7.08.2006

Oh those irresponsible Bush tax cuts…

The NYTimes of all places:

An unexpectedly steep rise in tax revenues from corporations and the wealthy is
driving down the projected budget deficit this year, even though spending has
climbed sharply because of the war in Iraq and the cost of hurricane
relief.
On Tuesday, White House officials are expected to announce that the
tax receipts will be about $250 billion above last year's levels and that the
deficit will be about $100 billion less than what they projected six months ago.
The rising tide in tax payments has been building for months, but the increased
scale is surprising even seasoned budget analysts and making it easier for both
the administration and Congress to finesse the big run-up in spending over the
past year.
Tax revenues are climbing twice as fast as the administration
predicted in February, so fast that the budget deficit could actually decline
this year.
The main reason is a big spike in corporate tax receipts, which
have nearly tripled since 2003, as well as what appears to be a big rise in
individual taxes on stock market profits and executive bonuses.

Despite this revelation, I’m quite certain we’ll be hearing flawed analysis from Krugman wannabes like this in the NYTimes and NPR all through the 2006 election.

If we cut taxes for the rich, either A) we raise other taxes or B) we increase
debt or C) we cut spending. A), B) and C) have incentive effects too; we must
consider net incentives.
A tax cut for the rich has minimal incentive effect.
That's because much income at the top is "passive." Corporate shareowners can't
increase their capital gains if tax rates fall--though they may change their tax
accounting.

27 comments:

Dan P. said...

So does this mean that corporations and executives are making sooo much more money that lower tax rates are increasing tax revenues?

Andrew said...

Thats exactly whats happening. The principal of diminishing returns applies even to marginal tax rates. So even with the Bush tax cuts causing the federal government to get a proportionally smaller piece of the US economic pie the economic growth resulting from the lower tax burden has caused the pie to grow much bigger. The inverse is currently visible in many european countries such as France that routinely attempt to reduce their budget deficit trough raising taxes only to find total revenues are even lower the following year.

dan p. said...

So how much longer do the lower & middle economic demographics have to eek through until they get to see some of that growth? Last I knew economic growth for the vast, vast majority of us comes through payroll, not so much corporate windfall.

It's like getting an additional 10 mpg out of a already efficient hybrid when you really would like more efficiency where there isn't very much..

Andrew said...

Probably always, but you’re talking about standard of living and over the last 50 years this has improved at unprecedented levels in the US. It just hasn’t improved as much as others in the top quartile of income distribution. My question is how does this have any bearing on you or I? Would a more progressive tax structure improve our standard of living? In a relative sense, yes; there would be much fewer people richer than us but in an absolute sense, as demonstrated by the economic stagnation in Europe, almost certainly no. While there are plenty of economic hacks out there who make a living legitimizing envy and selling fairy tales about how horribly oppressed we are by the wealthy benefactors of multinational corporations the reality is the economic success of those like Warren Buffet have as much to do with my relative poverty as the body builders at the gym have for my lack of fitness. The market economy is in no way a zero sum game. Wealth is entirely transient but we all contribute to the same pot come April 15. Personally I’d much rather have Warren pitch in the biggest wad of cash possible taking the burden off regular people like me.

dan p. said...

It would actually improve my quality of living quite a bit. Working with Weatherization (wx) my livelihood depends upon federal spending & utility $s. Next year wx budgets are getting slashed significantly because we are still running up huge budget deficits (despite tax revenues being what they are). Wx is a program that helps improve the quality of life for those in poverty, in absolute terms, not just relative ones. Seeing as how Buffet is turning to philanthropy something makes me think he wouldn't mind paying more taxes as long as they were spent wisely.

(and my wife is getting a degree in early childhood education, so once again slightly higher taxes at the cost of slower economic growth for the financially successful would be a positive for me.)

Andrew said...

Okay lets assume the total US economy is worth $100 and for the sake of simplicity we have a flat income tax at 10% so tax revenues are $10. Since the economy is running a deficit we raise taxes to 11% and predictably get $11 in revenue. Spending continues to increase and taxes go to 12% for $12, 13% for $13 and so on. We eventually find that after a certain tax rate increases in revenues don’t increase $1 for every 1% and instead increase at ever smaller fractions of 1% pretty soon we hit an equilibrium point where our 1% increase generates no additional revenue. To our surprise any 1% increases beyond this equilibrium point actually cause tax revenues to decline. So in keeping with the theories of Arthur Laffer and the Chicago School we reduce taxes and experience an increase in tax revenues like Ireland, UK, Chile, Russia, most of eastern Europe and now most recently, thanks to the Bush tax cuts, the US. You can only get so much milk out of the cow no matter how hard you squeeze. Raising taxes at this time would result in the benefits you seek.

Andrew said...

One other thing I forgot to mention. While it’s true that government services do help the poor in an absolute sense but an economic system that produces an increasing number of poor benefits no one. As things are now the US economy must produce around 150,000 jobs a month just to keep the unemployment rate static. With current productivity rates this means the US economy must grow at least a 3.2% rate annually. Italy, France and Germany who have substantially more progressive taxation than the US haven’t seen economic growth greater than 2% in more than a decade and all have unemployment in excess of 11% -- or nearly 3 times that of the US. Is this really what you’re willing to accept?

Joe said...

Andrew is making the assumption that recent economic growth in the U.S. is a result of the Bush tax cuts. This certainly may be true (fitting the Laffer curve theory). But, it may also be true that U.S. growth is just part of the natural recovery from the bust of dot-com and 9-11 years, and that it would have happened regardless of the Bush tax cuts. If so, then tax receipts would have been higher today without the tax cuts.

The Laffer theory lead Reagan to introduce tax cuts without seeing the accompanying rise in revenues. The problem with the Laffer curve is that there is no way to determine where we fall on it.

To respond to the general poverty issue, Dan and Andrew are both right. Since 1980, the return to a year of education has increased, with 4 year college graduates earing more, on average, than their parents. This rise comes from the increase in high-skill, high-wage jobs, as well as from the rise in general income per capita (so that people can pay for those skills). And it is true that the very wealthy have increased their lead on the middle-class, which as Andrew's body builder analogy suggests, is not necessarily bad economics, even if it is morally questionable.

The problem is that life for the unskilled worker has become more difficult than it was for his parents. There are simply far fewer jobs that offer decent pay for low-skilled work. This would be sad, but not necessarily unfair, if it weren't for the fact that poor people are much less likely to acquire the requisite training to compete in the high-skill labor market. So, they are stuck with low-wage, low-benefit jobs, with few prospects of acquiring more skills and thus better jobs. The minimum wage is worth less now than it was in the late 70s, when adjusted for purchasing power.

I wrote a long paper about all of this (which I got an A on), so if anyone wants a copy, or if anyone knows how to post it somewhere, let me know.

Andrew said...

I'm pretty sure tax revenues increased greatly under Reagan even though the proportional size of government vs. GDP declined during his presidency. This is why Reagan's presidency is considered to be one of the greatest validations of the Laffer curve. Oh, and like the Bush tax cuts, Reagan's shifted the tax burden even more greatly onto the top 10% of income distribution.

http://www.cato.org/pubs/pas/pa-261.html

Nominal federal revenues dou-bled in the 1980s from $517 billion to $1.031 trillion. From 1981 to 1989 real federal revenues climbed by 20 percent. As a share of GDP, however, federal tax revenues fell by 1.0 percentage point during that period.

Andrew said...

As for why the economy is better now than it was in 2000-2003 Joe’s correct, the normal ebb and flow of the business cycle probably has a lot to do with the rather robust economy we’re experiencing now. As a result it’s very hard for economists to quantify exactly how much stimulus effect any tax cut have given all the factors involved. However, as I’ve stated in previous posts, there is ample evidence that supports that the smaller government’s footprint is on GDP, the faster GDP will grow (See Ireland, UK, Chile, Russia, Eastern Europe, and Kennedy’s, Reagan’s -- and now 43’s USA) and the inverse (Old Europe, Scandinavia and, well, Communism). The reason for this is quite simple. Millions of average autonomous people all making decisions to forward their interests will always use economic resources more efficiently than any form of central planning – which is essentially what all government spending is. A dollar collected in taxes may only result in 50 cents in economic benefit due to waste and bureaucratic inefficiency while that same dollar left uncollected has a greater chance of being used to amplify the value of useful human enterprise. Capitalism is like the loaves and the fishes gentlemen we just need to have faith in the individual and stop worrying about whether or not we’re going to get ours.

Joe said...

According to John Mikesell (professor at my school and one of the foremost experts on public finance in the world) you're wrong. "President Reagan's 1981 tax reductions were based in part on the view, argued most effectively by Arthur Laffer...that federal personal income tax rates were above t* (the point of inflection on the laffer curve) and hence the rate reduction would help close the budget deficit by increasing tax revenue...Careful analysis has shown yields to have been reduced by the Reagan reductions, however." (Mikesell, Fiscal Administration, 6th edition, 2003).

Andrew said...

This is from the OMB.

http://www.heritage.org/Research/Taxes/images/chart.gif

I'm sorry, but my data says otherwise. Unless your professor takes issue with the data I'm not sure how he could come to that interpretation.

Andrew said...
This comment has been removed by a blog administrator.
Andrew said...

Here's the actual Historical tables from the OMB. I'd be very interested in hearing your professor explain how reagan's tax cuts caused an overall decline in tax revenues in light of table 1.3.

http://a255.g.akamaitech.net/7/255/2422/23feb20050900/www.gpoaccess.gov/usbudget/fy06/pdf/hist.pdf

Joe said...

The argument isn't that the tax cuts caused a decline in revenues. It's that the increase in revenues did not come from the tax cuts. I asked my own Public Finance professor to explain the situation, and this is what he wrote to me.

"That is a hotly debated question. The evidence is not clear one way or the other. Reagan not only cut taxes which supply siders believed would increase economic growth resulting in higher income and higher tax revenues but he also increased spending, primarily defense, which would have the same result on income and tax revenues. Which policy resulted in the higher revenues during the Reagan administration is an empirical matter which means its will be debated until we’re all dead."

Andrew said...

I haven’t heard that one before. So in other words your professor is making the Keynesian argument that increased government (deficit) spending is as effective in stimulating the economy as tax cuts. I would be fascinated to hear how this perspective squares with the experiences of Thatcher in the UK, Ireland, Chile, Russia and Eastern Europe. Who also lowered marginal tax rates and saw similar economic success.

dan p. said...

Andrew, back to the cow & away from Quantitative Methods :) I realize the 'economy' is doing just swell if you are a corporation or own a significant portion of one. However, poverty has also increased almost every year since 2000 in the midwest.
That troubles me more than the relief I feel from knowing we are marginally less in debt due to the economy's growth. btw, where is this growth coming from? I don't have a good feel of that..

Andrew said...

I think just about everyone has benefited from this better economy. Good paying jobs are plentiful and overall wages have increased over 4% over last year and household wealth is at record highs. You are correct that the poverty rate increased in the Midwest but this was the only region to see an increase and this was almost entirely due to the loss of good paying, unskilled manufacturing jobs. Without saying it directly, your real issue with the current economy seems to be income inequality and here the discussion becomes one of political philosophy rather than economics. Bush’s tax cuts have had little or no impact to income inequality and have allowed the US govt. to experience a much greater windfall while having a proportionally smaller footprint relative to GDP. That’s simply the whole point of this post that despite the years of hysterical pants wetting by Krugan, Reich et al the tax cuts were not irresponsible and appear largely responsible for sparing the US the kind of prolonged malaise created by Carter’s misguided Keynesian fiscal policies; something to keep in mind given the probability that a democrat might be in the oval office in 18 months.

Andrew said...

Here's a Washington Times editorial referencing research by Harvard Economist Alberto Alesina that strongly disagrees that government spending is an effective economic stimulus.

Harvard economists once thought cutting government spending was contractionary, something that would shrink the private economy. The Alesina study finds that big cuts in government spending are expansionary, making economies boom. Ireland slashed government spending by more than 7 percent of GDP in 1986-89, and economic growth from 1989 to 2001 averaged 7.2 percent per year. Japan spent hundreds of billions on Keynesian public works schemes after 1991, and economic growth averaged only 1.1 percent.

Part of the explanation is taxes. Ireland now has a 15 percent tax on corporate profits, a 20 percent tax on inflation-indexed capital gains and lower tax rates on labor. Japan imposed new taxes on sales, property and capital gains, while maintaining Asia's most punitive income-tax rates.

Alesina found that "labor taxes have the largest negative impact on profits and investment," partly because private workers "react to tax hikes or more generous transfer payments by decreasing the labor supply or asking for higher pretax real wages." But this study also found that big government spending is inherently bad for economic growth, even aside from taxes. Government hiring and pay raises lure workers from private businesses, which are forced to raise wages even if that means reduced hiring. Higher labor costs per employee depress profits and investment.

Many other new studies find equally bad effects of big government on economic growth. In the May issue of the same journal, for example, Ed Prescott of the University of Minnesota found that "differences in the consumption and labor tax rates in France and the United States account for virtually all of the 30 percent difference in the labor input per working-age person." Mr. Prescott calculates that the French would be 19 percent better off if they had a tax system no worse than ours.

dan p. said...

Yup, my concern is about political philosophy more than economics in this situation. But I'm still not sure where this growth is going to? Does anyone have insights on that, to bring this back to economics..

Andrew said...

Here’s another article documenting the real broad base increases in standard of living between 1967 and 2004. Quite simply the meme that "the Rich are getting richer and the poor are getting poorer" has no factual basis.

What the [Census Bureau and Fed] reports tell us is that the vast majority of Americans have not bumped into income glass-ceilings, but rather are experiencing an astonishing pace of upward income mobility. The Census data from 1967 to 2004 provides the percentage of families that fall within various income ranges, starting at $0 to $5,000, $5,000 to $10,000, and so on, up to over $100,000 (all numbers here are adjusted for inflation). These data show, for example, that in 1967 only one in 25 families earned an income of $100,000 or more in real income, whereas now, one in six do. The percentage of families that have an income of more than $75,000 a year has tripled from 9% to 27%.
But it's not just the rich that are getting richer. Virtually every income group has been lifted by the tide of growth in recent decades. The percentage of families with real incomes between $5,000 and $50,000 has been falling as more families move into higher income categories -- the figure has dropped by 19 percentage points since 1967. This huge move out of lower incomes and into middle- and higher-income categories shows that upward mobility is the rule, not the exception, in America today.
......
Turning from income to wealth, data from the Fed provide further confirmation of family economic gains for the middle class. The total net worth of Americans rose to just shy of $50 trillion in 2004. The Fed has not yet calculated the median household wealth for 2004, but we estimated that number by taking the average ratio of mean wealth to median family wealth over the past 10 years. This yields an estimate of $105,000 in 2004. This is almost double the median family-wealth level of 1983 and nearly triple the level of 1962. Until very recently, for a family to attain six figures of wealth was considered quite rich. Despite all of the groans about the over-indebtedness of American households, the new Federal Reserve Board data suggest that the family balance sheet is not highly levered. The ratio of debt to assets is only 18.3%.

dan p. said...

It's been a while, but here is the limited number crunching I was able to do:

table

source

With regards to your "poor are getting richer too" theme, the cost of living keeps on rising as well. Housing, fuel, education, health care are all rather expensive.

But that doesn't matter because I don't trust this particular admin to do anything positive with these circumstances. So we are left to the market to bumble along and hope consumers make well informed decisions. If they don't, buyer beware and a mistake can be come a very expensive one.

Andrew said...

Yes, those are all serious problems; things we should discuss in future posts; but not one of them has anything to do with the Bush tax cuts.

As for the costs of “mistakes” in our "bumbling" market driven economy I would much rather live in a society that allows me to maximize all potential risks and benefits in accordance with my judgement rather than some semi-comatose, training-wheels society like France.

dan p. said...

I thought thanks to the omnipresence of the global market place we are all interconnected and everything is inter-related. Therefore, all those issues and many more are inter-related to our tax policy.
By the way, would your view of the world be altered if you didn't happen to work in a profession that is on a wonderful upswing?
Working in the field of energy efficiency and housing is very exciting and promising for the most part, but there are several friends and family that haven't been as blessed as I. Those are the people that come to mind when I hear how wonderful things are for the economy. What do you think of when that economic good news is at the top of your google news search?

Andrew said...

I would love to hear how you think these issues are in any way directly affected by marginal income tax rates.

I think you need to update your perspective of my industry from 1999 somewhat. I was a junior in college when the bubble burst and was working for a tech company. I survived having most of my friends laid off, a year of doing their jobs in addition to my own (while going to school full time), having customers leave in droves, a year of unemployment, going to job interviews with 400 other applicants being repeatedly told I need to get a job in another industry, burning through all of my savings, having no health insurance, eventually getting hired by a company a hair away from being a sweatshop working 80 hour weeks for almost a year for shit pay, constantly being reminded that my job could be outsourced at any time all BEFORE I was able to land my present job which is still is lightyears away from being the slackers paradise replete with office pets and massage therapy circa 1999. I know a thing or two about both failure and fortune and while things are better in the tech industry now I’m entirely aware that in a few years they’ll probably be terrible again. Even when things were the worst in 2003-2004 I never once thought more government involvement would in any way remedy my situation. In fact, I'm fairly certain if all of this had happened in an country in Old Europe I'd still be unemployed.

dan p. said...

I would agree with you there that this gov't wouldn't have help your situation one bit. But 400 people applying for the same position. In a field with a labor situation such as that organization might have been an option with long term benefits.

I'm sorry for being tangential, but there was a blub on the Rachel Maddow show this morning (about 20 minutes in) that referenced this study. They even have a small summary for Indy. (The steaming will only work for today, after that it will be archived.) Basically, comparable goods cost more in areas of poverty compared to areas of greater wealth. So despite not paying much if any taxes, having possible other gov't aid, and having rising incomes, the surrounding market is still a disadvantage to their improvement in quality of life.

I don't have anything else to add in regards to marginal tax rates. So if you want to end the discussion that is fine with me. I've enjoyed this. It is always a pleasure to converse with someone smarter than myself. I look forward to it again in the future!

p.s. joe, i just realized i've had a class with your public finance prof. i enjoyed it quite a bit (as far as pub finance goes).

Andrew said...

No, no, tangents are great and I enjoy this discussion. I just happen to think it might help readability on the site to end this tax cut thread and start a new one on the topics you’ve brought up.