DeBunking Laffer

Tax Cuts Raise Revenue COMPLETELY DEBUNKED
by bonddad

Mon Feb 13, 2006 at 06:17:01 AM PDT

The Right Wing Noise Machine Economics Division has several themes running through their policy pronouncements and analysis. Their greatest canard is "tax cuts pay for themselves." The underlying facts directly contravene this assertion, but that doesn't stop various pundits from continually advancing their agenda. The primary reason is Republican economic statements are not centered around policy but instead on selling a message.

Tax Cuts Pay for Themselves is perhaps the greatest Republican canard. It's popular because at the root of the message is an easy sell; you can get something for nothing. Compounding the degree of obfuscation is that RWNM pundits continually rewrite the history, usually "forgetting" key facts.

The editorial pages of the Wall Street Journal originally started to advance this idea in the mid to late 1970s. The idea is based on a graph drawn by Arthur Laffer (reportedly on a cocktail napkin) and is usually represented by a simple semi-circle. The horizontal line represents tax rates and the vertical line represents tax revenue. The curve's central idea is there is an optimal level of taxation, represented by the semicircle's apex. It the level of taxation is above or below the apex, tax revenue will be lower than the theoretical optimal level.


There are several problems with this idea and its implementation.

There is no way to derive this model from any set of existing data. Supply and Demand, marginal cost equaling marginal revenue and all other bedrock economic concepts can be derived from existing data. The Laffer Curve can't be derived from existing data. Ever notice that whenever the Republicans start talking about tax cuts they never say "according to the data, a cut of this magnitude will increase revenue this much"? That's because they can't. Theories are nice, but if reality can't back-up the theory, the theory probably doesn't exist in reality. The scientific method prevents the acceptance of a theory which reality cannot substantiate.

The underlying assumption is taxes are always too high. The assumption of all Republican ideologues is taxes are always to the right of the semicircle's apex. Therefore, lowering taxes will increase revenue. What they forget to mention is according to the Laffer curve, if tax rates are left of the apex, lowering taxes could also decrease revenue. Because there is no way to extrapolate any "laffer" curve from any data there is no way prove or disprove the underlying assumptions of any tax increase or decrease. Because it is easier to sell tax cuts instead of tax increases, the assumption that rates are to the right of the apex fits in with a marketing plan, but has no basis in any actual evidence.

The academic version of conservative economic theory mandates that for every cut in taxes there must be a proportionate cut in government expenditures. Note this theory does not state that tax cuts pay for themselves. Instead, they argue for a 1 for 1 reduction in tax levels and government spending. In other words, if taxes are cut 10% then government spending should be cut by 10%. The problem with the actual implementation of laffer curve ideology is at the same time Republicans cut taxes, they disproportionately increase spending creating deficits.

Reagan and Bush II have implemented laffer curve theory. The actual results from both President's terms is available from the Congressional Budget Office, the Bureau for the Public Debt and the Bureau of Economic Analysis. The actual evidence from the historical record directly contravenes RWNM assertions.

Reagan cut taxes in 1981. For the years 1981-1984, tax revenue from individual taxpayers (in billions) was 286, 298, 289 and 298. In other words, there was a total of 12 billion dollars of difference between the lowest total revenue collection and the highest point of revenue collection. It is just as easy to argue the rate from which the cuts occurred weas already to the left of the apex, indicating a tax decrease would lower revenue. After all, revenue didn't increase, did it?

In fairness, part of the reason for the decrease in revenue was a slow economy. The US economy grew 2.5% in 1981 and -1.9% in 1982. But, the US economy grew 4.5% in 1983 (the income taxes for 1983 were collected in 1984). Yet, tax revenue increased a measly 3.1%. This bolsters the argument that tax rates were already to the left of the laffer curve's apex, largely because there was no dramatic increase in tax revenue as the laffer curve would stipulate despite a growing economy.

For the years 1985-1988 tax revenues increased in each year. The respective total amounts were (in billions) 335, 349, 392 and 401. While it looks like the tax cuts eventually increased revenue, that isn't the case. While the RWNM continually touts Reagan's 1981 tax cut, they forget several of Reagan's tax increases:

Quote:

The following year, Reagan signed another big tax increase in the Deficit Reduction Act of 1984. This raised taxes by $18 billion per year or 0.4 percent of GDP. A similar sized tax increase today would be about $44 billion.

The Consolidated Omnibus Budget Reconciliation Act of 1985 raised taxes yet again. Even the Tax Reform Act of 1986, which was designed to be revenue-neutral, contained a net tax increase in its first two years. And the Omnibus Budget Reconciliation Act of 1987 raised taxes still more.

The year 1988 appears to be the only year of the Reagan presidency, other than the first, in which taxes were not raised legislatively. Of course, previous tax increases remained in effect. According to a table in the 1990 budget, the net effect of all these tax increases was to raise taxes by $164 billion in 1992, or 2.6 percent of GDP. This is equivalent to almost $300 billion in today's economy.

(The previous section is from Townhall.com.)

For each year between 1985 and 1988, tax revenue increased from 334.5 billion to 401.2 billion - an increase of 20%. But for each of those years when tax revenue increased, there was also a legislative tax increase of one kind or another.

The total overall increase in tax revenue under Regan was 40.70%. Compare Reagan's increase to the Clinton administration's increase of 97% (from 509.7 billion in 1993 to 1.004 trillion in 2000) which raised taxes on upper-income taxpayers. Again, this bolsters the argument US tax rates are to the left of the laffer curve apex because a tax increase increased tax revenue.

Compounding Reagan's fiscal problems were his massive increases in discretionary spending. Discretionary spending was 307.9 billion in 1981 and 488.8 billion in 1989 - a 58% increase. So, while government revenue increased 40% during Reagan's presidency, discretionary government spending increased 68%. Reagan never balanced a budget. To pay for the difference, Reagan increased total US debtfrom 1.028 trillion in 1981 to 2.8 trillion in 1989. The debt/GDP ratio of debt under Reagan increased in every year of his presidency from 32.8% in 1981 to 51% in 1989.

The RWNM often advances the argument the US needed that spending to win the cold war. The problem is we have never paid that debt back. We are still paying for the cold war - 15 years later. Basically, the US is paying the interest on its national charge card.

Bush II implemented Reagan's concept to a T. Bush II has also achieved the exact same result.

Bush II cut taxes twice - once in 2001 and once in 2003 (the RWNM has started to only talk about Bush 2003 cuts, conveniently forgetting the first). Tax revenue from individual tax payers was 994 trillion in 2001 and 927 billion in 2005 - a 6.7% decrease. Some of this stagnation is from weak economic growth. US GDP grew 1.6% in 2002. However, the economy grew 2.7% in 2002, 4.2% in 2003 and 3.5% in 2005. Starting in the second quarter of 2004, the economy grew at better than 3% for 10 quarters. Yet, from 2003 - 2004, tax revenue from individual taxpayers increased from 797 billion to 809 billion.

Even comparing the growth in tax revenue from individual taxpayers over a longer time frame does not help Bush's overall figure. Going back 9 years (1 longer than Bush's two terms) gives Bush a 41% increase in individual taxpayer revenue (from 656 billion to 927 billion). Again, Clinton's tax increase on the rich which led to a 97% increase in revenue from individual taxpayers provided more government revenue (while still growing the economy at a healthy clip and eventually balancing his last three budgets).

Bush has also declined to use the other side of standard conservative economic thinking - a proportionate cut in government spending - coinciding with his tax cuts. Bush's discretionary spending increased from 649 billion to 967 billion - a 48% increase. Compare this increase to the "tax and spend" liberal Clinton, whose disrectionary spending increased from 539 billion in 1993 to 614 billion in 2000 -- a 13% increase.

This massive increase in government spending at a time when government revenue is decreasing has once again led to an increase in total national debt. The debt/GDP ratio under Bush has increased in every year of his presidency, rising from 57% in 2001 to 63% in 2005.


Conclusion
Under Reagan, the tax cuts led to stagnant government revenue from individual taxpayers. It wasn't until he started raising taxes the government revenue started to increase. However, Reagan spent like a "tax and spend" liberal, increasing the debt/GDP ratio in each year of his presidency from 33% to 51%.

Under Bush II, the tax cuts led to a 6.7% decline in revenue for the first 4 years of his presidency. Because his spending increases far outpaced the decrease in government revenue, the total national debt outstanding increased 41%.

To compare, Clinton increased taxes on the upper-income taxpayers, which led to a 97% increase in government revenue. He grew the economy at a health pace. He decreased the debt/GDP ratio starting in 1995 of his presidency.

The two attempts to prove "tax cuts pay for themselves" have failed. It is clear that if the laffer curve exists, the US tax rates are clearly to the left of the curve's apex indicating a tax cut will in fact decrease revenue.