A Tale of Two Tax Cuts

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  • 08/19/2022

The latest budget data confirm once again what I've been saying for the last 30 years: Cutting tax rates in the right way clears jobs and boosts economic revenues. On the other hand, attempting to revive economic growth by just "putting money in people's pockets" through tax credits, deductions and rebates not only fails to increase growth but also creates disincentives to work, save and invest, which ends up costing the government lost revenues.

The historical record couldn't be clearer. The Kennedy tax-rate reductions that triggered the prosperity of the 1960s and produced a windfall of government revenues indeed ended up helping balance the budget in 1964-65. Federal revenues doubled in the 1980s as a result of the Reagan tax-rate cuts. Today the evidence continues to mount that the Bush tax-rate reductions of 2003 also got the economy moving again and are leading to increased federal revenues.

The most compelling evidence comes from the latest Congressional Budget Office monthly report, which shows the totals for the first eight months of fiscal 2005 and tells us most of the story for the whole year. The most notable figure in the CBO report is that corporate income tax receipts are up a stunning 47.5 percent this year. Individual income taxes are also up sharply this year, leaping 20.5 percent over last year.

This is powerful evidence that the investment tax cuts - lowering the tax rate on dividends and capital gains and allowing an increase in the amount of investment spending that businesses may write off in the first year - breathed life back into financial markets, drove a broad revival of American business and increased personal income.

It could not be clearer: Where government revenues are concerned, economic growth really is everything. The economic recovery triggered by the 2003 tax rate reductions means not only greater prosperity for all Americans but more revenue for government, too. Are there disparities? Yes, of course. And are there inequities? Yes, but a rising tide lifts all ships. Where ships are in need of repair, government can and should step in to help out.

It was John F. Kennedy who noted 40 years ago that reducing punitive levels of taxation, such as the 60 percent tax on dividends prior to the 2003 law, is the best way to close the budget deficit. His words are as relevant today as in 1962:

"As I have repeatedly emphasized, our choice today is not between a tax cut and a balanced budget. Our choice is between chronic deficits resulting from chronic slack, on the one hand, and transitional deficits temporarily enlarged by tax revision designed to promote full employment and thus make possible an ultimately balanced budget."

"Tax revision designed to promote full employment" - that was Kennedy's way of distinguishing between reductions in tax rates that increased the incentive to work, save and invest, and tax credits, rebates and deductions that may actually decrease the incentive for productive behavior and cost the government revenue. All tax cuts are not created equal.

A recent study by Dan Mitchell of the Heritage Foundation makes this point vividly. The economy clearly performed better and tax revenues grew faster after the 2003 tax-rate reductions than after the 2001 tax legislation, which included a tax rebate, a new refundable child tax credit, a minuscule 1-percentage-point income tax-rate reduction and a small, gimmicky reduction in the death tax.

The reason, as Mitchell pointed out, is that the 2001 tax cuts were based on the Keynesian demand-side notion of putting money in people's pockets in the form of rebates and credits, which simply does not work to change economic incentives. "Supply-side tax cuts, by contrast," Mitchell observed, "do improve economic performance because they reduce tax rates on work, saving and investment."

The contrast between the effects of the demand-side 2001 tax cuts and 2003 supply-side tax rate reductions proves the point. In Mitchell's words:

"Economic growth since the 2003 tax cut has averaged nearly 4.4 percent on a yearly basis, compared to just 1.9 percent in the period following the 2001 tax cut. Net job creation since the 2003 tax cut has averaged more than 150,000 per month, compared to declining job numbers in the period after the 2001 tax cut. Tax revenues have grown by an average of more than 6 percent annually since the 2003 tax cut, compared to falling tax collections after the 2001 tax cut."

Bush's tax rate reductions, like JFK's supply-side tax cuts, have successfully reduced the deficit, despite Congress's continuing lack of spending discipline. While outlays have jumped by $110 billion so far this year, revenues have far outpaced them, rising by $183 billion and thus closing the budget deficit by $73 billion.

That's serious money. In fact, it's almost enough by itself to pay for stopping the raid on Social Security and saving the surpluses ($85 billion next year) in personal retirement accounts, the only true lockbox that will prevent government from getting its hands on the money.

While most members of Congress have been wringing their hands over how to pay the so-called "transition costs" for personal retirement accounts, they have completely overlooked the fact that Bush's 2003 tax-rate reductions created a prosperity dividend that can be used to make a down payment on permanent solvency. If Congress would take the next step and reform the federal tax code - by reducing tax rates even further and simplifying the code, completing the job it began of defining taxable income properly so as to completely eliminate double, triple and quadruple taxation of income - the prosperity dividend would increase and solve the problem of financing personal retirement accounts.

It's not rocket science, voodoo or magic. It's incentive-oriented economics. Cut tax rates, generate more economic growth, slow the growth of federal spending, capture higher revenues to make a down payment on personal retirement accounts. Stop the raid; start the accounts. I believe on these points, JFK and RWR would have agreed.


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