2005 Budget Laffers Last

NationalReview.com ^ | 28 October 2005 | Jerry Bowyer

[ChessExpert]

The final budget numbers got very little attention. .... And it turns out that these numbers paint a fairly encouraging picture. ... Perhaps that’s why they didn’t get much coverage

[Toddsterpatriot]

If I claimed tax cuts would raise more revenue, poor remember's head might explode. I was thinking of him.

[remember]

I also glanced at the second graph at that URL and noted that, corrected for inflation, total revenues dropped for two years (though I see now that it was from 1981 to 1983).

How much of the tax revenue during Carter's term was due to inflation pushing people into higher brackets? Reagan fixed that and now you blame him for indexing?

Maybe you should likewise take a little more time with your answers. How would fixing the bracket-creep problem cause revenues to drop? As the second table at http://home.att.net/~rdavis2/recsrc.html shows, inflation-adjusted individual income tax revenues dropped from $514.05 billion in 1981 to $455.25 billion in 1984 (figures are in 2000 dollars). That's a drop of 11.4 percent in real revenues over three years. Furthermore, according to page 12 of the Treasury document at http://www.ustreas.gov/offices/tax-policy/library/ota81.pdf, indexing of individual income tax parameters did not begin until 1985.

I have a different definition of "paying for itself". If you cut the rate from 70% to 50% and don't lose money, it's "paid for itself". I never claimed a tax cut would raise more revenues, except for capital gains tax cuts.

Revenues need to keep up with inflation. In addition, services to individuals need to keep up with population. Both of these can be accomplished by revenues keeping up with GDP growth. As you can see from the graph in post #35, individual income tax revenues have generally done this since 1952. You seem to be saying that we can ignore inflation. If that is the case, then you can be the one who explains to our soldiers in Iraq why their salaries cannot at least keep up with inflation.

Did that reduction in taxes help the economy to grow faster?

The following is from the analysis at http://home.att.net/~rdavis2/taxcuts.html:

The only remaining argument in favor of the Reagan tax cuts, at least from a revenue point of view, would seem to be that they permanently raised the level of the GDP, thus bringing in slightly higher revenues far into the future. According to the graph and second table, the GDP reached a high 8-year growth rate of 34.3% from 1982 to 1990. However, the GDP seems to have reaching a similar high about every ten years over the past several decades. It reached a high of 41.57% from 1958 to 1966, 29.20% from 1971 to 1979, and 32.58% from 1992 to 2000. Hence, these figures don't provide any strong evidence that the Reagan tax cuts permanently affected the GDP one way or the other.

Now, it does make sense that pumping borrowed money into the economy would cause some short-term increase in the GDP. However, that is likely to be offset by additional interest costs in the long-run. In any case, the figures don't reveal any lasting increase in GDP growth.

[Toddsterpatriot]

Maybe you should likewise take a little more time with your answers. How would fixing the bracket-creep problem cause revenues to drop?

You're joking, right? 2 taxpayers, taxpayer 1 makes $50,000, taxpayer 2 makes $100,000. One bracket, 20% and no deductions or exemption. Year one, tax revenue $30,000.

Year 2, 6% inflation, incomes rise 6%. Incomes now $53,000 and $106,000. Tax revenue $31,800. Real tax revenue $30,000. No change.

Same scenario, now with 3 tax brackets. $0-$40,000 15%, $40,001-$90,000 20%, $90,001-$150,000 30%. Revenue year one, taxpayer 1 pays $8,000. Taxpayer 2 pays $19,000. Year 2, 6% inflation, incomes rise 6%. Taxpayer 1, income $53,000, pays $8,600, real tax $8,113. Taxpayer 2, income $106,000, pays $20,800, real tax $19,623.

The government gets 2.7% more revenue. Taxpayer 1 pays 1.4% more, taxpayer 2 pays 3.3% more.

Revenues need to keep up with inflation.

During bracket creep revenues grew too much. It's only fair that they grow slower than inflation for a while.

inflation-adjusted individual income tax revenues dropped from $514.05 billion in 1981 to $455.25 billion in 1984

Without the tax cuts and considering the 2 recessions, how much should revenues have dropped?

You seem to be saying that we can ignore inflation.

Not at all. Do you have any info on real after tax income over this time frame?

[remember]

Maybe you should likewise take a little more time with your answers. How would fixing the bracket-creep problem cause revenues to drop?

You're joking, right? 2 taxpayers, taxpayer 1 makes $50,000, taxpayer 2 makes $100,000. One bracket, 20% and no deductions or exemption. Year one, tax revenue $30,000.

Year 2, 6% inflation, incomes rise 6%. Incomes now $53,000 and $106,000. Tax revenue $31,800. Real tax revenue $30,000. No change.

Same scenario, now with 3 tax brackets. $0-$40,000 15%, $40,001-$90,000 20%, $90,001-$150,000 30%. Revenue year one, taxpayer 1 pays $8,000. Taxpayer 2 pays $19,000. Year 2, 6% inflation, incomes rise 6%. Taxpayer 1, income $53,000, pays $8,600, real tax $8,113. Taxpayer 2, income $106,000, pays $20,800, real tax $19,623.

Once again, according to page 12 of the Treasury document at http://www.ustreas.gov/offices/tax-policy/library/ota81.pdf, indexing of individual income tax parameters did not begin until 1985. Hence, the 11.4 percent drop in real individual income tax revenues from 1981 to 1984 could not possibly have been due to the fixing the bracket-creep problem in 1985.

[Toddsterpatriot]

indexing of individual income tax parameters did not begin until 1985.

Yes, I saw that. I was answering your question in post #42:How would fixing the bracket-creep problem cause revenues to drop?

Hence, the 11.4 percent drop in real individual income tax revenues from 1981 to 1984 could not possibly have been due to the fixing the bracket-creep problem in 1985.

I didn't say that it was. You never answered my question. With the double dip recession and without the tax cut, how much should revenues have dropped? You can't blame a tax cut for revenues that were lost because of a recession, can you?

[remember]

You can't blame a tax cut for revenues that were lost because of a recession, can you?

True. But neither can you credit a tax cut for revenues that increase due to the recovery from a recession. The following graph shows receipts, outlays, and deficits since 1981:

The actual numbers and sources are at http://home.att.net/~rdavis2/mts.html. As you can see, the recovery from the 1980-82 recession was no more impressive that either of the recoveries that we've had since then. In addition, the graph shows two problems with the original article by Jerry Bowyer that started this thread. As you can see from his chart in post #7 above, Bowyer did not correct his revenue numbers for inflation. In addition, he was very selective in showing only the last four years. As the graph above shows, inflation-corrected revenues are still well below their 2000 highs. Hence, Bowyer is bragging about a partial recovery from a very deep drop in revenues.

[Toddsterpatriot]

As you can see, the recovery from the 1980-82 recession was no more impressive that either of the recoveries that we've had since then.

How about compared to recoveries before 1980-82?

OUTSTANDING CONSUMER CREDIT AND PERSONAL SAVING: 1959-2003
                         (billions of dollars)

              Personal Disposable    Total                Non-
     Personal  Current   Personal Consumer Revolving Revolving Personal
Year   Income    Taxes     Income   Credit    Credit    Credit   Saving
-----------------------------------------------------------------------
1959    392.8     42.3      350.5     56.0       0.0      56.0     26.7
1960    411.5     46.1      365.4     60.0       0.0      60.0     26.7
1961    429.0     47.3      381.8     62.2       0.0      62.2     32.2
1962    456.7     51.6      405.1     68.1       0.0      68.1     33.8
1963    479.6     54.6      425.1     76.6       0.0      76.6     33.3
1964    514.6     52.1      462.5     86.0       0.0      86.0     40.8
1965    555.7     57.7      498.1     96.0       0.0      96.0     43.0
1966    603.9     66.4      537.5    101.8       0.0     101.8     44.4
1967    648.3     73.0      575.3    106.8       0.0     106.8     54.4
1968    712.0     87.0      625.0    117.4       2.0     115.4     52.8
1969    778.5    104.5      674.0    127.2       3.6     123.6     52.5
1970    838.8    103.1      735.7    131.6       5.0     126.6     69.5
1971    903.5    101.7      801.8    146.9       8.2     138.7     80.6
1972    992.7    123.6      869.1    166.2       9.4     156.8     77.2
1973   1110.7    132.4      978.3    190.1      11.3     178.7    102.7
1974   1222.6    151.0     1071.6    198.9      13.2     185.7    113.6
1975   1335.0    147.6     1187.4    204.0      14.5     189.5    125.6
1976   1474.8    172.3     1302.5    225.7      16.5     209.2    122.3
1977   1633.2    197.5     1435.7    260.6      37.4     223.1    125.3
1978   1837.7    229.4     1608.3    306.1      45.7     260.4    142.5
1979   2062.2    268.7     1793.5    348.6      53.6     295.0    159.1
1980   2307.9    298.9     2009.0    351.9      55.0     297.0    201.4
1981   2591.3    345.2     2246.1    371.3      60.9     310.4    244.3
1982   2775.3    354.1     2421.2    389.8      66.3     323.5    270.8
1983   2960.7    352.3     2608.4    437.1      79.0     358.0    233.6
1984   3289.5    377.4     2912.0    517.3     100.4     416.9    314.8
1985   3526.7    417.4     3109.3    599.7     124.5     475.2    280.0
1986   3722.4    437.3     3285.1    654.8     141.1     513.7    268.4
1987   3947.4    489.1     3458.3    686.3     160.9     525.5    241.4
1988   4253.7    505.0     3748.7    731.9     184.6     547.3    272.9
1989   4587.8    566.1     4021.7    794.6     211.2     583.4    287.1
1990   4878.6    592.8     4285.8    808.2     238.6     569.6    299.4
1991   5051.0    586.7     4464.3    798.0     263.8     534.3    324.2
1992   5362.0    610.6     4751.4    806.1     278.4     527.7    366.0
1993   5558.5    646.6     4911.9    865.7     309.9     555.7    284.0
1994   5842.5    690.7     5151.8    997.1     365.6     631.6    249.5
1995   6152.3    744.1     5408.2   1140.6     443.1     697.5    250.9
1996   6520.6    832.1     5688.5   1242.2     498.9     743.2    228.4
1997   6915.1    926.3     5988.8   1305.0     521.7     783.4    218.3
1998   7423.0   1027.0     6395.9   1400.3     562.8     837.5    276.8
1999   7802.4   1107.5     6695.0   1512.8     590.5     922.3    158.6
2000   8429.7   1235.7     7194.0   1686.2     658.9    1027.4    168.5
2001   8713.1   1243.7     7469.4   1822.2     703.9    1118.3    127.2
2002   8910.3   1053.1     7857.2   1902.7     716.7    1186.0    183.2
2003   9208.0    991.4     8216.5   1998.5     744.9    1253.6    173.5



Great table. You have this data in real dollars? If so could you chart it versus the individual real income tax revenue numbers in post #42?

[Toddsterpatriot]

If so could you chart it versus the individual real income tax revenue numbers in post #42?

Just the disposable personal income numbers that is.

[Toddsterpatriot]

As a % of GDP. :^)

My point is, I guess, that if tax revenues drop from 9.36% of GDP in 1981 to 7.77% of GDP in 1984 is the 1.59% drop in revenues offset by a larger increase in disposable income?

[Pelham]

A "Laffer Curve" is really just a simple elasticity curve applied to taxes, useful in demonstrating a theory but having no predictive value. There is no way to know where you are on the curve, or what its shape is. Reagan's economists never claimed that lowering marginal rates would increase the yield to the Treasury. That's why President Reagan asked for budget cuts from Tip O'Neil, which O'Neil reneged on.

The Reagan economists' actual prediction was that economic growth, stimulated by lower rates, would recoup much of the revenue loss forecast by static analysis. And that is what happened. Some 66 cents of each dollar cut was regained from growth. The data can be found in Lawrence Lindsey's study "The Growth Experiment".

[Pelham]

Alternately, please post a link to a budget document or credible economic study that purports to show that any major cut in income tax rates has ever paid for itself.

Are you familiar with Lindsey's "The Growth Experiment"? IIRC his study found only one instance of a rate cut "that paid for itself", and that was the capital gains cut of 1978. From Martin Anderson's "Revolution" you can learn that the Reagan team never made a claim that rate cuts would pay for themselves, only that they would stimulate growth and recoup some of the revenue loss predicted by static analysis. Anderson spends a good number of pages debunking "the myth of the supply siders" and disassociating the Reagan program from the "myth". Anderson was one of President Reagan's chief economic advisors dating back to his time as Governor, so Anderson's memoir carries some weight.

[remember]

As you can see, the recovery from the 1980-82 recession was no more impressive that either of the recoveries that we've had since then.

How about compared to recoveries before 1980-82?

The following graph shows the growth in real revenues since 1940:

The actual numbers and sources are at http://home.att.net/~rdavis2/recsrc.html. Once again, I see nothing remarkable about the growth in revenues during the eighties. Likewise, I saw nothing remarkable in the analysis at http://home.att.net/~rdavis2/taxcuts.html.

Great table. You have this data in real dollars? If so could you chart it versus the individual real income tax revenue numbers in post #42?

Hey, I'm not your charting monkey! Just kidding :) The fact is, I have too many other projects in my queue. I'll add that to my list of possibilities for the future.

[Larry Lucido]

Government needs to be smaller. I don't care if tax cuts pay for themselves. Money kept in my pocket is better spent than if taken by government.

That said, there is the law of diminishing returns that is a corrolary to Laffer. Confiscate too much, you get less because folks produce less or find loopholes. So, yea, if you take less, you'll encourage at least some extra productive activity and thus some extra revenue that would otherwise have evaporated.

[remember]

Alternately, please post a link to a budget document or credible economic study that purports to show that any major cut in income tax rates has ever paid for itself.

Are you familiar with Lindsey's "The Growth Experiment"? IIRC his study found only one instance of a rate cut "that paid for itself", and that was the capital gains cut of 1978. From Martin Anderson's "Revolution" you can learn that the Reagan team never made a claim that rate cuts would pay for themselves, only that they would stimulate growth and recoup some of the revenue loss predicted by static analysis. Anderson spends a good number of pages debunking "the myth of the supply siders" and disassociating the Reagan program from the "myth". Anderson was one of President Reagan's chief economic advisors dating back to his time as Governor, so Anderson's memoir carries some weight.

No, I was not familiar with that particular book. However, I have now looked at a few articles about it on the web. In particular, there's a critique of the book at http://www.prospect.org/web/page.ww?section=root&name=ViewPrint&articleId=5314.

Regarding Anderson's statement that the Reagan team never made a claim that rate cuts would pay for themselves, I believe that to be correct. I previously read a National Review article by conservative columnist Bruce Bartlett at http://www.nationalreview.com/nrof_bartlett/bartlett031303.asp that stated:

In fact, no one in the Reagan administration ever said that the 1981 tax cut would pay for itself. This is just a canard that is assumed to be true because it has been repeated so often. Every official statement ever made by President Reagan or any of his staff made clear that the tax cut would lose large revenues, and administration budget documents projected large revenue losses that were almost identical to Congressional Budget Office estimates.

Regarding capital gains tax cuts paying for themselves, I haven't studied the issue closely and know that there is some controversy about that. That's why I referred to "any major cut in income tax rates" above. However, I did have a discussion about this with someone on this forum a few months ago. I'll repeat it the remainder of this message. Before I do, though, thanks for the information on the two books. Anyhow, following is the excerpt from my prior discussion:

Now, maybe you don't consider these capital gains tax cuts to be "major tax cuts", but I think that a cut that increased revenue can be said to have paid for itself. Do you agree?

You're right to suggest that there may be some disagreement as to whether capital gains tax cuts are "major tax cuts". According to a 2002 CBO report titled Capital Gains Taxes and Federal Revenues:

Individual income tax receipts from capital gains realizations normally make up about 4 percent to 7 percent of individual income tax revenues (see Table 1); they are usually between 2 percent and 3 percent of total receipts. Yet they receive a great deal of attention in revenue forecasting.

In any case, I haven't studied the effect of capital gains tax cuts on revenues. Taking a quick look at some of the on-line studies, however, there appears to be some disagreement on this topic. Following is an excerpt from a favorable Cato study titled The ABCs of the Capital Gains Tax:

On balance, the evidence supports the case for an immediate capital gains tax cut. The economic evidence--and more important, recent actual experience-- suggests that a rate reduction would increase capital investment, new business formation, jobs, and the rate of growth of GNP. When the positive economic impact of a capital gains tax cut is fully accounted for, the current proposed capital gains tax cut will almost certainly be a revenue raiser over the long term or, at worst, will leave the deficit unchanged.

However, following is an excerpt from an unfavorable study titled How Much Will the Capital Gains Tax Cuts In The House-Passed 1997 Tax Plan Really Cost?:

The official estimates of these provisions is that they will increase tax revenues by $2.7 billion over the 1997-2002 period, and then lose $37.5 billion over the following five fiscal years. Even based on these estimates, one must question the soundness of such a fiscal policy because of its ever-growing cost in future years. Citizens for Tax Justice has concluded that the official figure are probably grossly optimistic. We find that a more reasonable estimate of the revenue cost of these proposals is $169 billion over ten years.

Also, following is an excerpt from an unfavorable study titled: Would a Capital Gains Tax Cut Stimulate The Economy?:

In the past, the Joint Committee on Taxation has estimated that capital gains rate reductions of the magnitude assumed in the current proposal would boost realizations sufficiently to increase revenues in the first year or two that the proposal is in effect. After this initial surge, however, the additional realizations would subside, and revenues would decline. Another factor reducing revenues over time is that investors would shift more funds into assets that generate capital gains to take advantage of the lower tax rates. By moving more funds out of assets that generate more highly taxed ordinary income — such as interest and dividends — and into capital gain assets, investors would pay less in taxes overall, further reducing revenues to the Treasury over the long term. Although no official Joint Tax Committee estimates of the proposal are available, these effects would be expected to result in revenue losses totaling more than $50 billion over the next ten years. (In 1999, the Joint Tax Committee estimated a similar proposal to cost $52 billion between 2000 and 2009.

Hence, not having studied the issue in detail and seeing the amount of apparent disagreement there is on this topic, I withhold my opinion, at least until I can look at the data in more detail. Unfortunately, there appears to be less data available on this topic. In addition, the volatile nature of capital gains revenues makes it a harder area to study. However, it should be remembered that capital gains revenues normally make up just about 4 percent to 7 percent of individual income tax revenues. Still, I do plan to look at them when and if I have time and will post anything interesting that I find.

[Pelham]

This, to me, is a tendentious misrepresentation of Lindsey's book:

Lindsey explains everything through supply-side incentives, makes selective use of the data, and tells a simplistic and polemical story.

IIRC Lindsey, then a Harvard prof, had his grad students run a complex regression analysis of the Reagan era to see what effects, if any, the tax cuts had on the economy. The book is a version of this study intended for the lay reader, but the data and how it was developed is described there in detail.

I saw no spinning of the evidence by Lindsey. If he wanted to spin a story instead of relate what his study discovered he could have claimed that any or all of the rate cuts increased the take to the Treasury- who would have been the wiser? That idea has a life of its own, as we know too well. As it is the only cut that showed an increase in revenue was signed by Carter, an amusing irony. Moreover I think Lindsey's subsequent career in Dubya's administration speaks of Lindsey's integrity. He didn't agree with the administration's estimate of the cost of the Iraq war, and was let go when he wouldn't lowball the cost. It's obvious in retrospect who was correct in this dispute.

Regarding Bartlett, Bartlett is expressing Anderson's sentiments in that quote you cite. Martin Anderson goes a bit further, he names the guilty parties who plagued the Reagan economists with exaggerated and false claims about their program (Jude Wanniski and George Gilder, just to spoil the suspense).

[remember]

I saw no spinning of the evidence by Lindsey. If he wanted to spin a story instead of relate what his study discovered he could have claimed that any or all of the rate cuts increased the take to the Treasury- who would have been the wiser? That idea has a life of its own, as we know too well. As it is the only cut that showed an increase in revenue was signed by Carter, an amusing irony. Moreover I think Lindsey's subsequent career in Dubya's administration speaks of Lindsey's integrity. He didn't agree with the administration's estimate of the cost of the Iraq war, and was let go when he wouldn't lowball the cost. It's obvious in retrospect who was correct in this dispute.

I have no reason to doubt Lindsey's integrity. In addition, I did respect him for having the courage not to lowball the cost of the Iraq war.

Regarding Bartlett, Bartlett is expressing Anderson's sentiments in that quote you cite. Martin Anderson goes a bit further, he names the guilty parties who plagued the Reagan economists with exaggerated and false claims about their program (Jude Wanniski and George Gilder, just to spoil the suspense).

I agree that those "guilty parties" did hurt the Reagan cause. In addition, I think that their magical thinking is dangerous to the financial health of our country. Accepting that cuts in income tax rates have benefits and costs allows there to be a needed rational debate about whether those benefits are worth the costs and whether those costs are affordable. Believing those costs to be a "free lunch", however, makes that debate appear to be unnecessary. It would be as dangerous as a belief that government spending has such magical stimulative effects on the economy that the spending pays for itself.

[Pelham]

In addition, I think that their magical thinking is dangerous to the financial health of our country. Accepting that cuts in income tax rates have benefits and costs allows there to be a needed rational debate about whether those benefits are worth the costs and whether those costs are affordable. Believing those costs to be a "free lunch", however, makes that debate appear to be unnecessary.

That's been my worry as well, and I wonder if we aren't seeing that scenario played out right now. Politicians are no more likely to want to read economic studies and memoirs than anyone else, and they are just as likely to subscribe to the Everybody Knows school of financial history. When that history has been distorted by over-enthusiastic and less than scrupulous cheerleaders you have the recipe for big trouble.

[remember]

That's been my worry as well, and I wonder if we aren't seeing that scenario played out right now. Politicians are no more likely to want to read economic studies and memoirs than anyone else, and they are just as likely to subscribe to the Everybody Knows school of financial history. When that history has been distorted by over-enthusiastic and less than scrupulous cheerleaders you have the recipe for big trouble.

True. We can hardly expect those who know little about economic realities to oppose cuts in their taxes and increases in benefits that they receive from the government. It is the responsibility of those who should know better, especially those who we PAY to know better, to do their jobs. Otherwise we are, as you said, in big trouble.