Wednesday, January 31, 2007

Debunking the Ten Myths About the Bush Tax Cuts

A pernicious post has been making the conservative/Republican blogs in the last couple of days. Conservatives are claiming that the Bush tax cuts actually increased government revenue, and it would have been even higher had we just raised the lowest income class' taxes.

Here are the "Myths":

Myth #1: Tax revenues remain low.
Fact: Tax revenues are above the historical average, even after the tax cuts.

Myth #2: The Bush tax cuts substantially reduced 2006 revenues and expanded the budget deficit.
Fact: Nearly all of the 2006 budget deficit resulted from additional spending above the baseline.

Myth #3: Supply-side economics assumes that all tax cuts immediately pay for themselves.
Fact: It assumes replenishment of some but not necessarily all lost revenues.

Myth #4: Capital gains tax cuts do not pay for themselves.
Fact: Capital gains tax revenues doubled following the 2003 tax cut.

Myth #5: The Bush tax cuts are to blame for the projected long-term budget deficits.
Fact: Projections show that entitlement costs will dwarf the projected large revenue increases.

Myth #6: Raising tax rates is the best way to raise revenue.
Fact: Tax revenues correlate with economic growth, not tax rates.

Myth #7: Reversing the upper-income tax cuts would raise substantial revenues.
Fact: The low-income tax cuts reduced revenues the most.

Myth #8: Tax cuts help the economy by "putting money in people's pockets."
Fact: Pro-growth tax cuts support incentives for productive behavior.

Myth #9: The Bush tax cuts have not helped the economy.
Fact: The economy responded strongly to the 2003 tax cuts.

Myth #10: The Bush tax cuts were tilted toward the rich.
Fact: The rich are now shouldering even more of the income tax burden.

Matthew Yglesias and Angry Bear are both starting to write articles about it. A lot of good rebuttals can be found in the comments. Among the more notable:

(At Matthew Yglesias' site)

The 18.4% number is from the CBO. I wrote an email to Sullivan about this and posted it on my website. The problem is that in 2000 taxes were 20.9% of GDP and spending 18.4%, while in 2006 taxes were 18.4% and spending was 20.3%. Taxes have gone down (contra Heritage, which was just using estimates), and spending as in fact gone up. But the increase in spending is in part due to defense (from 15 to 17% of the budget), but mostly due to medicare and medicaid, which have grown from 17 to 25% of the budget. Sullivan calls this a "middle class entitlements" problem, but it's really a health care problem. As usual.

Posted by: arbitrista on January 31, 2007 06:17 AM

Sully posts this under the sub-head, "Some things the Left won't tell you..." And he has a point. Heritage is fond of saying, "The rich pay all the taxes". Indeed, the Left won't tell you this without adding, "They also make all the money."

Practically every "myth" listed by Heritage is a) a serious spin job and b) even so, symptomatic of the rich getting insanely richer, while the poor and middle classes stagnate. Sullivan somehow thinks this supports the idea that we need to cut middle class entitlements.

Posted by: lewp on January 31, 2007 08:27 AM

What Heritage and Sully are really skimming past in a big hurry is the distinction between on-budget and off-budget (Social Security and Medicare payroll tax) receipts. There has been, and continues to be, a serious shortfall in on-budget receipts, made up for by the long-expected surge in payroll taxes that we're supposed to be saving up for my g-g-generation's retirement.

Look at the last two pages (pp.33-34 in the text) of Table 2.3 of the 2007 budget (big-ass PDF) (same link as Ragout gave above), and you notice that, between WWII and the onset of the Reagan tax cuts, the on-budget revenues were between 13.7% and 17.9% of GDP.

During the Reagan-Bush years (excluding 1982, when the budget was still semi-Carterish), the on-budget revenues were between 12.6% and 13.8% of GDP. During the Clinton years, between 13.3% and 15.9%. In the Dubya years, 11.6% to 12.9%.

So Sully and Heritage are hiding fundamental untruths about the budget behind the false front of a technically accurate statement.

Posted by: RT on January 31, 2007 09:49 AM

(From Angry Bear ***Warning*** Highly technical information follows)

"regarding myth#4: Couldn't Riedl be correct in that over the longer run (FROM 2003 - 2006) the tax cuts have had a cumulative effect and finally began paying for themselves 3 years later?"

The short answer is no. The reason is that the tax cut would have to be replicated in the second, third, fourth, etc. years as well. In other words, you would have to make the tax cut permanent. If that's the case, then you can never catch up. If the tax cut pays for itself in 3 years, then by that time you've already accumulated another 2 years worth of increased deficits.

A supply side tax cut depends upon the assumption that workers will forego leisure and work more hours (i.e., push out the supply curve) if tax rates are lower. So going from a 90% marginal rate to a 70% marginal rate definitely pays for itself through supply side effects.

Oftentimes you hear people talking about tax cuts as a demand stimulus paying for themselves. On the demand side this is impossible. It is mathematically impossible. To see why look at the old Keynesian fiscal multiplier formula. For example, let's take a very primitive multiplier formula of:

Y = 1 / (1 - c(1-t)) x A


c = the marginal propensity to consume

t = the marginal tax rate

A = autonomous demand

Start out with c = 0.9 and the marginal tax rate = 0.9 and A = 100. In that case the multiplier is:

1 / (1 - (.9 x (1 - .9))) =

1 / (1 - (.9 x .1)) =

1 / (1 - .09) = 1 / 0.91 = 1.10

So demand would b e 1.10 x 100 = 110

Now lower taxes to 10 percent and keep A = 100.

1 / (1 - (.9 x (1 - .1))) =

1 / (1 - (.9 x .9)) = 1 / (1 - .81) =

1 / 0.19 = 5.26

So cutting taxes would give new income of:

100 x 5.26 = 526

Under the old regime tax collections would have been 90% of 100, or $90.

Under the lower tax rate of 10%, total income would be much higher ($526 vers $100), but tax collections would only be 10% of $526 = $52.60.

The point is that there is no way tax cuts pay for themselves unless there is a parallel supply side effect. Just working it on the demand side won't get you there. And the supply side effect depends upon the marginal worker's tradeoff between income effects (higher income means increased demand for leisure) and the substitution effect (lower tax rates increases the opportunity cost of leisure).
2slugbaits | 01.31.07 - 7:30 pm | #


(Back to me again) I am thinking part of "Myths" that are listed are also based on nominal tax revenues, not adjusted for inflation. One of the posters at Angry Bear mentioned low interest rates (therefore deficit borrowing costs are lower compared to previous years); so that may be a factor as well.

What really got me was Myth #7 is basically complaining that low-income tax cuts are to blame. Yeah, if only we taxed the poor more, we'd eliminate the deficit....

I'd be interested to hear some other's rebuttals of any of the "Myths."

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