagan’s spending on the defense industrial base and U.S. semiconductor manufacturers.


Nor did these Cold War leaders cut taxes with the idea of exporting capital to outsourced industries, boosting foreign productivity and competitiveness; rather, they worked to champion U.S. industry and indigenized technology, the middle class, and American workers. Today’s supply-siders overlook the economic nuances of the time. As David Goldman has noted, the late Robert Mundell persuaded not only the Gipper but also JFK on the merits of trimming marginal rates. The supply-side godfather also insisted on tight money by Reagan’s time, following the pattern of the Federal Reserve under Kennedy 20 years earlier.

Despite being embraced as gospel by the GOP donor class, creatures of Wall Street, and their beneficiaries, both the supply-side construct and playbook are a spent force. The interlocking set of supposed “free market” policy prescriptions built around supply-side economics—free trade, outsourcing, open borders, a tax-favored financial sector, deregulated U.S.-domiciled multinationals, and a low-wage “gig” economy—has served the winners of globalization, corporate and financial interests, far more than America, her communities, families, and workers.

Which leads to fatal blind spots in the present. The donor class glitterati assume, for example, that the effects of Reagan slashing the top rate from 73 to 28 percent can be replicated at even lower rates, although cuts of that magnitude can only happen once. And, by downplaying the ravages of globalization, specifically the deindustrialization and financialization of America, influential supply-side voices such as the editors of the Wall Street Journal presume an economy that no longer exists.

No doubt about it, Reagan’s 1981 across-the-board rate reductions triggered a boom, and one that outlasted Kennedy’s. But the 40th president had to enact “revenue enhancers” in three successive years to dig out of the yawning budget hole he created. Not until his second term did the Great Communicator deliver his signature tax achievement, the Tax Reform Act (TRA) of 1986.

A supply-sider’s dream, the 1986 legislation capped the lowest possible tax rate at 28 percent in exchange for an expanded tax base by scaling back loopholes, deductions, and credits. But, overlooked by tax cutters today, Reagan effectively raised taxes on capital while lowering them on labor by subjecting both sources of income to the same rates. Under the new law, hedge-fund managers could not get away with paying lower tax rates than those paid by the machinists and welders employed by companies they bought and sold.


Moreover, while the TRA cut the corporate-tax rate, Reagan signed the legislation expecting corporations nonetheless would pay $120 billion more in taxes (almost $281 billion in 2023 dollars) within five years because of closed loopholes to offset the reduction in wage and ordinary income-tax revenue. For all these reasons, the carefully written and debated legislation garnered bipartisan support, reflected by Tip O’Neil’s support in the House and a 74–23 tally in the Senate.

But this model supply-side reform didn’t last. Because the TRA wasn’t revenue-neutral as expected, President George H.W. Bush was forced to raise taxes, although he did so in the opposite way of his predecessor: increasing taxes on workers while decreasing them on investors. By favoring capital formation relative to labor production, the Omnibus Budget Reconciliation Act of 1990 greased the skids for the financialization of the U.S. economy, incentivizing hedge-funds over productive sectors, especially labor-intensive industries such as manufacturing. Except for a few years under President Clinton, the capital-gains rate dropped from a cap of 28 percent under the TRA to 23.8 percent today, while the top rate on and wages and ordinary income jumped to 37 percent.

Even with tax hikes under Clinton, America roared in the 1990s—contradicting supply-side predictions—due to factors mostly unrelated to taxes. There was the “peace dividend,” the low interest rates of balanced budgets, the I.T. revolution, and the baby boomers’ peak years of productivity and family formation. At the same time, the architects of our economy were betting the country’s future on high finance and globally traded sectors. The boom would not last. Per capita corporate profits, which had tracked wages for decades, started soaring over average wages and never looked back. American wage growth went out the window.

By deindustrializing and financializing our economy, globalization killed at least two conditions required for supply-side economics to work. First, global profit-seeking shortchanged domestic investment across entire sectors as U.S. companies globalized production and outsourced labor. Second, globalized capital markets made deficit-financing for tax cuts cheap and easy, hiding and delaying the erosion of long-term growth by higher interest rates from fiscal deficits.

In theory, cutting corporate taxes can boost capital formation, capital expenditures, and R&D. But if corporate America channels tax savings to build consumer products and capital goods overseas, they are boosting the productivity of foreign workforces, not America’s.

Indeed, after globalization, corporate tax cuts failed to deliver widespread wage growth, quality jobs, or domestic investment outside elite metropolitan areas. The George W. Bush tax cuts of 2001 and 2003, for example, preceded the most anemic growth since World War II in all areas except one, corporate profits. The dividend tax cut in 2003, moreover, caused no change in domestic corporate investment or wage growth. Likewise, President Trump’s cuts on corporate income and overseas profits in 2017 went mostly to stock buybacks rather than domestic investment or R&D.

Similarly, marginal-rate income tax cuts have consistently proved to be sugar rushes for the economy. In 2006, a Treasury Department analysis of the “dynamic scoring” used by President Bush to rationalize his 2003 tax legislation found the cuts could weaken the economy absent spending cuts, which never materialized. Contrary to the exaggerations of napkin theorist Art Laffer and Bush and Trump administration officials, the 2003 and 2017 tax cuts failed not only to “pay for themselves” but to reestablish the sustained growth America had experienced before, say, China joined the World Trade Organization in 2001.

These failures come as no surprise as America has run an economy of smoke and mirrors since the early aughts. No longer centered on production, our financialized, deindustrialized economy has been puffed up by debt-financed consumerism from a parasitic relationship with China and from a Federal Reserve that backstopped America’s credit card with money printed out of thin air.

We sold manufacturing sectors to China while the titans of finance—investment bankers, venture capitalists, and management consultants—profited from flipping American companies to the highest bidder. Half of North Carolina’s furniture manufacturing jobs: gone to China. One million computer and electronic production jobs, especially in Georgia and Alabama: also gone to China. Tesla builds cars in China because California’s lithium producers went to China, where Chinese company CATL, the world’s largest E.V. battery maker, supplies the critical battery pack from its Shanghai factory. Apple uses China’s Foxconn’s mammoth sweatshops to make its precision glass holy grail, the iPhone, because Ohio’s glassmakers went to China.

Through leveraged buyouts and other private equity schemes, American finance stripped U.S. companies to their alleged core businesses and sold off “unproductive” components to Chinese and other Asian employers of cheap labor. All this slicing and dicing whittled away the productive ecosystem of American industries, but generated windfall profits for the financial sector and corporate shareholders.

By connecting America’s masters of the universe to China’s industrial titans, we turbocharged China’s ability to produce and undersell consumer products and capital goods back to America. While Chinese industry boomed, America’s money changers aligned themselves with Beijing’s strategy of working its way up the value chain. Beijing’s exchange-rate manipulation discounted its currency to the dollar, finishing off U.S. companies as Americans purchased artificially cheaper Chinese imports.

The whole process fueled Beijing’s export-led growth, enabling China to amass gargantuan dollar reserves. The Communist power then lent those dollars back to the United States, underwriting our borrowing spree for decades after 9/11, as tax cuts again and again shortchanged the Treasury of revenue. China became an enormous purchaser of Treasury securities—using the very dollars quantified by our massive trade deficits with the Asian power—helping both parties in Washington finance deficits.

This Ponzi scheme totters as geopolitical competition with China heats up, as downgraded U.S. creditworthiness threatens higher borrowing costs, and as federal interest payments rise to record levels, soon to surpass the defense budget. Can we borrow enough from China to pay back Beijing, now that the Chinese are pumping their brakes on lending to us? Even during the Trump administration, Chinese central bankers hesitated about their level of Treasury purchases to fund the 2017 tax cuts. Most likely, we will lean even more on the Federal Reserve, our Wizard of Oz for smoke-and-mirror financial magic.

Since the 2008 financial crisis, the Fed has been our lender of first resort, paving the way for trillion-dollar deficits by buying trillions in Treasurys. Now, the central bank, and government reserves such as the Social Security Trust Fund, hold 40 percent of our debt, vastly more than China’s current share of 2.6 percent. But after depressing interest rates artificially for years, the Fed is losing tens of billions of dollars—unheard of in its history—because of rising borrowing costs. The musical chairs of deficit finance will last only so long.

All this macroeconomic money laundering is the financial corollary of deindustrialization. Relying on China’s dollars and the Fed, Washington used a credit card to pay trillions of dollars for 20 years of war, Wall Street bailouts, and Covid-19 spending, without taxing Americans to pay for any of it. Our national debt rocketed from $5.8 trillion in 2001 to now approaching $33 trillion.

Until now, the conventional wisdom was that American debt was the safest in the world, but Fitch’s recent downgrade of U.S. Treasurys from AAA to AA+ is a fire alarm in the night. And as the central bank auctions off even more U.S. debt, ridding its balance sheet of $1 trillion in asset purchases during Covid, that action will keep pressure on high interest rates, making hoarding cash as much or more worthwhile than investing.

Our two-decade consumption-driven binge wrecked the country’s fiscal position, making tax cuts at best irrelevant and at worst aggravators of the problem. Economic policy must focus on rebuilding a hollowed-out America and rebalancing a debt-ridden government, jobs that tax reductions aren’t cut out for. Yet supply-siders remain spellbound by the elusive promise of slashing taxes. Can we keep the charade going? If ever a new policy model were needed to move the country out of the service-sector, consumerist, debt-ridden dead end, the time is now.

Especially if American conservatives want a more promising future than Liz Truss.