Tax Cuts Raise Tax Revenues - Vanity

Buwaya

[buwaya]

I have an interest in the Federal Budget, being a sort of busmans holiday to my professional duties. I have been following the Congressional Budget Office postings for several years. In the course of a discussion on budget deficits, I decided to look into whether tax cuts do or do not raise tax revenues. The conventional wisdom today is that they don't. It seems to me, after examining the evidence in specific cases, that we have solid evidence to the contrary.

This particular case can be traced to specific provisions in a specific piece of legislation, the Jobs and Growth Tax Relief and Reconciliation Act (JGTRRA) of 2003. The core of this was a reduction in the Long-Term Capital Gains tax rate to 15% (down from 20%), and the treatment of some dividend income at Cap Gains rates. In the case of both Cap Gains and Dividends, the CBO, the Joint Committee on Taxation, and the Office of Management and Budget predicted revenue losses as a result.

Capital Gains -

Jan 2004 Capital Gains Tax revenue projections, in billions

http://www.cbo.gov/showdoc.cfm?index=4985&sequence=5

2002 - 57

2003 - 45 - Change in rates, May 2003

2004 - 44

2005 - 49

2006 - 54

They were predicting an actual reduction in Capital Gains tax revenues as a result of the tax cut, various numbers being touted by various sources, from $5.4B quoted by some, to perhaps $45B 2003-2006, by the CBO, based on its earlier 2003 forecast, to some rather incredible figures in the JCT "Blue Book" - http://www.house.gov/jct/s-8-03.pdf , see p.22.

Note also this summary, by some leftish activists, who seem eager to swallow such estimates -

http://www.cbpp.org/3-10-05tax.htm

Actuals

http://mirror1.cbo.gov/ftpdocs/77xx/doc7731/01-24-BudgetOutlook.pdf

2002 - 58

2003 - 50 - Change in rates, May 2003

2004 - 61

2005 - 84

2006 - 103

i.e., by my take Capital Gains taxes yielded $101B more through 2006 than the CBO initially predicted post-tax reduction, or $66B more than the CBO predicted earlier in 2003 for a no-cut scenario. This growth is in spite of the fact that asset valuations did not increase at anywhere near the rates at which revenues did, and that the CBO was rather accurate in its economic predictions.

Dividends -

Unfortunately, as tax liabilities from dividends are not calculated separately, being subsumed into the individual income tax rates, this is not as simple to work out as is the case with Capital Gains.

But we can examine reported dividend income, and get some idea that way. The IRS site only offers summary statistics through 2004, however. See -

http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133414,00.html#_prelim

But there is an interesting pattern -

Taxable Income from Dividends In Billions

Year Dividend income reported 1998 114

1999 127

2000 141

2001 111

2002 94

2003 183 (105 + 78) - May 2003 Tax Reform

2004 242 (137 + 105)

The numbers in parentheses reported for 2003 and 2004 are the ordinary dividends plus dividends that qualify for Capital Gains rates. I expect that when we get the numbers for 2005-06 we will see the same pattern continue, as this is a partial explanation for the unanticipated increases in income tax collections.

At first inspection it seems that a significant behavioral effect was induced that prompted a very large increase in dividends issued and reported. What was the exact result of this in terms of individual income tax collections is not going to be easy to estimate, but its clear that tax collections as a result must have increased greatly, even if one assumes that ordinary dividends are mostly taxed at the top marginal rate vs 15% for qualified dividends.

This also was not primarily the result of economic growth induced by the tax cut, or of any other sort of economic growth, as the rise in dividends greatly exceeded the rate of GDP growth and even exceeded the increase in corporate profits.

The result of this is that the CBO and all the others have consistently underpredicted revenues, by 5-6%. They are not just doofuses, because they do an exceptional job of economic prediction and estimation of outlays, where they are off maybe 0.2% a year out, which considering the uncertainties and complexity, is steely-eyed budgeteering.

These low predictions are, I am speculating, but with some confidence, based on a conventional wisdom that tax cuts do not yield revenue increases approaching the revenue reductions, i.e., that "clawback" is limited to maybe 25%. In these cases "clawback" proves to be more like 200% or more.

Another reason for this error on the part of all the official forecasters was because they fail, consistently, to take behavioral effects into account - the increase in the likelihood that individuals will be willing recognize capital gains, for instance, or corporations to issue dividends, if the cost of doing so is reduced. Their models seem to be assuming that revenues are tied to macroeconomic conditions only.

Somebody should be eating crow. And it would seem rather difficult to make a case for Capital Gains or Dividend rates to be raised, as they seem to be closer to a revenue-maximizing optimum at this rate than the previous one, as collections are approaching the FY2000 "bubble" period though we are not really experiencing a bubble.

The underestimates are on-going. The CBO has already revised its FY2007 revenue growth projections from 4.6% to 5.6%. The first four months of the year show revenue growth at almost 10%. The CBO will have to revise upwards again, maybe by April.

The recent news stories about the "cost" of retaining these tax cuts ("$1.9 Billion", etc.) should be seen in this light. These "cost" estimates, projected over ten years no less, are pointless and foolish, if for no other reason the fact that the accuracy of prediction of the CBO, OMB, etc. is incapable of giving us anything of value on revenues so far out.

[sr4402]

President Kennedy cut taxes big time, did his cuts reap additional revenue?

I would look into that as today's partisans will doubt anything other than someone they believe in.

[E. Pluribus Unum]

Something that really pisses me off is when people point out the budget "surpluses" that Clinton had.

There were no surpluses, there was early tax revenue realization from people rolling their conventional IRAs over into Roth IRAs.

When Roth IRAs started, you could roll your conventional IRA over and take four years to pay the taxes due. The four years of Clinton's "surpluses" were the four years when taxpayers who had rolled their conventional IRAs into Roth IRAs were paying billions in extra taxes.

As soon as the Roth rollover payments were over, the "surpluses" miraculously disappeared.

The press would never have pointed out the obvious. They were desperate to credit Clinton with anything and everything good that they could.

[Bigun]

I believe that the evidence is now overwhelming that Authur Laffer (the Laffer curve) is exactly correct when he says that once overall tax rates reach a certian point higher rates DO NOT result in more revenue.

[buwaya]

Thats not the whole story, though that may have been a factor. You will see that Capital Gains revenues, Corporate Tax revenues and Dividend income also took a dive post-bubble.

[buwaya]

A lot of people misinterpreted Laffer. Among them people who look only to the economic effects of taxation. A typical refutation of Laffer is to measure GDP growth post-tax reforms, which misses much of the point.

[Niteranger68]

A lot of people misinterpreted Laffer. Among them people who look only to the economic effects of taxation. A typical refutation of Laffer is to measure GDP growth post-tax reforms, which misses much of the point.

Another big misunderstanding of the Laffer Curve is that it is a static representation of a dynamic process. The curve will change shape with changing tax rates. For me, I use the Laffer Curve to separate those who see taxation as a source of revenue, versus those who see taxation as a form of punishment.

[E. Pluribus Unum]

Thats not the whole story, though that may have been a factor.

Seems odd that the "surpluses" coincided exactly with the Roth Rollovers. I guess I'm just stoopid.

[buwaya]

Its a complex business, there are plenty of revenue streams and many are related to each other. And there are multiple factors working on each.

A good way to understand what went on is to separate out the revenue sources and see the various trends.

The Roth rollovers would have resulted in larger Capital Gains revenues I would think. Cap Gains was a strong contributor to increased overall revenues. Another factor that drove Cap Gains was the appreciation of assets. The S&P 500 multiplied 4X from 1995-2000 for instance.

[Jim W N]

The only problem I had with the Laffer Curve wasn't the concept but some of the terminology still popular, namely "Supply Side" economics, as though the main validation for lowering taxes is from the viewpoint of the government ("it's 'good' because it benefits their 'supply side'").

Lowering taxes isn't primarily for the benefit of government, it's for the benefit of us the people. I couldn't care less if it helps or hurts the government. By and large, a "hurting" government (not enough revenue for its bloated, obese appetite) would benefit our country.

[Bigun]

A lot of people misinterpreted Laffer. Among them people who look only to the economic effects of taxation. A typical refutation of Laffer is to measure GDP growth post-tax reforms, which misses much of the point.

I believe that is true and that many of those are doing so not for lack of understanding but rather for their political leanings.

[Bigun]

Another big misunderstanding of the Laffer Curve is that it is a static representation of a dynamic process. The curve will change shape with changing tax rates.

Another very valid observation!

Thanks!

[Niteranger68]

Lowering taxes isn't primarily for the benefit of government, it's for the benefit of us the people. I couldn't care less if it helps or hurts the government. By and large, a "hurting" government (not enough revenue for its bloated, obese appetite) would benefit our country.

Agreed, but the beauty of Dr. Laffers curve shows that lower tax rates can produce higher tax revenue. Both sides "win".

[buwaya]

You underestimate the power of ideology I think. I do not think its a matter of a hypocritical denial of understanding, but a real inability to understand, even by experts.They are blocked in their understanding by the boundaries of their world-view. They fail even to develop curiosity on the question.

I have not seen a good outcomes analysis of the effects tax cuts in the public media, not even in business and economic publications like the WSJ, nor an examination of the fiscal forecasting record of the CBO et. al., not even as trivial an exercise as mine. Even the Presidents own OMB is plunging blindly on and undercutting the Presidents arguments.

[Bigun]

You underestimate the power of ideology I think.

Perhaps but I doubt it.

I do not think its a matter of a hypocritical denial of understanding, but a real inability to understand, even by experts.They are blocked in their understanding by the boundaries of their world-view. They fail even to develop curiosity on the question.

I think you are being too kind! That is undoubtedly true in some cases but I still stand by my earlier statement. For too many it is a purposeful denial of FACT for political purposes.

I have not seen a good outcomes analysis of the effects tax cuts in the public media, not even in business and economic publications like the WSJ, nor an examination of the fiscal forecasting record of the CBO et. al., not even as trivial an exercise as mine. Even the Presidents own OMB is plunging blindly on and undercutting the Presidents arguments.

Nor will you see any such thing from the political lifers and MSM lemings who currently occupy our centers of government. The one thing they fear above all things is CHANGE! CBO's continued refusals to adopt dynamic vs static scoring is a prime example.

[Jim W N]

...the beauty of Dr. Laffers curve shows that lower tax rates can produce higher tax revenue. Both sides "win".

Right. However, to reiterate, I don't like the government-view perspective in which the economic debate was/is couched, or at least reported. The positive "supply-side" effect (govenment-eze for more money for them) is residual. The main reason to cut taxes (and keep cutting them until its around 10% (total, no multiple taxation or change to sales tax)) is it's the right thing to do. The people who earned it should keep and dispose of their hard-earned money as they please. Another oh-by-the-way benefit that affects, but is more important than government benefit, is it's good for the economy in general.

I guess its another way of saying that our country is about the people not the government.

[Niteranger68]

Right. However, to reiterate, I don't like the government-view perspective in which the economic debate was/is couched, or at least reported. The positive "supply-side" effect (govenment-eze for more money for them) is residual. The main reason to cut taxes (and keep cutting them until its around 10% (total, no multiple taxation or change to sales tax)) is it's the right thing to do. The people who earned it should keep and dispose of their hard-earned money as they please. Another oh-by-the-way benefit that affects, but is more important than government benefit, is it's good for the economy in general. I guess its another way of saying that our country is about the people not the government.

Well said. As a matter of basic principle, I can't disagree.