New School Politics

Fruits of the Bush Taxcut

Ryan | 27 08 2007

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The WSJ writes:

Since the Bush tax cuts of 2003, the budget deficit has fallen by $217 billion mostly because of a continuing torrid pace of revenue growth. …For the Bush tax cuts to have been a give-away to the rich, people paying the higher marginal tax rates would have to be carrying a smaller share of the income tax load. But the IRS data indicate that they are not paying less. Instead, they are paying more — lots more. More surprisingly, the richest 1%, 5% and 10% of the taxpayers are shouldering a larger percentage of the income tax burden at the federal level than the tax estimators said they would had the Bush tax cuts never materialized. …The amount of tax paid by those earning more than $1 million a year increased to $236 billion in 2005, up from $132 billion in 2003, the year of the tax cut. This was a 78% increase in taxes paid by millionaire households.

…[L]ower tax rates on capital gains and dividends also caused a huge jump in reported income. The National Bureau of Economic Research found an “unprecedented surge in regular dividend payments after the 2003″ Bush tax cut. Likewise, the lowering of the capital gains tax was followed by a 150% increase in the amount of capital gains unlocked by the 15% tax rate. Lower tax rates expanded the tax base.

This is a textbook manifestation of the Laffer Curve and it is surely an effect of tax cuts such as those under Presidents Reagan and W. Bush. However, the Laffer curve remains a weak justification for cutting taxes. Of first importance is that growth in revenue is only a direct result of economic growth caused by tax cuts. Remember that the only reason revenue can increase at the same time that taxes decrease is that the economy is growing more rapidly at the margins than taxes are being reduced. If taxes are cut enough–below the optimal rate–revenue is theorized to fall (all things remaining equal) however it could not compensate for the fact that tax cuts would still cause the overall national income to grow (not to mention that since all things do not remain equal in the real world, revenue would eventually grow because of augmented economic growth).

But even if all things did remain equal, I would still choose to tax far below the optimal rate because under such conditions we are essentially dealing with the question of how to allocate funds in the economy. Thusly it is a question of incentives–how to distribute money, how to spend money most efficiently, how to minimize wasteful costs, and how to properly establish time-preferences are all issues encompassed therewithin. My answer to all those questions, especially the overriding one, is that by allowing people to keep what they earn we encourage hard work, inventiveness, thriftiness, and investment, all of which are vital to economic health.

The underlying dilemma in using the Laffer effect as a justification for tax cuts is that the curve is actually a double edged sword. If you argue for cutting taxes when they are above the optimal rate you must also argue for raising taxes if they are below it. Tax reform should not be used as a means to bolstering the Congressional purse but rather as a means of reducing its relative scope and creating incentives to generate economic progress.