Bruce the Apostate

Fewer conservative--well, not "conservative," fewer Bush-loyal--websites are printing Bruce Bartlett's columns. So it is only fair that more reality-based websites do so:

Bruce Bartlett column for 3-29-06: Belatedly, Republicans in Congress have become concerned about the federal budget deficit. But this is making it harder for them to find the votes to extend previously enacted tax cuts, some of which expire in 2008 and all which disappear after 2010. Tax cut supporters are now arguing that failure to extend the tax cuts will actually cause revenues to fall, thereby defeating the goal of deficit reduction.

As the Wall Street Journal put it on March 23, “The revenue data are further proof of the success of the Bush tax cuts of 2003. The fastest way to stop this revenue windfall, and blow an even larger hole in the deficit, would be to fail to extend the 15 percent tax rate on capital gains and dividends through 2010, thus assuring a huge tax increase after 2008.”

The flip side of this argument is that the 2003 tax cuts are said to be raising federal revenue because of a Laffer curve effect. The Journal cited the “astonishing” 14.6 percent increase in federal revenue in 2005 over 2004, which it rounded up to 15 percent. It also noted that revenues in the first five months of fiscal year 2006, which began last Oct. 1, are up 10.3 percent over the same period in fiscal year 2005. No other evidence was offered.

But how likely is it that the Laffer curve is causing revenues to rise, as opposed to normal operation of the business cycle? Not much, in my opinion.

First of all, the Laffer curve came to prominence during a period when the top tax rate on dividends was 70 percent and the rate on long-term capital gains was 40 percent. Economist Arthur Laffer correctly pointed out that a 100 percent tax rate would raise no revenue and that rates close to this would reduce revenue below what a lower rate would bring in. Given the tax rates in existence, it was plausible to argue that a reduction in the top rate and capital gains tax would raise revenue.

However, when President Bush took office, the top rate on dividends was down to 39.6 percent and the rate on long-term capital gains was just 20 percent—far below the rates Ronald Reagan inherited. It is very implausible that these rates were in the “prohibitive” range of the Laffer curve, such that a rate reduction would raise revenue.

But even if we grant the theory, how likely is it that the recent rise in revenue owes anything to this effect? Again, not much.

The fact is that it is only in very exceptional circumstances that there would even be the possibility of a tax cut that would so stimulate growth that it would pay for itself. Even the Bush Administration admits this. The 2003 Economic Report of the President (pp. 57-58) says, “Although the economy grows in response to tax reductions…it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity.”

Recent academic research suggests that feedback effects would offset only a fraction of the static revenue loss, that which would result from no effect on consumption or incentives. A 2004 study by Harvard economists N. Gregory Mankiw and Larry Weinzierl found that a cut in taxes on capital might recoup 17 of the static revenue loss in the first three years and a cut in taxes on labor could recoup 13 percent. Mankiw served as chairman of the Council of Economic Advisers under President Bush. A study by the Congressional Budget Office in December 2005 found that a tax rate cut would recoup at most 20 percent of the static revenue loss in the first five years.

Overall federal revenues are just barely back to where they were five years ago in nominal terms. According to the CBO, federal receipts were $2,025.5 billion in 2000 and $2,153.0 billion in 2005. Revenues fell 1.7 percent in 2001, fell another 6.9 percent in 2002, and fell again by 3.8 percent in 2003. They didn’t start to bounce back until 2004, when they rose by 5.5 percent.

Revenues as a share of the gross domestic product fell every year from 2000 to 2004, from 20.9 percent to 16.3 percent. The 2005 increase only raised revenues to 17.5 percent—still well below their historical average of 18.1 percent of GDP. It seems to me that the normal cyclical expansion after the end of the recession in 2001 has done far more to raise revenue than any Laffer curve effect. Revenues are simply returning to trend, nothing more.

In short, there is very little likelihood that revenues are rising because the 2003 tax cuts or would fall if they are not extended. The case for extending them must be made on other grounds.

Comments

[Charles Kinbote]

Austan Goolsbee at Chicago wrote a paper on this a couple of years ago:

http://gsbwww.uchicago.edu/fac/austan.goolsbee/research/laf.pdf

The abstract:
A burgeoning literature in public finance seeks to estimate the impact of marginal tax rates on the
behavior of the rich. This literature argues that by leading people to shift income out of taxable form
when rates rise, high marginal rates and progressivitiy in the tax code can create a substantial
deadweight loss while raising little revenue, even if the elasticity of labor supply is zero. The literature
has used natural experiment methods on data from the tax cuts of the 1980s and estimated a large
behavioral response of high-income taxpayers. In this paper, I use the same methods as this literature
but examine tax changes from previous decades that generated the same type of tax variation as the tax
cuts of the 1980s but with potentially fewer, or at least different, problems of spurious correlation. The
evidence from both aggregate cross-sectional data on tax returns and panel data on executive
compensation indicates that the responsiveness of high-income people seems to be relatively modest in
almost all time periods except the 1980s. The lowest estimates of the elasticity based on the 1980s
data exceed even the highest estimates from data on any previous tax change.

[ken]

A condideration of tax cuts without its corresponding increase in deficit spending is dishonest.

Every dollow the government spends but does not get through taxes must be borrowed. These borrowed dollars are spent on such things as salaries either directly or indirectly. These salaries are taxed and the government gets back about a third of what it borrowed to spend on those salaries in the form of taxes.

The revenue increase is as much due to increased deficit spending as by any other economic activity, imo.

[pgl]

Ouch! Bruce actually frames them in terms of what was the impact on output abstracting from the business cycle effects. No wonder the National Review et al. will not publish his writings. Bruce is too honest for them! Thanks for providing this copy.

[a different chris]

>This literature argues that by leading people to shift income out of taxable form

Yeah, yeah, so don't tax the rich so harshly, you jealous lefties!!!

Or...maybe the problem is with that little phrase Mr. Goolsbee tried to slip by us: "Taxable Forms".

Methinks the rich have too many tax shelters, and that's the problem that should be addressed. Bet I could get a lot of votes running on that.

Conservatives are so careful to tell us (or maybe just to reassure themselves) that Americans "don't hate the rich". And we don't. But we do hate their ability to avoid taxes, and I'd like to see a Republican just come out and tell us that they deserve to keep more than we do.

[elliottg]

You know Bruce states emphatically that he still would vote for Bush over Kerry today knowing everything he knows now. Hardly qualifies him as an apostate.

[Tom]

"You know Bruce states emphatically that he still would vote for Bush over Kerry today knowing everything he knows now. Hardly qualifies him as an apostate."

No, but certainly adds to his credibility.

As for the Laffer curve, estimates range to as low as 10% as to where were still benefit from tax cut. Keynes thought it to be 25%. We currently are at 29%

[MobiusKlein]

How did the Laffer curve become such a misused force? It's a trivial excersise in Calculus - continuous functions have minimums and maximums. Since the boundry conditions are know, zero at 0% tax rate, and zero at 100% tax rate, and positive at some tax rates in the middle, there must be a maximum. (or possibly many, not just a simple curve.)

The policy part is completly different. Just because there exists a maximum revenue generation point, does not imply that the government should set taxation to that value. (The Government's job is not to maximize revenues!) The Laffer curve example also ignores the Time domain - how does revenue vary over time. It also ignores non-revenue implications of tax policy, and many other simplifications.

[liberal]

Brad DeLong wrote, "So it is only fair that more reality-based websites do so:..."

Where does fairness come into it? It's a question of effectiveness of tactics.

[liberal]

I've seen that Goolsbee paper, or a very closely related one, cited by Charles Kinbote before.

Good stuff.

[liberal]

MobiusKlein wrote, "How did the Laffer curve become such a misused force? It's a trivial excersise in Calculus - continuous functions have minimums and maximums."

Agreed---it's a complete goddamn joke. Amazing how many people take it seriously.

[Howard]

you know, you would think that the journal editors would remember what they said about the clinton tax hike and just stfu, but no....

[spencer]

We use to talk about bracket creep in the days of high inflation that constantly moved individuals to higher tax brackets.

I wonder if the ATM is now doing that and how much of the rebound in receipts comes from individuals becoming subject to the ATM?

[bakho]

On issue the "tax cuts pay for themselves crowd" fails to address is the Fed. The Fed stimulates or brakes the economy to a non-inflationary range. So if tax cuts cause a large economic stimulus, the Fed will raise interest rates to keep the economy from expanding too fast. Since the revenue generated by the tax cuts supposedly comes from faster economic expansion, the additional revenue will never be seen because the Fed will step in to raise interest rates and slow the expansion. So instead of tax cuts "paying for themselves", tax cuts may serve only to cause the Fed to raise interest rates.

The way out (as Bill Clinton found) is to collect revenue as a way to keep interest rates low. Eventually, this course led to budget surplusses and certainly did not damage the economy.

[robert waldmann]

update: apology for the longness obviousness and boringness of this comment moved up here as no one would read far enough to read an aopolgy at the end.

Bartlett is a relatively sane conservative. However, he implicitly makes a claim which is not well supported. He assumes that tax cuts caused increased economic growth. Obviously tax cuts can slow growth as deficits crowd out investment.

As far as I know, there is no clear evidence on the effects of taxes on growth. In contrast there is strong evidence that government consumption is bad for growth. Subtraction suggests that deficits are terrrible for growth.

In fact, if I agreed that tax cuts mean more growth and a larger deficit, I would support tax cuts. The deficit is not bad because it is a sin, but because it has bad economic consequences. The worst effect might not be crowding out but global financial imbalance which causes a crisis when the dollar tanks, but in this case too, tax cuts cause low GNP growth and correct dynamic scoring gives a larger impact on the deficit than does static analysis.

If the debate is restricted to the range of views expressed in Bartlett vs the WSJ editorial page, it is decided in advance.

Obviously, you fear crowding out and are close to panic about a hard landing. Readers of this blog are probably sick of hearing about it from you. No way they will have read this far in this comment accusing Brad DeLong of being soft on the WSJ editorial page. so apologies at the start where they will be read.

[ilsm]

Tax cuts, along with other much larger stimuli: huge deficits, Chinese production stopping price inflation, foreign CB's going along pegged to the dollar and negative real interest rates caused whatever weak growth and slight rise in tax receipts.

Tax cuts were the cause of deficit and do not imply they cause stimulated growth.

Had tax cuts been less the recovery would be more substantial and less lopsided to low wage jobs.

No basis for that conclusion any more than the assertion tax cuts mean growth.

[a different chris]

>estimates range to as low as 10% as to where were still benefit from tax cut.

Your estimates are crap and you misrepresented Keynes. Attend, dude:

Let's take Average Economic Unit Guy. Let's use real numbers: You reduce his marginal to 10% from whatever. This frees up, just for fun, $1000 for him to invest.

Now he's AEUG. And he HAS to be average, because you're giving across the board tax cuts. Well, sorry, AEUG, but the economy is pretty tightly controlled to about 3.5% real growth. So that's what AEUG's investment strategy is gonna net him.

Ok, so we'll leave everything in the year-of-the-tax-cut dollars. You come back to AEUG in, say, 10 years. He has invested the $1k and come up with:

(1.035)^10 *1000 = $1410.59 Hey, he's 410 richer than otherwise!! So we're nearly halfway there...uh, wait a minute.

Genius, you cut the tax bracket to 10%. So AEUG smilingly hands you $41.05.

I think anybody who tries to say that tax cuts will pay for themselves is either a complete liar, a moron, or the worse: somebody who knows the numbers are wrong so they absolutely refuse to do the 10th grade math that they know will slap them in the face.

Which are you?

[Thorstein Veblen]

"2003 tax cuts are said to be raising federal revenue because of a Laffer curve effect. The Journal cited ... 14.6 percent increase in federal revenue in 2005 over 2004..."

Am I missing the obvious? Does anyone recall the repatriation tax in 2005? Does anyone look at the run rate of revenues? One would presume that February and March, 2006 are going to look rather dismal.

2005 wasn't Laffer, it was corporations being asked if they would prefer to pay five cents on the dollar today, rather than be obligated to thirty cents on the dollar tomorrow. Not exactly rocket science. That source is now gone; you can't lower that tax rate again to pull in taxes.

[Fred Hapgood]

> The policy part is completly different. Just because there exists a maximum revenue generation point, does not imply that the government should set taxation to that value. (The Government's job is not to maximize revenues!)

Right, but it is good thing to know the maximum revenue generation point because it sets a useful bar on policy discussions. So... what is the MRGP? How much money could the government raise if that was its only objective? Right now it extracts $4T from a $12T economy. Could it go to $6T?
Probably. $8T? Maybe not. So until someone more intelligent comes along let's say it looks like the very most that the government could get out of the current economy is $7 trillion. I think that's
a number worth knowing.

[Barry Ritholtz]

Weren't there tax cuts in 2001 also? They didn't seem to stimulate much in the way of tax flows.

Hmmm . . . maybe its not the tax cuts -- perhaps its slashing interest rate levels that were 50 year lows that generated all that economic activity -- new and existing home sales, construction, cash out refi loans, renovation, additions.

At this point 1 year ago, I recall seeing research from Northern Trust and Merrill Lynch discussing that 42% of all new private sector jobs were "Real Estate cmplex" related.

Look beyond the trillion dollar tax cut to the $5+ trillion real estate complex . . .

[RKKA]

"The way out (as Bill Clinton found) is to collect revenue as a way to keep interest rates low."

OTOH, the R beside the Smirking Chimp's name was good enough to convince partisan hack Alan Greenspan to take interest rates even lower, despite a policy that spewed red ink all over the chart.

[STS]

Thorstein:

Good point about the American Jobs Creation Act (aka profits repatriation). Typical of our AWOL media that nobody heard about the role it played in bumping up tax revenues.

Btw, I like your moniker. Mr. Veblen was quite the wiseguy -- another Twain in a different genre. You might enjoy the irony in the fact that he used to live on Sand Hill real estate now home to high powered Venture Capital firms whose continued use of the exhorbitantly expensive address for status certainly qualifies as "conspicuous consumption".

[Jeffrey Kramer]

The idea that 100% taxation would yield no revenue at all is hardly self evident. If a government put itself in charge of income distribution and required that all citizens work in order to be eligible for their share of such distributions, would everybody stop working?

[Fred Hapgood]

> The idea that 100% taxation would yield no revenue at all is hardly self evident. If a government put itself in charge of income distribution and required that all citizens work in order to be eligible for their share of such distributions, would everybody stop working?

That's not 100% taxation, because you're getting paid and (presumably) getting to keep what you're getting paid. 100% taxation is when you are left with nothing.

[Scote]

You are right, So until someone more intelligent comes along let's say it looks like the very most that the government could get out of the current economy is $7 trillion.

[Jeffrey Kramer]

Fred: I meant, suppose that all our paychecks were seized by the government before we got our hands on them, and our only source of income was what the government then redistributed to us. Would that not be "100% taxation"? If not, how (theoretically) could there be such a thing as 100% taxation?

[liberal]

Fred Hapgood wrote, "So until someone more intelligent comes along let's say it looks like the very most that the government could get out of the current economy is $7 trillion."

No. You're assuming that the only way to increase taxes levied is to increase taxes as they are.

Economic rents---particularly land rent---can, however, be taxed fully without any distortionary effects.

[Tom]

DChris,

You're passable at simple math, reading comprehension- no so much.
I state the estimates go down that low, not that I personally believe that.
I feel it is closer to Keyes belief of 25%. Mankiw estimates that tax cuts only pay for 50% of themselves, which is a conservative enough figure for most economists. You Average guy get an immediate one hundred percent return.
He loses $500 worth of services for keeping that $1000.

I also advocate spending cuts to offset the tax cuts. The Laffer Curve is simple in design, and it is debatable as to whether what point is the top of the curve. It is also widely accepted (except for fools who continually spout off about lend rents & such.). Examples sited above are corrected when one applies actual facts. Bush’s tax cuts did not come into effect until 2003, Clinton’s 1993 tax raise did not kill the economy, but the economy was very lackluster until 1997-8 coinciding with the capital gains tax cut. Not claiming the tax cut was responsible for all prosperity, but it is a piece of the pie.

[Neil']

Why would WSJ writers be so dumb as to actually believe in literal tax cuts paying for themselves with rates already this low? Or are they reflexive ideologues/shrubbots?

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5096&exhibition=14&pass=public&size=default&lang=eng

Red-bellied Woodpecker in Flight
New York City-Central Park, The Ramble.

Thanks for all, Bruce :)

[howard]

Tom, the 2001 tax cut most assuredly did kick in in 2001; it just had further provisions backloaded. The 2003 tax cut, since you're interested in what you call "facts," was said by bush and team to provide 5.5M new jobs between july 1, 2003 and december 31, 2004. here we are in march, 2005, and we still haven't made it.

and the economy under clinton was most assuredly not lacklustre until 1997. meanwhile, the wsj editorial page, home of laffer curve admiration, claimed that the 1993 tax cut was the end of reaganomics and most assuredly would cause a recession, which, sure as shooting, came along in 2001.

we're glad that you favor offsetting spending cuts: please elucidate to us what cuts you would make to get government spending down to 17% of GDP.

Neil', the answer is your second choice.

[anne]

"The economy from 92 to 97 was, most assuredly, average."

Oh, for however much more of such a gloriously average economy.

[anne]

What was so comforting about the growth between 1992 and 1997, or growth to 2001 which was a result of policy in the earlier years, was that we were able to grow just about as fast a productivity and labor force growth allowed without worrisome inflation. So, we continually absorbed women and men to the labor force and did so in a way that continually approached and than went beyond a balanced budget.

[anne]

Most telling, possibly, was how well labor fared in wages and benefits from 1992 to 2001 :) though with so little inflation. These were surely fine years.

[liberal]

Tom wrote, "The economy from 92 to 97 was, most assuredly, average."

Please cite comparative statistics supporting this claim.

"3.85 vs 3.6 is not better ?"

What are you referring to here?

Don't forget that current GDP isn't all that it appears to be because of the ballooning trade deficit.

[Bruce Webb]

"If a government put itself in charge of income distribution and required that all citizens work in order to be eligible for their share of such distributions, would everybody stop working?"

Apologies to Jeffrey in advance because I understand he meant no such implication but sometimes theoretical economic arguments divorced from the actual historical realities lead to pretty absurd results.

But "Arbeit Macht Frei" and "Gulag Archipelago" are really not appropriate starting points for any kind of economic discussion. And I hope to God Jeffrey is simply too young to understand the historical references.

You just do not enter any political/economic discussion with the assumption that one pole starts with total state control. Both the Left and Right tried that in the last century. And the results were pretty shitty, defining "shitty" as millions of people dead.

Believe me Jeff that is not a path you want to embark on, even theoretically. Because a lot of earnest German Philosophers in the late nineteenth century didn't connect their Pan-Germanism and anti-Semitism to its realities forty and sixty years later.

You dumb down the advanced intellectual assaults to street levels and you end up with Kristalnacht and the "Reverend" Fred Phelps.