Sunday, February 19, 2006

Cheney takes aim at tax policy, sends truth to the hospital

Update: Added an image.

Cheney Says New Unit Will Prove Tax Cuts Boost Revenue:
Vice President Cheney said Thursday night that the verdict is in before the Bush administration's new tax analysis shop has even opened for business: Tax cuts boost federal government revenue.

"The president's tax policies have strengthened the economy, as we knew they would," Cheney told the conference, according to a text posted on the White House's Web site. "And despite forecasts to the contrary, the tax cuts have translated into higher federal revenues."

Tax revenue falls after big tax cuts

Actually, here is the list of federal tax receipts for the last eleven years:

billions of 2000 $% of GDP

In both cases, we see a decline in tax receipts since the enactment of tax cuts, and a rise in tax receipts since taxes increased. Correlation isn't causation, of course, but this fails to support the hypothesis that cutting taxes raises revenues. That isn't to say that it's impossible, just that there's just no empirical evidence that any tax cut has done any such thing.

The graphic shows tax revenue since 1978, adjusted to 2002 dollars. The green dots are years in which a chagne in tax law increased taxes by at least an average of $30 billion over the subsequent two years, the red dots are years in which taxes were cut by more than $30 billion in the subsequent two years. As you can see, tax receipts rise relative to GDP following tax hikes (the 1983 tax hike was smaller than the previous year's cut), while tax receipts tend to fall following tax cuts.

The Laffer Curve
If taxation were 100%, no one would work and tax revenue would be 0. Cut taxes and people work and pay taxes, raising the tax receipts. If the tax rate were 0, people would do a finite amount of work and pay no taxes. Increasing taxes would raise revenue. This logic gives us the so-called "Laffer curve." There is some equilibrium tax rate (T* in the figure) at which any increase or decrease in tax rates would yield a cut in revenue, either due to reduced taxable labor and spending or due to the reduced government's cut. We clearly aren't at that point. Raising taxes in the '90s raised tax receipts as a percentage of GDP (so the tech bubble alone can't explain it). Cutting taxes in 2001 lowered tax receipts, even as a percentage of GDP (so the recession alone can't explain it). That means we aren't at or near the equilibrium point, we're at the part of the curve where more taxation raises revenues and lower taxes decrease revenues.

Professional economists are all in basic agreement about that. There are some people with an ideological axe to grind, but they can't be taken seriously.

Consider this page, the first you get when you search Google for: tax revenue.

It contains bold assertions, but no meaningful data. A link to a chart of "Top Federal Income Tax Rates" is taken as a proxy for over-all taxation. That's meaningless, since the top marginal rate isn't the mean rate of taxation, let alone the potentially more meaningful median tax rate. There's also a claim that Reagan's tax cuts caused rising tax revenue, a claim which ignores the fact that Reagan's 1981 tax cut (the largest since 1967) was followed by the largest tax increase since 1967 (according to this report from the Bush Treasury Department).

The tax increase of 1993, which was followed by a historic period of economic growth, was the second largest increase since 1967, while 2001's tax cut was the second largest, and has been followed by a sluggish recovery which has failed to even reach most families (inflation adjusted median family income has declined over the Bush years).

This is another case where Dick Cheney missed what he was aiming at, and a lot of people have been hurt as a result.