An odd and discouraging news story appeared in the October 5 Washington Times titled “House or Senate Shake-Up Likely to End Tax Cuts.”
Rob Portman, the director of the Office of Management and Budget, and Ed Lazear, chairman of the Council of Economic Advisers, did an interview with reporters and editors at Washington Times. Reporter Patrice Hill wrote the story.
Now, we cannot know all that was said at this gathering, but the report about the meeting can only be described as disappointing, as the President’s advisers seemed to fail to make a robust case for the economic benefits of tax relief, while also apparently missing some key causes regarding budget deficits and even economic growth.
Let’s take the following point reported by the Times first: “But they [Portman and Lazear] conceded that the tax cuts have not prompted more people to get work and contribute to the economy, while they cut deeply into government revenue and contributed to record budget deficits that have not shown much improvement until recently. ‘We do not say the tax cuts pay for themselves,’ said Mr. Lazear. ‘The point is that they created a positive environment for income growth’ while helping make the 2001 recession shallower than it otherwise would have been.”
Well, it seems peculiar to say that the tax cuts failed to prompt more people to get work and contribute to the economy, especially since employment growth kicked into gear right after the 2003 tax cuts – the key pro-growth tax measures passed during the Bush years – were passed and took effect. In fact, from July 2003 to September 2006, the U.S. economy added 7.4 million jobs.
For good measure, while most tax cuts do not fully pay for themselves, there certainly is a revenue feedback effect – often quite significant -- when pro-growth tax cuts are implemented. Again, we have seen this, as federal revenue growth picked up after the 2003 tax cuts gave a boost to the economy. In fact, a remarkable stretch of three straight years of declining federal revenues was reversed, as revenue growth resumed and accelerated after the 2003 tax cuts were implemented.
In addition, it is very difficult to make the case that the initial 2001 tax cut package made the 2001 recession shallower. Key aspects of the 2001 tax relief measure that would have provided some energy to the economy were delayed, to be phased in slowly at later dates. In fact, one can make the case that the long phase-in period for tax relief in the 2001 tax measure provided few immediate benefits for the economy, and in fact, the economic recovery under-performed until the 2003 tax relief bill was passed.
The Times article continues later: “Despite the revenue surge this year, the administration is projecting a precipitous drop in revenue growth to 2.4 percent in fiscal 2007, in large part because of generous cuts in the alternative minimum tax enacted by Congress. Also cutting revenue by $17 billion, they said, is the administration's decision to eliminate the telephone excise tax that President Theodore Roosevelt enacted to pay for the Spanish-American War, and to refund some of that tax. Partly as a result of the drop in revenue, the administration expects the budget deficit to rise again in 2007 to $339 billion from $296 billion or less in 2006. As a percentage of economic output, the deficit would rise to 2.4 percent from 2.3 percent, assuming Congress holds a tight line on 2 percent growth in domestic discretionary spending as prescribed by the administration.”
In reality, revenue growth for the government is tied to economic growth. If the economy continues to chug along, then revenues will continue to grow. The problem when it comes to the U.S. budget and its deficit is way too much spending, not too little revenue growth. For example, federal spending has increased by an annual average rate of 7.7 percent during the Bush budget years, far outpacing the rate of inflation, for example.
Finally, the Times story notes: “Mr. Lazear said he sees economic growth bottoming out at around 3 percent this year and next. The economy cannot grow as fast as the 4 percent average growth rates attained in the late 1990s, he said, because growth in the labor force has slowed sharply this decade. ‘It's a function of the aging work force and slower population growth,’ he said. Mr. Lazear conceded that the cut in the top tax rate from 38 percent to 33 percent and other Bush tax cuts should have provided an incentive for more people to work, but instead both men and women have been dropping out of the labor force.”
First, the reporter, I assume, made a mistake in that the top tax rate declined from 39.6 percent to 35 percent under President Bush (not 38 percent to 33 percent). Second, the economy certainly can grow at 4 percent per year, which by the way has been the average rate of real growth during recovery/expansion years post-World War II. Growth is not just about population growth, but also about productivity, investment, innovation, invention, entrepreneurship, and so on. For good measure, while labor force participation declined from its 2000 peak, it has been climbing higher in 2005 and 2006.
Finally, it must be highlighted that real GDP growth accelerated markedly once the 2003 tax cuts were passed, with real gross private domestic investment expanding at a rapid clip as well. This is no mere coincidence, as those tax relief measures enhanced incentives for working, investing and entrepreneurship.
Funny, but one might expect a more robust defense of tax cuts coming from the President’s own leading men on the economy.
Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council
October 10, 2006
