Friday, March 17, 2006


Numbers don't lie: the truth about tax cuts

If you missed this story back in January, like I did, don’t feel bad. Somehow or other the entire MSM managed to let this get by them. But Donald Luskin was on the job, and analyzed the actual fiscal results of the 2003 capital gains tax cut. And guess what? Once you cut through all the crap, it turns out that tax cuts cause economic growth and result in increased revenues. Now where have we heard that before?

Now let’s move forward a year, to January 2004, after the capital-gains tax cut had been enacted. Table 4-4 on page 82 in CBO’s Budget and Economic Outlook of that year shows that the estimates for capital-gains tax liabilities had been lowered to $46 billion in 2004 and $52 billion in 2005, for a two-year total of $98 billion. Compare the original $125 billion total to the new $98 billion total, and we can infer that CBO was forecasting that the tax cut would cost the government $27 billion in revenues.

Those are the estimates. Now let’s see how things really turned out. Take a look at Table 4-4 on page 92 of the Budget and Economic Outlook released this week. You’ll see that actual liabilities from capital-gains taxes were $71 billion in 2004, and $80 billion in 2005, for a two-year total of $151 billion. So let’s do the math one more time: Subtract the originally estimated two-year liability of $125 billion from the actual liability of $151 billion, and you get a $26 billion upside surprise for the government. Yes, instead of costing the government $27 billion in revenues, the tax cuts actually earned the government $26 billion extra.

CBO’s estimate of the “cost” of the tax cut was virtually 180 degrees wrong. The Laffer curve lives!

This straight-A report card on supply-side tax-cutting was noted Thursday by Daniel Clifton of the American Shareholders Association — the man who predicted that exactly this would happen when the tax cuts were first enacted.

Clifton wrote on his blog,
a capital gains tax cut spurs the growth of new businesses, increases the wage of workers, enhances consumer purchasing power, and grows the economy at large, resulting in more overall gains to be taxed. When capital is taxed at a lower rate, any revenue losses are offset because there is more overall capital being produced, and thus more total revenue being generated.

Using the same kind of analysis, we can see that attempts to raise tax revenues by raising tax rates simply doesn’t work. Consider the massive increase in personal income-tax rates imposed by President Clinton and a Democratic Congress in 1993. Compare actual total tax revenues for the four years from 1993 to 1996 to what had been estimated by CBO in 1992 before the tax hikes took effect. Despite increasing the top tax rate on incomes by 16 percent to 28 percent, actual revenues only beat the 1992 estimate by less than 1 percent.

So what led to the gusher of tax revenues in the late 1990s that helped to put the federal budget into surplus? Simple: It was the capital-gains tax cut engineered by a Republican Congress in 1997. Compare actual total tax revenues for the three years from 1997 to 1999 to what had been previously estimated by CBO in January 1997. Despite cutting the capital-gains tax rate by 28 percent, actual total revenues beat the 1997 estimate by more than 11 percent.

As Luskin points out, these are actual numbers, not estimates or the rambling guesswork of politicians or pundits. The same thing happened in the ‘80’s. The Reagan tax cuts ultimately resulted in the most massive infusion of revenue any government anywhere in the world had ever seen. But what about the persistent myth that tax cuts cause deficits? Well, it is exactly that, a myth. When a deficit follows a tax cut and its resultant revenue boost, the deficit is the result of spending, not tax cuts. Here’s how that works: I don’t recall the exact number, but Congress in the post-war era overspent revenue at a rate of say $1.25 spent for every dollar in revenue. At that rate, if you have $100 in revenue, you spend $125, a $25 deficit. Spend at the same rate and increase your revenue to $1000. Now you spend $1250, a $250 deficit. Get it? Unless you reduce the rate of spending, as revenues increase deficits will increase too.

So what balanced the federal budget in the second half of the ‘90’s? The fiscally conservative congress which took over in 1994 and actually reduced the rate of spending, the 1997 capital gains tax cut… and billions of actual cash dollars transferred from Social Security and used to pay down debt and get to that “budget surplus” Clintonistas like to crow about.

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