Myth 1: Tax cuts “pay for themselves.”
“You cut taxes and the tax revenues increase.” — President Bush, February 8, 2006Conservative Republican management of the economy either just appears anti-American or their plan is to destroy the middle-class that made America a global economic power.
“You have to pay for these tax cuts twice under these pay-go rules if you apply them, because these tax cuts pay for themselves.” — Senator Judd Gregg, then Chair of the Senate Budget Committee, March 9, 2006
Reality: A study by the President’s own Treasury Department confirmed the common-sense view shared by economists across the political spectrum: cutting taxes decreases revenues.
Proponents of tax cuts often claim that “dynamic scoring” — that is, considering tax cuts’ economic effects when calculating their costs — would substantially lower the estimated cost of tax reductions, or even shrink it to zero. The argument is that tax cuts dramatically boost economic growth, which in turn boosts revenues by enough to offset the revenue loss from the tax cuts.
But when Treasury Department staff simulated the economic effects of extending the President’s tax cuts, they found that, at best, the tax cuts would have modest positive effects on the economy; these economic gains would pay for at most 10 percent of the tax cuts’ total cost. Under other assumptions, Treasury found that the tax cuts could slightly decrease long-run economic growth, in which case they would cost modestly more than otherwise expected. (http://www.cbpp.org/7-27-06tax.htm)
The claim that tax cuts pay for themselves also is contradicted by the historical record. In 1981, Congress substantially lowered marginal income-tax rates on the well off, while in 1990 and 1993, Congress raised marginal rates on the well off. The economy grew at virtually the same rate in the 1990s as in the 1980s (adjusted for inflation and population growth), but revenues grew about twice as fast in the 1990s, when tax rates were increased, as in the 1980s, when tax rates were cut. Similarly, since the 2001 tax cuts, the economy has grown at about the same pace as during the equivalent period of the 1990s business cycle, but revenues have grown far more slowly. (http://www.cbpp.org/3-8-06tax.htm)
Some argue that, even if most tax cuts do not pay for themselves, capital gains tax cuts do. But, in reality, capital gains tax cuts cost money as well. After reviewing numerous studies of how investors respond to capital gains tax cuts, the Congressional Budget Office concluded that “the best estimates of taxpayers’ response to changes in the capital gains rate do not suggest a large revenue increase from additional realizations of capital gains — and certainly not an increase large enough to offset the losses from a lower rate.” That’s why CBO, the Joint Committee on Taxation, and the White House Office of Management and Budget all project that making the 2003 capital gains tax cut permanent would cost about $100 billion over the next ten years. (http://www.cbpp.org/policy-points4-18-08.htm)
Myth 2: Even if the tax cuts reduced revenues initially, they boosted revenues and lowered deficits in 2005 to 2007.
“Some in Washington say we had to choose between cutting taxes and cutting the deficit… Today’s numbers [the updated 2006 budget projections] show that that was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring.” — President Bush, July 11, 2006
Reality: Robust revenue growth in 2005-2007 has not made up for extraordinarily weak revenue growth over the previous few years.
When discussing revenue growth since the enactment of the tax cuts, Administration officials typically focus only on revenue growth since 2004. This provides a convenient starting point for their arguments, as it sets a very low bar. In 2001, 2002, and 2003, revenues fell in nominal terms (i.e. without adjusting for inflation) for three straight years, the first time this has occurred since before World War II. Measured as a share of the economy, revenues in 2004 were at their lowest level since 1959. Given this historically low starting point, it is not surprising that revenues have recovered since then. Supporters of the tax cuts selectively cite revenue growth over just the past three years to argue that the tax cuts fueled increases in revenues.
Table 1:
Total Real Per-Capita Revenue Growth in 22 Quarters after the Last Business Cycle Peak
2001-2007
1.7%
Average for All Previous Post-World War II Business Cycles
12.0%
1990s Business Cycle (Following Tax Increases)
16.2%
Even taking into account the growth in revenues in fiscal years 2005-2007, total revenues have just barely increased over the 2001-2007 business cycle, after adjusting for inflation and population growth. (The business cycle began in March 2001, when the 1990s business cycle hit its peak and thereby came to an end.) In contrast, six and a half years after the peak of previous post-World War II business cycles, real per-capita revenues had increased by an average of 12 percent, and in the 1990s, real per-capita revenues were up 16 percent (see Table 1). Revenues in 2007 were still more than $250 billion short of where they would have been had they grown at the rates typical in other recoveries.
Further, while the Administration has credited the tax cuts with the drop in the fiscal year 2007 deficit to “only” $162 billion, the 2007 budget would have been in surplus were it not for the tax cuts. Based on Joint Committee on Taxation estimates, the total 2007 cost of tax cuts enacted since January 2001 was $300 billion (taking into account the increased interest costs on the debt that have resulted from the deficit financing of the tax cuts). This means that even with the spending for the wars in Iraq and Afghanistan, the federal budget would have been in surplus in 2007 if the tax cuts had not been enacted, or if their costs had been offset. While supporters of these tax cuts claim that their positive economic effects have lowered their cost, the non-partisan Congressional Research Service found in a September, 2006 report that “at the current time, as the stimulus effects have faded and the effect of added debt service has grown, the 2001-2004 tax cuts are probably costing more than their estimated revenue cost.”
Looking out over the next several decades, when deficits are projected to be far larger (because of the impact on the budget of the continued rise in health care costs and the retirement of the baby boomers), the tax cuts, if extended, will still be a major contributor to the nation’s fiscal problems. (http://www.cbpp.org/1-29-07bud.htm) To put the long-run cost of the tax cuts in perspective, the 75-year Social Security shortfall, about which the President and Congressional leaders have expressed grave concern, is less than one-third the cost of the tax cuts over the same period. (http://www.cbpp.org/3-31-08socsec.htm)
Tax Cuts and the Economy
A consistent finding in the academic literature about the effects of tax cuts on the economy is that these effects are typically modest. In the short run, well-designed tax cuts can help to boost an economy that is in a recession. In the longer run, well-designed tax cuts can have a modest positive impact if they are fully paid for. For example, the recent Treasury analysis found that if the President’s tax cuts were made permanent and the costs of the tax cuts were paid for by reductions in programs, economic growth would increase by a few hundredths of one percentage point annually. Meanwhile, studies by economists at the Joint Committee on Taxation, the Congressional Budget Office, the Brookings Institution, and elsewhere have found that if tax cuts are not paid for with spending reductions, they are likely to have modest negative effects on the economy over time, because of the negative effects of the increased deficits. Tax-cut proponents often claim that the economy will be badly damaged if the tax cuts are not extended; these claims are without foundation.
Myth 3: The economy has grown strongly over the past several years because of the tax cuts.
“The main reason for our growing economy is that we cut taxes and left more money in the hands of families and workers and small business owners.” — President Bush, November 4, 2006
Reality: The 2001-2007 economic expansion was sub-par overall, and job and wage growth were anemic.
Members of the Administration routinely tout statistics regarding recent economic growth, then credit the President’s tax cuts with what they portray as a stellar economic performance. But as a general rule, it is difficult or impossible to infer the effect of a given tax cut from looking at a few years of economic data, simply because so many factors other than tax policy influence the economy. What the data do show clearly is that, despite major tax cuts in 2001, 2002, 2003, 2004, and 2006, the economy’s performance between 2001 and 2007 was from stellar.
Growth rates of GDP, investment, and other key economic indicators during the 2001-2007 expansion were below the average for other post-World War II economic expansions (see Figure 2). Growth in wages and salaries and non-residential investment was particularly slow relative to previous expansions, and, while the Administration boasts of its record on jobs, employment growth was weaker in the 2001-2007 period than in any previous post-World War II expansion. (http://www.cbpp.org/8-9-05bud.htm)
Median income among working-age households, meanwhile, fell during the expansion. Census data show that among households headed by someone under age 65, median income in 2006, adjusted for inflation, was $1,300 below its level during the 2001 recession. Similarly, the poverty rate and the share of Americans lacking health insurance were higher in 2006 than during the recession. (http://www.cbpp.org/8-28-07pov.htm)
