August 31, 2009
The Lasting Legacy of the Bush Tax Cuts
From The 2009 Budget Deficit: How did we get here? by John Irons, Kathryn Edwards, and Anna Turner:
This Issue Brief examines the details and causes of the current budget deficit and the role the current recession has played. The years between 2001 and 2007 saw a large deterioration in the budget balance, which was driven chiefly by legislated policy changes. The Bush-era tax cuts are the largest contributors to this period of policy-induced increases to the federal budget deficit. . . .
Chart C: from Irons, Edwards and Turner (2009).
Posted by Menzie Chinn at August 31, 2009 07:38 PMdigg this | reddit
Just imagine what this will look like in another 3.5 or 7.5 years. I look forward to that post.
Posted by: PM at August 31, 2009 08:12 PM
In contrast to your summary, the emphasis of the article was that "The recession itself is the most important cause" of the deficit.
(It should be noted that the bulk of the Obama 'stimulus' is spent later.)
I hesitate to defend Bush, one of the worst Presidents in effect of all, but I cannot understand why you are so hung up on his tax cuts. It was the fact that they were matched with spending increases that renders them pernicious.
On the other hand, as a Keynsian, you should like anything that increases the deficit "stimulus", as the Bush tax cuts seem to do.
Posted by: algernon at August 31, 2009 08:30 PM
Until today, I thought Menzie was an economist.
The deficits were caused by SPENDING INCREASES. The cuts are not to blame, the spending is.
If a person spends more than they make, is it more logical to tell them to spend less, or to increase their income?
Clinton cut taxes too, on capital gains, in 1997. Why was that tax cut good? If Bush had done the same type of tax cut, wouldn't that be a good tax cut?
Clinton also bombed Iraq in 1998 on account of Saddam's WMD programs, but I digress.....
Plus, Obama's deficits dwarf Bush's. I look forward to your condemnation of his massive deficits that are far, far larger than Bush's.
Menzie has unwittingly put himself in a position where he will have squirm when confronted with the massive Obama deficits.
Posted by: Heterosexual at August 31, 2009 09:30 PM
- This is the static scoring mistake again. The 2001 baseline is preposterous.
- The most significant contributor to the deficit prior to 2008 is interest payments on the debt--without which the budget would have been in balance nearly every year in the past 30.
- The TARP is not an expense (yet) so it is not appropriate to consider part of the debt. It is a leveraged investment.
Posted by: Jon at August 31, 2009 10:50 PM
"It was the fact that they were matched with spending increases that renders them pernicious"
That was the point, the tax cuts create the revenue for that spending(wow, is it hard for some people)
"increases the deficit "stimulus", as the Bush tax cuts seem to do"
????????. Alot of "Keynesians" don't believe in tax cuts or consumption padding rebates but investment spending. Huge difference that is lost on your breed I guess.
Posted by: Johnson at September 1, 2009 01:19 AM
Menzie, your BDS is showing. If he had just had another good year, as 2006 was, then we would have been talking about how "O" cost us that great budget surplus. Clinton was lucky Bush was not. Which was the better Prez for it?
Posted by: CoRev at September 1, 2009 04:51 AM
"The Bush-era tax cuts are the largest contributors to this period of policy-induced increases to
the federal budget deficit."
Did you miss that sentence algernon?
Posted by: Joe at September 1, 2009 05:05 AM
Way to go, Menzie, show those hypocrite Republicans who is really responsible for the budget mess the Obama administration has to fix. Looks like some pretty awful management over the last 8 years, that's for sure. I see the GOP faithful still can't accept the truth by the first comments, but their failures will haunt this country for many more years, long enough time for everyone to realize without doubt who drove this country into the ground. We can thank Bush and his capital worshiping sheep who have no idea what fiscal management is (or fiscal responsibility or even ethical regulatory management-lots of failures in that bunch of fools). We'll never forget you.
Posted by: GOP failed at September 1, 2009 05:08 AM
It is hardly an established fact that budget imbalances are only "pernicious" when induced by spending increases. The Bush tax cuts, in themselves, were enough to turn surplus into deficit. His spending increases made there on contribution to the structural deficit, but the tax cuts alone would have caused a structural deficit.
That, and the fact that they skewed after-tax income toward more heavily toward the rich, seems pernicious enough to me.
One reason to stay on the topic of Bush tax cuts is that there remains an effort to leave them in place, rather than allow them to expire. They are not just a bit of political history. Another reason is that, when we discuss the magnitude of budget effects, it is good to have a benchmark. There was plenty of cheering for tax cuts that have a larger negative budget consequence over time than any medical reform proposal currently receiving serious consideration, but the argument is made that the medical reform proposals are too expensive. If one asks "too expensive, compared to what?" a reasonable answer is "well, if the Bush tax cuts weren't too expensive, then why is health care?"
Posted by: kharris at September 1, 2009 06:01 AM
Hmmm... let's see. Government spending as a percentage of GDP for FY 2009 will be *much* higher than tax revenue as a percentage of GDP has *ever* been in the history of the United States, and we are supposed to believe that tax cuts are the problem? It's ludicrous.
Bush was a bad President, but try not to let that cloud your reasoning.
Posted by: Mark at September 1, 2009 07:14 AM
I thought tax cuts were the be all end all, so why in the hell did we have a recession that began under Bush? Even a simpleton should understand guns AND butter. Bush pulled the same shit as Reagan and it didn't work, again. Zero private sector jobs created in a decade and the market lower as well.
Posted by: me at September 1, 2009 07:23 AM
Sorry, Professor, I don't buy it. "The fault, dear Brutus, is not in the stars but in ourselves..."
You can't blame a projected $800 bil. budget deficit in FY 2016 (when we will have full employment) on something Bush did in 2001. At some point, the Obama boys need to, like Harry Truman, declare that "the buck stops here."
The very worst budget deficit that was all Bush's was 3.6% of GDP in FY 2004. In FY 2007, when Bush had essentially full employment, the budget deficit was merely 1.2% of GDP, even with all those Big Bad Tax Cuts.
According to Obama's OMB, not one single fiscal year through FY 2019 (!!) will see a budget deficit with less than 3.7% of GDP. If Obama gets a second term, OMB says the deficit would average over 4% of GDP, which is more than in Reagan's second term or Bush's first term. Moreovr, OMB's projections are based on optmistic assumptions that health care "reform" and cap-and-trade will be budget neutral, that Iraq and Afghanistan will be wound down easily, that the military will not need to rebuild it resources, that Obama can "bend" the health cost curve.
Obama has choices, for spending, for reform, for taxation. He is avoiding the hard choices. We need to hold him accountable.
The Democrats created Social Security, Medicare, and Medicaid (over Republican opposition), and never properly funded them. They resisted all attempts by Republicans to reform those programs, using proposed reforms to terrorize elderly voters into voting Democrat. The Democrats totally refused to engage Bush when his Treasury outlined how insolvent the programs are and proposed ideas for reforming the programs. Nor did Congressional Democrats offer alternatives: the subject was closed for discussion.
The Democrats think that Medicare, having been declared insolvent by Treasury and CBO, should be expanded to include everyone. That's what I do: if I cannot afford to go to a restaurant once a week, I respond by going out every night. Let's make the country more insolvent.
Now the chickens have come home to roost, as Rev. Wright used to say. The babyboom will start retiring in 16 months, and the deficit is about to explode. It is time the Democrats, for the first time in 75 years, pony up to the bar and pay for what they ordered. It is time for the Democrats to stop blaming Bush and acknowledge that the fault is in themselves.
Posted by: B.B. at September 1, 2009 07:49 AM
B.B., just to start with the single most egregious mistake you make: social security is properly funded.
your second most egregious mistake is to assume that a householder and the US government are the same.
as for CoRev, i can't call them egregious mistakes on CoRev's part: it's simply CoRev's willful obtuseness. in 2000, bush insisted that we could "afford" his tax cuts and still maintain the "lockbox;" translated into english, that means that it's not acceptable to count the prepayment of social security against the deficit, since bush specifically promised that the social security surplus would be maintained. so the percentage of gdp numbers that CoRev provides us are...crap.
more broadly, given that the bush administration pushed through medicare D without a funding source and the war in iraq without a funding source (indeed, they proudly opposed funding the war), i have no idea what in the world CoRev is talking about here.
Posted by: howard at September 1, 2009 08:31 AM
heterosexual: Yes, capital gains tax cuts are widely viewed as positive.
Clinton bombed Iraq in 1998; his administration did not invade and occupy not one but two countries. Clinton could have tried to persuade the Israelis to unilaterally disarm their nuclear arsenal as well as respect the spirit of the failed Oslo Peace Accords (as opposed to continually expanded the illegal settlements) and perhaps the Sept. 11th terrorist attacks on NYC might have been avoided but he didn't.
Love the way you whip yourself into a partisan fury. Do you find learning easier in that state of mind or more difficult? Just curious.
Posted by: GNP at September 1, 2009 09:15 AM
Not being an economist, the way the piece was written it makes it sound like President Bush just enacted tax cuts to benefit the wealthy. They were enacted to bring us out of a recession he inherited. Where there no baseline projections based upon this and the 9-11 bombing?
President Clinton also balanced the budget on the backs of the military. The spending remained relatively flat for 8 years. Yes congress was involved and could have increased the spending, but his administration submitted the initial proposals.
Lastly the reports mentions the Freddie and Fannie debacle. President Bush requested congress reform the agencies, but was blocked. I am not sure why this did not play into the analysis.
Posted by: MikeMainello at September 1, 2009 09:55 AM
A bit of the attempted slippery reasoning here is to just claim that nothing matters but right now. If Bush created a very large structural deficit, we should ignore that, say the Bush apologists. The fact that Obama is undertaking a Keynesian policy response that partially addresses a recession is the bad thing.
No kids. Running a structural deficit is bad. Bush tax cuts assured that the US would have a structural deficit, no matter what else might have happened. That is simple fact. Will Obama worsen the structural deficit? Quite possibly, and that would be a bad thing, too. One way to reduce the odds of increasing the structural deficit is to allow Bush's "temporary" tax cuts to expire.
Is there anybody here who really doesn't understand the difference between a structural deficit and a stimulus-induced cyclical widening in the deficit? Cause if you don't you really need to be asking question, not making misguided statements. Anybody who does understand the difference, and writes comments which willfully ignore the difference, is simply being dishonest.
Posted by: kharris at September 1, 2009 09:57 AM
Professor, pull your hands from over your eyes and ears.
Obama is running things now, and into the ground.
Amping up the military presence in Afghanistan, still shipping out prisoners to terrible countries, Gitmo still open, turning a blind eye to outrageous pay and practices on taxpayer-saved Wall Street.
Quit using Bush as a bogeyman, and straighten out your President, sir.
Otherwise, you and the other Madisonites are in for a very long 3 1/2 years.
Posted by: jg at September 1, 2009 10:07 AM
Take a look at the Board of Directors for the EPI and who they represent - a who’s who from the labor movement - wtih 29% of their funding from labor unions. But I'm sure that the policy analysis is strictly non-partisan, unlike anything from those ideologues at the Heritage Foundation.
I don't defend everything Bush did. But I fail to see how taking reckless fiscal policy and putting it on steroids is somehow going to save us.
Posted by: GWG at September 1, 2009 10:43 AM
There will be no peace dividend to save Obama's "_ss", the way Clinton's bacon was saved. Since we did not have the chance to finish the war by 4 more years of Republican governance and Obama has decided to fight in Afghanistan the way Johnson fought in Vietnam, we are going to deal with very high inflation and a loss in the Middle East. The good news is it only took 12 years to undo the mess Carter caused, so we should be good to go by 2024. It's deja vu all over again. The Bush tax cuts were and are wonderful, to bad they are going away. Remember 1931 went down hill after the interest rates went up, well 2010, as tax rates go up, equals 1931. Watch out, better get the wife and the baby in the house, the storms coming!!!
Posted by: Steve at September 1, 2009 10:52 AM
Johnson, "That was the point, the tax cuts create the revenue for that spending(wow, is it hard for some people)"
It takes many years, probably a couple decades, before economy grows enough for revenue to cover previous shortfalls from a cut. IIRC, a 2% tax cut (assuming taxes are about 20%) that result is about .25% one time bump in GDP growth converging to .125% higher gdp growth long term would take over 40 years for payback.
Posted by: aaron at September 1, 2009 10:56 AM
2002 1,853.4 First Bush Tax Cut (Keynesian)
2004 1,880.3 Second Bush Tax Cut (Supply Side)
Year 2000 was the highest tax receipts up to that time. Tax revenues started to decline the last two Clinton budgets. The first Bush tax cut, a Keynesian redistribution of wealth, was passed in 2001 becoming effective 2002. The second Bush tax cut, a supply side tax cut designed by Rep. Bill Thomas, passed in 2003 becoming effective in 2004. Tax receipts increased every year after the second Bush supply side tax cut.
Notice that, while revenues declined from 2001 through 2003, government outlays increased every year. So I will let you guess whether it was outlays or revenues that increased the deficit.
BTW, this foolish spending is why the Republicans lost the House and Senate.
Facts are stubborn things.
Posted by: DickF at September 1, 2009 11:34 AM
We have a great experiment here. There is massive spending planned in 2010 (mid-year election bribes?). The Democrats are also planning to allow the Bush tax cuts to expire. Now if things go as anticipated if 2010-11 tax receipts increase it will be because of the stimulus, not taxes, but if tax receipts decline it will be because of tax increases (Bush taxes decline). Believe me I will remind you of this post.
Posted by: DickF at September 1, 2009 11:40 AM
Johnson is under the deranged assumption that we are on the right side of the "Laffer Curve". Unfortunately, as it has been shown time and again, we are now on the left side of the "Laffer Curve"...any tax cuts will result in lower revenue!
Keep praying to Reagan GnOPe'rs and maybe one day the country will have a 0% tax rate and the country will have revenue coming out of its ears!
Posted by: Gridlock at September 1, 2009 12:18 PM
Call the Bush tax cuts as evil and irresponsible as you want -- but Obama has said he's renewing the bulk of them ($2 trillion worth), and has explicitly promised
So they are the "Obama tax cuts" now. As has been pointed out repeatedly by Diane Lim Rogers...
... left-leaning commentators are reiterating their disdain towards the Bush tax cuts ...
but are failing to recognize that almost all of the tax cuts that President Obama has proposed --and in fact all of the deficit-financed tax cuts President Obama has proposed -- are in fact the old Bush tax cuts, which will now become the Obama tax cuts as soon as President Obama signs the extension into law before the end of next year.
And while those who have hated the Bush tax cuts but love President Obama would like to believe that President Obama is letting the worst part of the Bush tax cuts (those "for the rich") expire, the truth is that the Obama tax cuts will still go disproportionately to the rich, even with the upper tax brackets expiring.
Yep. The Bush/Obama tax cuts are a sad truth that all of us (Reagan supply-siders, Clinton fiscal conservatives, and even the most liberal of Obama supporters) don't want to believe our new President who stood for "change" could let happen.
The Democrats have the White House and 60% of both the Senate and House.
If they keep these tax cuts as they are planning to do, then say: "Obama tax cuts".
There will be nobody to blame for the damage they do going forward into the future from there but them.
There comes a time when those who are in full control have to take responsibility for what they do -- and stop pretending that those they ejected from the house are still running things.
Posted by: Jim Glass at September 1, 2009 12:26 PM
"B.B., just to start with the single most egregious mistake you make: social security is properly funded".
Social Security requires a near 2% of GDP revenue increase by 2030 to finance trust fund operations, via income taxes (as they are what finance T-bonds).
That's so the govt can repay itself, with money collected from taxpayers, for spending the Social Security payroll taxes previously collected from taxpayers on items other than Social Security.
This near 2% of GDP tax increase amounts to a 15% across-the-board income tax increase on everybody (individuals and businesses) at the same time when another revenue increase twice as large will be needed for Medicare and Medicaid.
If that sounds "properly funded" to you, fine.
Posted by: Jim Glass at September 1, 2009 12:34 PM
When dollar shock arrives, owing ten or twenty trillion bucks won't seem like such a big deal. Of course, the asians who subsidized this will be pretty pissed off, and the 20% U6 will be a bummer. But the federal debt will really seem like the gigantic scam perpetrated on foreign and domestic savers that it is.
Posted by: John Law at September 1, 2009 01:07 PM
jim glass, we'll start with you. yes, the bush tax cuts become the obama tax cuts if he keeps them in place. what's your point?
as for social security: i have no idea what you're talking about. presumably, it has something to do with the fact that bush claimeed that he could cut taxes and preserve the lockbox and didn't. what does that have to do with the funding of social security? (i mean, i get the game you're trying to play, but it doesn't wash: the problem you're discussing is a general fund problem, not a social security funding problem).
and then we have DickF, who also wants to play the game. to provide us an honest discussion, DickF, what you need to do is provide us a general fund discussion. i already know how that will come out, and it's not favorable to your perspective.
(let us also note that your so-called "supply side" tax cut spectacularly failed on it's primary justification: job creation. you do remember the 5M new jobs that tax cut was supposed to create between july 1, 2003 and december 30, 2004? you don't remember the jobs, of course, because no where close to that total was created in that span. but i digress.)
MikeMainello, it's fine not to be an economist, but at least you need to be informed. Bush did not "inherit" a recession; the short recession of 2001 took place entirely on his watch.
9/11 didn't create or contribute to a recession, for the simple reason that the recession was over a month later.
military spending under Clinton averaged, in real terms, higher than military spending throughout the cold war. perhaps you can explain to us how this amounts to balancing the budget on the back of the military; perhaps you can explain what it is in the post-cold war era that required cold war level spending.
and your understanding of bush's so-called reform of fannie and freddie is quite incomplete, my good man.
in short, you're not only not an economist, you're not an informed citizen.
Posted by: howard at September 1, 2009 02:11 PM
"We have a great experiment here. There is massive spending planned in 2010 (mid-year election bribes?). The Democrats are also planning to allow the Bush tax cuts to expire. Now if things go as anticipated if 2010-11 tax receipts increase it will be because of the stimulus, not taxes, but if tax receipts decline it will be because of tax increases (Bush taxes decline). Believe me I will remind you of this post."
We already ran that experiment. During the Korean War we increased both government spending and tax rates and the economy boomed (tax revenues soared):
Posted by: Mark A. Sadowski at September 1, 2009 03:30 PM
Menzie - A very useful and interesting graph. Puts things in perspective. Thanks.
Posted by: don at September 1, 2009 03:36 PM
The EPI brief never gave any numbers to categorize the Bush tax cuts, nor did it specify where in the attached chart those were accounted for, so I have to assume that they were included in "other legislative revenue" changes.
At a glance, it would appear that this is the 3rd largest contributor to the current deficit, behind economic/technical (puzzilingly including the Fannie/Freddie support as a "technical" change?) and legislative spending.
I think the intent behind those words is to say "the largest single contributor," but surely it's inconsistent to lump a number of tax cuts together as one item (the "Bush Tax Cuts") to call it the largest contributor, but to look at spending increases (which together were a larger contributor to the deficit) as separate line-items.
If all tax cuts are to be lumped together, why not lump all spending items together? Clearly they aren't, as [All Spending] > [All Tax Cuts] while the opposite point is made in the quote you cite above. Is there a functional reason for this disparate treatment, or is it simply to create a talking point?
Posted by: renowiggum at September 1, 2009 03:39 PM
Howard. Yes, the 2001 recession happened entirely during Bush's term. To be exact, it began in March of 2001. So you are suggesting with less than two months in office Bush caused the recession? I suppose the fact that the NASDAQ was down almost 29% in December of 2000 had nothing to do with it. Perhaps you should be a little more careful about calling others uninformed. Of course I do not really expect civility from those blinded by hatred.
Posted by: GWG at September 1, 2009 03:53 PM
DickF, look at tax receipts as a percentage of GDP.
Receipts in 2005 were 17.6% of GDP. outlays were 20.2% of GDP. In 2000, outlays were 18.4% of GDP and revenue was 20.9% of GDP.
We would have had a surplus in 2005 under Clinton's rates.
Facts are stubborn, I agree.
Posted by: Joe at September 1, 2009 04:46 PM
Howard, I'll forever remember your excellent people skills. Now to quote from About.com
A good example was the stock market crash and subsequent economic downturn in 2000. This was not a recession in technical terms because GDP growth was negative in Q3 2000, Q1 2001, and Q3 2001, none of which were consecutive. However, anyone who lived through it knows that it felt like a recession during all that time. And in fact, GDP growth did not reach over 3% until Q3 2003.
So the market crashed and the economy slowed down, but technically it was Bush's fault that the economy went into a recession. Do you teach at a college? Just wondering.
Now as pointed out by others, revenues continued to grow and congress continued to spend even more. Yes the republicans were voted out by there base because they didn't listen.
At least President O and his Obamascare plan is exposing his party as the worse of both evils. Who knows hopefully the republicans have learned and will listen to the tax payers.
Posted by: MikeMainello at September 1, 2009 04:50 PM
Bush is not remembered fondly by fiscal conservatives. Not a few take exception to the expansion of health benefits and the Iraq war and the return to deficit financing.
On the other hand, Clinton looks a resounding success in terms of fiscal policy: he reformed welfare, stuck to pay-go, reducing govt's share of GDP by 3-4%, and balanced the budget.
If Clinton is the template for the Obama administration, a lot of us would support it. But for the Obama administration to propose a deficit projection of what--6% of GDP--as far as they eye can see? This is well into banana republic territory: Italy, Hungary, or Argentina.
If you are arguing that deficit reduction should be the primary goal of the current administration, say so. If not, why are you bashing Bush for a fiscal policy that makes him look like a fiscal hawk compared to the Obama administration?
I have been scathing in my criticisms of economists in the run up to this crisis. I have been so because I have had opportunity to do some of the analysis ex-post and been appalled by the lack of 'sentries', of professional public servants guarding the public interest. One of the key causes of this absence is an increasingly politicized bureaucracy with tendency for information to be processed through a political lens. It's not what is said, it's who says it. If a Republican president proposed a $9 trillion deficit for 10 years, you would be all over it. But if a Democrat proposes it, I have to read about it from Jim Hamilton. And yet the outcome will be the same: it will end badly, regardless of ideology. Economists need to say that.
Posted by: Steve Kopits at September 1, 2009 05:46 PM
Howard, I would like an explanation of how that Ole "Lock Box" would work. Please inform us which laws would need to be changed to make it even legally possible. BTW, once the lock box was started to be filled, where would that money go? Invested? If invested, in what safe investment? US treasuries, perhaps?
Posted by: CoRev at September 1, 2009 05:57 PM
"If a Republican president proposed a $9 trillion deficit for 10 years, you would be all over it. But if a Democrat proposes it, I have to read about it from Jim Hamilton. And yet the outcome will be the same: it will end badly, regardless of ideology. Economists need to say that."
Separate the standardized (acyclical) budget deficit from the rest. (That is to say perhaps at least $4 trillion is due to the fact we are in a very serious recession.) Then you might understand our situation. Then you might start questioning why Bush only only added to the problem, by adding trillions to the deficit when unemployment was very low, and in so doing did absolutely nothing to further our long term solvency.
Posted by: Mark A. Sadowski at September 1, 2009 06:38 PM
Menzie, great post as always.
Too bad about the freak show that is your commenters these days.
Some of the people should learn something about economics. They might enjoy it.
Posted by: RN at September 1, 2009 06:39 PM
MikeMainello, revenues did not "continue to grow." Real revenue increased 500 billion between 96-2000. Real revenue decreased 50 billion between 2001-2005.
According to treasury, under Clinton's rates, tax revenue would have exceeded 2.5 trillion dollars in 2005. We would have had a surplus even with the increased spending.
Bush's tax cuts caused the deficits. Facts are stubborn.
Posted by: Joe at September 1, 2009 07:22 PM
Mark A. Sadowski on September 1, 2009 03:30 PM
"We already ran that experiment. During the Korean War we increased both government spending and tax rates and the economy boomed (tax revenues soared)"
This is the 21st Century. The world is an entirely a different place with different inputs and stimulus than existed in the mid 20th Century.
Posted by: Babinich at September 2, 2009 02:42 AM
Just for my education...
What's the law as of right this second? The Bush tax cuts expire next year, right? And there has been no Congressional movement to prevent that from happening, right?
So, being betting men, what's the chances that those tax cuts expire?
Posted by: Buzzcut at September 2, 2009 05:59 AM
I really don't think there's any merit to that argument. No one in the research community has ever criticized Ramie's paper on those grounds.
Ramie's paper focused on the spending side and so when estimating the effects of a spending change failed to take into account the large tax increase that took place. This probably understated the effects of the spending increase, and it's worth noting that the spending increase exceeded the tax increase.
There is a recent paper by David and Christina Romer that focuses on tax changes. Nevertheless it effectively corroborates what Ramie found.
Their paper identified all significant legislated tax changes in the period 1947 to 2006 (is that recent enough for you?). What was revolutionary about the paper was that it classified tax changes according to their intended purpose. A tax cut was classified as "endogenous" if it spending driven (done to accomodate a change in spending) or countercyclical (designed to be stimulative in a downturn, and so a tax cut). All other tax changes were classified as "exogenous." Here is a passage that I think is relevant (page 22 of the March 2007 version):
"Following a spending-driven tax increase, real GDP on average rises moderately, reaching a maximum of 0.7 percent after two quarters (t = 1.5). Thereafter the effect fluctuates irregularly around zero and is always far from significant. Thus looking at how the economy behaves after tax changes driven by spending changes yields estimates of the effects of tax changes that are starkly different from those based on exogenous tax changes."
In short tax increases coupled with spending increases (fully one for one) yielded no statistically significant effect on the economy, and in fact, on average, at least temporarily, they increased GDP.
In the final analysis, Romer's working paper found that, with the exception of countercyclical tax changes (possibly because there were too few, or because the economic downturn obscured their effect), the only tax change that had a statistically significant effect on GDP were those that reduced the federal budget balance. (And in fact, in most cases, this increased an existing budget deficit.)
Theoretically, it is possible that the methods employed in Romer's paper could be applied to spending policy changes. The implication is of course that "exogenous" spending changes would have a much larger multiplier than the value estimated by Valerie Ramey for example.
Posted by: Anonymous at September 2, 2009 06:38 AM
That last anonymous would be me (I'm still drinking my morning coffee).
Posted by: Mark A. Sadowski at September 2, 2009 06:55 AM
By contrast, the CBO says it is the recession that is responsible: (August 2009 Budget Update, available at www.cbo.gov).
"The dramatic expansion of the deficit in 2009 (up from 3.2 percent of GDP in 2008) results from a projected rise in outlays of 24 percent (the largest percentage increase since 1952) and a drop in revenues of 17 percent from last year’s levels (the largest percentage drop since 1932).
Those changes have largely been the result of the severe economic downturn and the fiscal impact of federal policies enacted in response."
Posted by: RogerClemens at September 2, 2009 07:21 AM
Mark A. Sadowski wrote:
"We already ran that experiment. During the Korean War we increased both government spending and tax rates and the economy boomed (tax revenues soared):"
I don't normally question data presented here because usually it is accurate. Your statement is simply wrong.
A tax cut was passed in 1947 but vetoed by Truman and the veto was upheld. In 1948 the tax cut was reintroduced and passed into law. Economic growth in the 6 years following the tax cut averaged 4.6% (1947-1953). From 1953 through 1960 growth averaged 2.4%.
The Korean war marked the beginning of an economic decline that continued through the Eisenhower administration and up until the Kennedy-Johnson tax cuts. Eisenhower took the conservative Keynesian position that is still common in the Republican party that we must first balance the budget before tax cuts. The result was economic malaise during the Eisenhower administration.
Posted by: DickF at September 2, 2009 08:34 AM
Joe is incredibly ignorant, and has no business being on an economics blog.
If the tax rate rises, fewer people bother to work, as their take-home is less and less. Hence, GDP shrinks. Even if the percentage of GDP that taxes comprise of rises, the GDP shrinks, ensuring that total tax dollars are the same or even less when the tax rate is higher.
Get it? (I doubt you can grasp it).
I bet you think that the solution to Obama's huge deficits is to raise all taxes to 50% of income.
I thought the USSR was no more. Joe's existence shows how illiterate the Democratic voter base is, and how much Democrats depend on ignorance to get elected.
Posted by: Heterosexual at September 2, 2009 09:05 AM
So if you think capital gains tax rates are positive, that element of the Bush tax cuts should be preserved, no?
Or is it only positive if a Democrat does it?
Furthermore, Clinton bombed Saddam specifically due to WMD programs. Did he 'lie' about WMDs? Clinton did invade and occupy two countries, Bosnia and Kosovo. Niether was with 'UN approval'.
Go read a history book. Or any book, for that matter.
It seems that if a Democrat takes a particular action, it is 'good', but if a Republican takes exactly the same action, it is 'bad'. It is amazing that such people can pass as functioning adults. GNP and Joe are both horrendously ignorant people who are unable to see the gaping hypocrisy of their ignorance.
Posted by: Heterosexual at September 2, 2009 09:09 AM
In the Obama era, talking about budget deficits is obviously racist.
Expecting spending restraint is racist too.
Tea parties are racist.
Posted by: GK at September 2, 2009 09:12 AM
I have said it before but apparently you missed it. Bill Clinton was a better supply sider in his policies than George Bush. Clinton was probably the second best supply sider since the 1920s.
Posted by: Anonymous at September 2, 2009 09:51 AM
I'm sorry but your Korean war tax history is amazingly wrong. During the Korean War, Truman imposed excess-profit taxes and increased individual income, corporate taxes, and payroll taxes.
The top corporate income tax rate went up from 38% to 42% in 1950, to 50.75% in 1951, and 52% in 1952. The excess profits tax was effective from 1 July 1950 to 31 December 1953. The tax rate was 30 percent of excess profits with a 70 percent ceiling for the combined corporation and excess profits taxes. The only time corporate taxes ever were higher was during World War II.
The top personal income tax rate went up from 82.1% in 1949 to 84.4% in 1950 to 91% in 1951. The only time it ever was higher was 1944-1945.
In addition the payroll tax was boosted by 50% from 2% to 3% in 1950.
Federal tax revenue as a percent of GDP rose from 14.4% in 1949 to 18.7% in 1953 and Federal
spending as a percent of GDP rose from 14.3% in 1949 to 20.4% in 1953.
In fact there are only two wars in our nation's history in which there wasn't a tax increase:
the Iraq War and the 1846-48 Mexican-American War.
Posted by: Mark A. Sadowski at September 2, 2009 10:05 AM
When you use anything as a % of GDP you are factoring in government spending so it distorts the %.
But thanks for making my point.
To measure results you have to look in the years after an event not the year of the event.
In the five year period following the 1948 tax cut from 1949 to 1953 tax revenue increased by 81.2%. In the next five year period from 1954 to 1958 tax revenue increased by 20.6%. The tax cut in 1948 gave us an increase in tax receipts. The spending on the Korean War and Eisenhower's refusal to continue tax cuts, even raising tax rates, caused the increase in tax revenue to stagnate despite increases in the tax brackets as you report.
If you look at the international climate during this time Germany had an economic boom also fueled by tax cuts. Japan also had an economic boom but their tax cuts are not so easily seen. The US sent a Keynesian economic team to Japan and the Japanese adopted their tax plan but then created loop holes so that the effect of the increased taxes was neglible on production. This international boom helped the US avoid a worse economic decline during the Eisenhower administration.
Posted by: DickF at September 2, 2009 11:32 AM
"Joe is incredibly ignorant, and has no business being on an economics blog.
If the tax rate rises, fewer people bother to work, as their take-home is less and less. Hence, GDP shrinks. Even if the percentage of GDP that taxes comprise of rises, the GDP shrinks, ensuring that total tax dollars are the same or even less when the tax rate is higher.
Get it? (I doubt you can grasp it)."
My impression is that Joe is referring to the empirical evidence and that you on the other hand are probably referring to your navel. Have you ever asked yourself how people actually behave according to the empirical evidence?
Most estimates of the labor supply curve have concluded that the total wage elasticity of labor supply is practically zero above the 60th percentile of earnings distribution. That is indeed why the CBO assumes changes in the top marginal personal income tax rate have practically no impact on output.
In fact there are several studies that have estimated that the total wage elasticity of labor supply is negative above a certain threshold. That suggests that an decrease in the top marginal tax rate would actually induce those affected to work less, not more.
This shouldn't be too surprising if you really think about it. Above a certain income level people place a relatively higher value on increased leisure than increased income. That's because everyone has exactly the same number of hours in a day, but the rate of earnings is highly variable.
In short, when confronted with the actual empirical evidence, the Laffer Curve disappears into a cloud of supply side fairy dust.
Posted by: Mark A. Sadowski at September 2, 2009 12:13 PM
That is without a doubt about the most convoluted reasoning I have ever seen.
You seem to be arguing that the tiny cut in personal income tax rates that took place in 1948 (the only change in taxes that year) with the top marginal rate falling from 86.5% to 82.1% was responsible for the massive growth in revenue from 1950-1953 but that the much more drastic increases in corporate, personal and payroll tax rates that practically took place yearly throughout that period had absolutely nothing to do with the massive increase in revenues.
And, in addition, to be consistent with your reasoning, those more drastic increases in corporate, personal and payroll tax rates that practically took place yearly throughout that period somehow failed to slow output growth year after year, because the tiny reduction in personal income tax rates in 1948 caused a gigantic boom that simply overwhelmed them.
I just don't buy it. And frankly, when a research paper that makes that argument gets published in a reputable research journal, I'll be absolutely astonished.
Posted by: Anonymous at September 2, 2009 01:07 PM
Mark, that's no argument against supply side. It's an argument for progressive taxation, not higher taxes in general.
Any tax cut that results in a higher growth rate is a good thing. Stimulus spending lowers our potential growth rate for a quick, mostly paper, bump. If we get a 1% bump in GDP for years, but we get a long term growth rate of 2.95% instead of 3 percent, that's no deal.
Posted by: aaron at September 2, 2009 01:39 PM
Most estimates of the labor supply curve have concluded that the total wage elasticity of labor supply is practically zero above the 60th percentile of earnings distribution.
Don't be so sure. The entire scale shifts downward, making the '60th percentile' itself a moving target.
I know a number of people who have voluntarily left $500K jobs in investment banking for $200K jobs at corporations, due mainly to the high marginal taxes on the extra $300K earned. Their logic is : Why work 100 hours/week only to pay 48% in taxes? Go down to shorter hours, and get the added satisfaction of depriving the state of the fruits of OUR labor.
A lot of highly paid professional women opt to be stay at home moms, largely because of the high marginal tax rates on her income, as the husband's income already pushes them into a high bracket.
Posted by: Heterosexual at September 2, 2009 01:41 PM
That is indeed why the CBO assumes changes in the top marginal personal income tax rate have practically no impact on output.
What about small businesses on the same tax schedule? A restaurant with $500K annual income will have to lay off one waitress due to an increase in the top marginal rate.
So yes, a high top bracket reduces total output, particularly in the form of the employees of the employer in the top bracket.
You ivory tower people don't have any grasp of actual real-world situations, and it shows.
Posted by: Heterosexual at September 2, 2009 01:43 PM
That also make me wonder what the tax rate does to high income people's willingness to spend.
Posted by: aaron at September 2, 2009 01:57 PM
"Stimulus spending lowers our potential growth rate for a quick, mostly paper, bump. If we get a 1% bump in GDP for years, but we get a long term growth rate of 2.95% instead of 3 percent, that's no deal."
Well, yes and no, it depends. The CBO analysis of the current stimulus for Senator Grassley found that real GDP would be reduced by 0%-0.2% by 2019. That amounts to a reduction in average annual growth rate of 0%-0.02% over that time period. The analysis also implied that if a sufficient amount of the stimulus had been spent on education, R&D or infrastructure the impact on long term growth rates could have been positive not negative.
There are very few people who make $500,000 (or even $200,000) who do not decide that incorporating is a far better option than paying taxes as a proprietorship, a partership or an S-corporation. The reason is simple. Corporations have generous depreciation rules, exemptions, deductions, and credits. The average effective tax rate for a corporation in the United States was 13.4% from 2000-2005.
And I speak from experience. My father was incorporated as a technical consultant on the dyeing and finishing of textile fibers. He made considerable money and paid very little of it in taxes.
P.S. It's also my experience that high earning people who choose to work fewer hours do it for the simple reason that they value their leisure or family time more. Tax rates almost never influence that decision.
Posted by: Mark A. Sadowski at September 2, 2009 03:57 PM
"What about small businesses on the same tax schedule? A restaurant with $500K annual income will have to lay off one waitress due to an increase in the top marginal rate."
That's ridiculous. That's $500K in *revenue*, not $500K in profit. People made this mistake all the time when talking about Obama's tax plans during election season. That's why most of the "small businesses making $250K will be hurt by Obama" claims was BS -- they made $250K in revenue, not profit. A very small proportion of people make $250K/year, and very few small businesses (relatively speaking) make $250K in *profit*.
Posted by: corntrollio at September 2, 2009 09:33 PM
That's ridiculous. That's $500K in *revenue*, not $500K in profit.
No, I meant profit. A good restaurant with a booming patronage can make that much profit in a year, and STILL be forced to lay off a waitress due to higher tax rates.
Posted by: Heterosexual at September 2, 2009 10:42 PM
There are very few people who make $500,000 (or even $200,000) who do not decide that incorporating is a far better option than paying taxes as a proprietorship, a partership or an S-corporation.
What if you are an employee of a corporation, making that much? What then? You cannot incorporate.
There are many professions where hundreds of employees in a corporation will make that much, such as Investment banking, Management Consulting, or a major Law Firm. Thus, incorporation is not an option for a $500K employee.
Posted by: Heterosexual at September 2, 2009 10:44 PM
DickF "The tax cut in 1948 gave us an increase in tax receipts."
You continue to make the same circular argument. You assume that tax rates would not have been higher under the higher rates. Then you conclude that supply side tax cuts increase tax revenue.
To compare, you have to actually compare revenue under the new lower rate to a fair estimate of what revenue would have been under the old higher rate. You can't simply use the old revenue number and conclude that since the new number is higher tax cuts increased revenue.
Posted by: Joe at September 2, 2009 10:49 PM
Your number are even worse than mine. With a .2% reduction, we end up with smaller GDP after just 6 years and from there on out.
I agree with your other points, but on education I'm not quite sure. There are structural problems with the education system that money won't address. More education won't improve things, there are plenty of educated people out there that aren't worth a damn (even though they may be paid well). It's not so much a money thing as a cultural thing, life is too easy for most people to choose to commit to disciplined learning. I'm one of them, I should be doing something much more technical and productive, but I get paid well and the time and money it costs to go back to school just doesn't seem worth the risk that I will come out and not make much more money (especially right now). The quality and relevance of the material in many programs is very questionable. Take MBAs. Take them all and get rid of them, they're worthless.
Posted by: aaron at September 3, 2009 06:45 AM
Sorry Mark, read your comment wrong, saw it as a .2% reduction in growth.
Posted by: aaron at September 3, 2009 07:07 AM
You continue to make the same circular argument. You assume that tax rates would not have been higher under the higher rates. Then you conclude that supply side tax cuts increase tax revenue.
Which is more of a circular argument.
1) An interpretation of historical data where tax revenue increases when taxes were cut and decreases when taxes were increased (see study by David and Christina Romer), that tax cuts have a positive impact on tax revenue (assuming the Laffer effect), or
2) an interpretation of history where massive injections of cash and spending are followed by an economic decline but apologists argue that "things would have been worse if we hadn't done something?"
Posted by: DickF at September 3, 2009 01:33 PM
"A good restaurant with a booming patronage can make that much profit in a year, and STILL be forced to lay off a waitress due to higher tax rates."
How much does a restaurant pay a waitress? How many restaurants make $500K or more in profit? What would be the *gross* revenue of a restaurant making $500K in profit? You're doing a lot of handwaving here. You're going to have to do some math to prove this point, given that it would be at most a 4-5% tax increase for individual income at the highest marginal rate, and an enterprise this big is not necessarily paying individual taxes.
If you're going to complain that people don't understand real world scenarios, show us that you do.
Posted by: corntrollio at September 3, 2009 01:58 PM
"There are many professions where hundreds of employees in a corporation will make that much, such as Investment banking, Management Consulting, or a major Law Firm. Thus, incorporation is not an option for a $500K employee."
Yes, but then they're not a small business with employees, are they? Sheesh!
Posted by: Anonymous at September 3, 2009 02:26 PM
No one believes we are anywhere near the Laffer peak. Not even Art Laffer believes we are near that peak. We are well to the left of the Laffer peak. Really not even close.
Instead of looking at half-baked historical examples chock full of confounding factors, why don't you try working out a simple math model that asks if it is even mathematically possible for a cut in tax rates to increase revenues given that we are far to the left of the Laffer peak? Go ahead. Amaze us. If you know what you're doing it shouldn't take you more than 5 minutes to prove that your claim is false. But do give it a try and please show us your math. Thanks. I'll check back later to see how you're doing.
In the companion post kharris asked if anyone understood the difference between structural deficits and cyclical deficits. I think the answer to that question is for the most part "NO", commentators at this blog do not know the difference. How sad. Looks like Prof. Chinn has a lot of missionary work to do.
Posted by: 2slugbaits at September 3, 2009 03:43 PM
"An interpretation of historical data where tax revenue increases when taxes were cut and decreases when taxes were increased (see study by David and Christina Romer), that tax cuts have a positive impact on tax revenue (assuming the Laffer effect)"
You're not referring to the recent paper by the Romers that found that exogenous tax changes (tax cuts that increased a deficit) were the only kind that were stimulative, are you? The reason why I mention this is because David Romer described the results of that paper as "Hyper-Keynesian." I'm also very familiar with that paper and frankly I have no idea what you are talking about. If, on the other hand, you are referring to another paper please let me know which one it is.
I was the most recent anonymous (I finally filled "remember me" on all my computers).
Posted by: Mark A. Sadowski at September 3, 2009 04:17 PM
"I know a number of people who have voluntarily left $500K jobs in investment banking for $200K jobs at corporations, due mainly to the high marginal taxes on the extra $300K earned. Their logic is : Why work 100 hours/week only to pay 48% in taxes? Go down to shorter hours, and get the added satisfaction of depriving the state of the fruits of OUR labor."
This seems to be the most suspect claim of all. I would love to know about these mythical people who "voluntarily" went from earning $500K to $200K solely because of taxes. How many people do you think earn $500K/year, and how many of them do you think "voluntarily" drop down to $200K/year? Here's a hint, the top 1% in 2006 was at $365K or so, and the top 5% was at $175K or so. We're clearly talking about the extreme margins here.
Some of these arguments are tired and just plain wrong, and from people who know very little about tax policy. The Laffer is indeed a "laugher." Most people conveniently forget that many tax code changes that occurred during Reagan's time were actually tax increases because they only focus on the marginal tax rates. Here's a decent analysis of a few of the provisions passed under Reagan, but not all:
Posted by: Anonymous at September 3, 2009 06:37 PM
My father was hardly the only one in my family who owned a business. I have relatives in Europe who also have businesses but that's not relevant to US tax law of course.
But my aunt Mira Puszman (my father's sister) founded Villa Tatra, a Slavic fine arts and crafts shop, restaurant and confectionary in 1976 in Lyons, Colorado. I used to vacation there every Christmas. (It was fun to have a Polish Christmas in the snow covered Rockies.) She retired from it ten years ago and then moved to Arizona to start an art gallery.
She ran it as a proprietorship and when the business grew so big that it would have been preferable to incorporate she chose instead to sell it.
Villa Tatra exists to this day. It is built in the traditional architecture of the Tatra Mountains in Poland. If you're ever in Colorado stop there for a really good time (don't forget to request some chilled Belvedere):
Posted by: Mark A. Sadowski at September 3, 2009 07:06 PM
It's hard to find images of the structure of Villa Tatra itself. I found the following three on Flickr:
This really brings back memories. Good times.
Posted by: Mark A. Sadowski at September 3, 2009 07:45 PM
"What's the law as of right this second? The Bush tax cuts expire next year, right? And there has been no Congressional movement to prevent that from happening, right?"
Incorrect. There has been Congressional and Presidential movement to preserve some of the tax cuts, such as the rate cuts to the middle class and below, and of course there have been moves for additional AMT patches.
The overall Bush tax cuts cut a higher percentage of tax of the poor and middle class than the rich, and the tax cuts were a greater percentage of their income. Certainly of course the rich got a greater dollar figure tax cut. At the same time, the economy saw an increase in the income of the rich, but it's difficult to say that that was caused by the Bush tax cuts. Unless you're a supply-sider, that is, and you think that the lower marginal tax rates on the wealthy caused the wealthy to work more and thus make more money. Most people here seem not to be.
The paper also seems to include the bipartisan AMT patches under "Bush tax cuts."
It seems somewhat strange to blame just Bush for these bipartisan tax cuts. Perfectly acceptable to blame him for the portion that are and will be extended, though.
Posted by: John Thacker at September 12, 2009 09:30 PM
The analysis and conclusÄ±ons set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of GovernorsÄŸ. See the artickle: The Effect of Anticipated Tax Changes on Intertemporal Labor SÃ¼pply and the Realization of Taxable Income
Posted by: Anonymous at November 8, 2009 05:53 AM