The Debates over the Bush Tax Cuts |

The Debates over the Bush Tax Cuts

Have tax cuts evolved into a money grabbing frenzy and if so, for whom?

By Mitch Gurney

August 19, 2010

A popular mantra for keeping the Bush tax cuts is we need them to help keep America competitive in the global market by encouraging more investment to create more jobs and greater output by our economy. Now think about that for a moment in relation to what we have just discussed here. What part of America are they referring to, corporate America? Hell, through outsourcing corporate America has a corner on the global market. Investing where, here or abroad? Create jobs where, here or abroad? Create increased output where, here or abroad? Well, we know the answers to those questions. Who really needs help in competing in the global market are America’s workers. But there’s nothing in these tax cuts that will help with that.

It’s disingenuous to claim that tax cuts are needed to spur investment and create jobs when that is not happening, at least not here in the U.S anyway. It seems pointless to argue over whether these tax cuts have worked or even argue over their virtues and who needs them and why if our government is losing money year after year and amassing huge debts in the process. What clearer evidence do we need to tell us something is seriously wrong?

Policy makers in Washington are debating whether to keep some, none, or all of the Bush tax cuts (set to expire Jan 1, 2011). The topic of taxes is one hot potato and as usual this will be a mean spirited debate only to intensify as that date draws near. A great deal of misinformation will most certainly make the rounds as the rhetoric builds in the days ahead. Given the seriousness of our financial crisis we need less politics and more bipartisan efforts but unfortunately that will not happen.

Division lines have long been drawn with Republican leaders proposing keeping the tax cuts while the Obama administration and some Democratic leaders propose extending most of the tax cuts enacted in 2001 and 2003.  President Obama has repeatedly proposed extending all the Bush cuts for persons making under $200,000 a year and families earning $250,000.  Hearings have already begun in the Senate Finance Committee in regards to this issue.

Tax cuts in general are sold to the American people on the premise that we need them to stimulate the economy by spurring consumer spending and help keep America competitive in the global market by encouraging more investment to create more jobs and greater output by our economy. But what happens when the majority of goods are imported as a consequence of outsourcing and companies are no longer investing in our own economy? Who benefits from supply side economics and consumer spending under these conditions? I intend with this commentary to challenge these prevailing ideas about tax cuts and explore whose benefiting the most.

This subject is very complex with as many differing theories as the universe has stars and with nearly as many players. Many readers may already have a good understanding of the issue but I suspect that for every one individual who does there are perhaps another five who don’t. I apologize up front for the length of this commentary but I found it challenging providing sufficient background on how tax cuts and our tax system works in order to effectively explain my thoughts about tax cuts and the impact this has on our society. For those that don’t already understand the depth of this issue and its many nuances my hope is that you find this information helpful and gain a deeper awareness of the huge power struggle this creates and why.

Our nation is in one hell of a financial mess and taxes, its primary source of revenue, are at the center. While some aspects in each of the differing arguments for tax cuts have validity, today, the nation’s unhealthy financial condition places policy makers in a difficult situation with difficult decisions ahead that will prove extremely difficult in striking a balance between rising the revenues needed now to pull this nation’s finances even marginally out of the hole and appeasing those that financially benefit the most from them. The stakes are very high. And there’s big political muscle aligned to exert its will and policy makers will need to get some back bone.

There are basically two tax cut theories each similar in expected outcome yet different in their focus. One is the  demand-side Keynesian style tax cuts (KSTC) typically favored by the Democrats focused toward the middle to lower income wage earners that are expected to stimulate consumer spending. A theory holds that lower income wage earners spend more and save less, mainly out of pure economic necessity. The KSTC concept is traced back to the Kennedy administration and associated to a speech he gave in 1962 (Newsreel) when pushing a tax cut proposal later enacted in 1964. At the time Republicans opposed the cuts as they perceived them as inflationary. And to a degree this is true in that when spending increases typically inflation follows.

The Republicans tend to favor supply-side style tax cuts (SSTC) coupled with deregulation focused toward the affluent and corporations for the purpose of stimulating investing. A theory holds that the affluent are more likely to save and invest since they have more disposable income. Corporations in turn need to continually invest for business expansion and growth.  The SSTC concept is based on the Laffer curve and it in combination with supply side economics is what inspired Reagan economics that lead to the Reagan tax cuts in 1981. In contrast to KSTC, SSTC are believed by many proponents to produce longer term growth.

For additional reading, please see the following articles:

How Tax Cuts Work ; Democrat vs. Republican Tax Cuts ; The Pros and Cons of the Bush Tax Cuts

Both have their appeal with the public for obvious reasons. And like drugs, tax cuts can be addictive. Everyone likes more money in their pocket and the stakes get higher as income levels rise. Politicians love them as they buy votes. But have tax cuts evolved into nothing more than a money grabbing frenzy and if so, for whom?

Both are expected to stimulate and grow the economy at different levels in different manners benefiting different market participants. KSTC if successful increases consumer spending thereby stimulating production and hiring; SSTC if successful encourages the affluent and corporations to invest thus providing the resources necessary to meet demand and expand production leading to hiring and future growth. SSTC proponents argue that production finds its own demand therefore it is not generally necessary to stimulate demand. The underling objective is that these actions are believed to eventually increase Fed revenue, albeit at lower tax rates, by expanding the tax base.

However some claim federal revenue tends to increase over time regardless whether there’s a change in policy or not and this is because of long-run economic growth, inflation, growth in wages, and annual population growth as young people enter the work force thereby automatically expanding the tax base. As you might expect Fed revenue goes up when the economy expands and declines during a recession.

Proponents for each theory present compelling evidence to support their positions. Some proponents for SSTC argue that Harry Truman, John F. Kennedy, Ronald Reagan, and George W. Bush are success models that support their theory. With Reagan, proponents often fail to mention that before he left office taxes were increased twice. Following enactment of Reagan’s tax cuts, the “Economic Recovery Act of 1981” (ERTA) personal income tax revenue dropped drastically. Taxes were raised immediately the next year via the “Tax Equity and Fiscal Responsibility Act of 1982” – enacted primarily to offset some of the revenue loss caused by ERTA – and the second tax increase was the “Deficit Reduction Act of 1984,” both had a positive impact on revenue and helped to stabilize them. Those who favor continuing the Bush tax cuts argue they are needed to help stimulate the economy. In a twisted form of logic some proponents say they want lower taxes and less government yet expect government to be the mechanism for economic growth.

In essence the Kennedy, Reagan, and GW Bush tax cuts were a combination of both concepts mostly as a consequence of political compromise. This issue has been debated for a very long time. A Google search brings up plenty of related articles. There’s a boat load of white papers that argue the issue either way from numerous big name think tanks, the Heritage Foundation, Cato Institute, Center on Budget and Policy Priorities , and the Tax Foundation plus others. Some think tanks are front organizations for corporations, the affluent and other special interest groups. Typically their research papers are funded by someone or group. It seems reasonable to expect that some might promote the virtues of lower taxes on behalf of a group they represent since nearly everyone benefits, although perhaps some more than others.

Clearly nobody likes taxes and the more income you earn the less you like them. But no one has proposed any alternatives for how government is to fund itself and still pay for all the services we expect it to render. A recent report by the Tax Policy Center found an astonishing 43 percent of Americans pay no taxes at all. Many of us that do pay taxes go to great expense to recover a few bucks at tax time. We’ve all heard that owning a home gives you a nice tax break. A middle income two wage family, for example, claiming deductions of $40k in mortgage interest and $8k in property taxes for 2009, would have gotten a combined Fed tax refund of about $7k. From the financial angle it seems they’d be further ahead to save $41k and let Uncle Sam keep the $7k, looks like he needs it.

Have these tax cuts really worked as intended? There are so many variables at play, too many to list here, it’s rather tricky to determine for sure. On a more practical level, can we really afford them now? Besides taxes having been raised on several occasions after a reduction perhaps the most glaring is the government’s habit for deficit spending, often at massive levels.  At this stage in history it’s really non-productive to point fingers but with each tax cut regardless whether enacted by a Republican or Democratic administration massive spending ensued. The massive spending for the War on Poverty and the Vietnam War during the Johnson-Nixon era, massive military build-up spending during the Reagan era, and the two wars of the Bush era coupled with out of control Congressional spending cast dark clouds over most of the anticipated outcomes. The recent bailouts by the Bush and Obama administrations have only compounded the problem. Accumulatively all these factors now place the U.S government’s finances in serious peril if revenue is not increased soon and cutting spending alone won’t be enough.

Obviously for taxpayers all of the key tax cuts have been beneficial. The Kennedy cuts enacted in 1964 and took effect in 1965 lowered the top tax rate from 91% to 70%. Reagan’s 1981 tax cuts lowered it to 50%. The top rate went through numerous adjustments after 1981 finally settling in 1993 at 39.6%. The Bush 2001 tax cuts lowered it to 35%, set to expire Jan 1, 2011. A single taxpayer earning $200k in 1962 would have paid about $152k in fed income taxes at the time. The following chart compares the different taxes the same wage earner might have owed had their earnings remained the same but adjusted for inflation during each respective time period when the key rates were changed (1964, 1981, 1993, and 2003) and based on the tax brackets applicable following each change. The chart than compares what the taxes might have been in 2009 if the respective bracket were still applicable today. Bear in mind the amount of estimated taxes on earnings are determined by the progressive tax rate system (discussed below) and the number of brackets and rates levied on earnings varied throughout this time period. For example in 1962 there were twenty-four different brackets and rates while in 2009 there were six. The Tax Foundation in 2008 had prepared comparisons between the Clinton-Bush tax brackets rates found here.

Click on graph for sharper image

But how has the Treasury faired through all of this and have the cuts delivered as promised? With all of the revisions made since 1964 how the hell is anyone to know for sure? Except for a series of government papers most do not analyze the long term historical trend of Fed revenue to determine whether there really has been an increase given that the economy and tax base supposedly automatically expands annually. The Laffer curve states that tax rates and tax revenues are distinct—that tax rates too high or too low will not maximize tax revenues.  So it’s not an exact science and therefore a matter of guess work as to when tax rates become too low.

The idea that lowering taxes increases revenue defies basic principles of arithmetic. Let’s work some simple math to illustrate my point. I realize that taxes and rate formulas are more complicated than this but to keep this simple:

  • Let’s take single taxpayer Gina, a business owner of Java Café and she employs 3 people for an annual salary of $25,000 each
  • Gina earns $250,000 per year – placing her the 33% tax bracket – (2009 Tax Bracket rates)
  • Gina’s estimated taxes = $82,500
  • Now, the Fed cuts her tax rate to 23%, thus reducing her annual taxes to $57,500 – saving her $25,000
  • Now Gina hires a new employee – Taxpayer Joe –and pays him an annual salary of $25,000
  • Terrific, we’re on the right track, right? But…wait how is the Fed to make up the full $25,000 hit to the bottom line?
  • Joe’s income places him in 15% tax bracket (2009 rate). His estimated tax =$3750, leaving the Fed in the hole for $21,250
  • If you extrapolate this example out the shortfall grows much bigger. Say we have 1000 Gina’s, and keeping all things equal let’s say all 1000 Gina’s hire a Joe, the Feds shortfall is now $21.2 million
  • No matter how you shake this out, mathematically the Fed will be collecting less than if no changes had been made

Wonderful, now that we have all these Joe’s employed, each will spend some money and spur the economy – I’ll explore this in just a moment.

SSTC proponents argue that because of our progressive tax system higher rates discourage wage earners if they fear earning more only bumps them into a higher tax bracket. By lowering taxes people are thus more inclined to work harder and earn more thereby producing more. It is argued that the resulting growth would generate increases in fed revenue that eventually eclipses the initial but temporary decline in lost revenue following the tax cuts. The government sacrifices revenue (similar in nature to stores discounting prices to stimulate sales) by cutting tax rates that potentially generates more volume in the long run if the tax base and economy expands as expected.

In the article, The Pros and Cons of the Bush Tax Cuts the author provides the following example that illustrates this:

For example if the total income available to tax in the 90% bracket is one billion dollars ($1,000,000,000) than the government will collect nine hundred million dollars ($900,000,000) in taxes…If we cut the top rate from 90% to 50% and, [because]…higher income people [decide] to work and invest, more income [becomes] available for taxation in the 50% bracket [which could for example] increase to two billion dollars ($2,000,000,000) the government’s … taxes [collected] rises to one billion dollars ($1,000,000,000) – [resulting in an increase of]…one hundred million ($100,000,000) more than at the previous 90% rate.

Let’s see how the progressive tax system impacts a single tax payer earning $372,950K per year by using an Income Tax Calculator and calculate the taxes based on the 2009 tax brackets:

  • The top tax bracket for 2009 was 35% on earnings of $372,951 and up. Our tax payer at $372,950 falls in the 33% bracket:
  • His estimated average tax = $105,532
  • Now let’s say he earned $373.950 pushing him into the top 35% bracket
  • His estimated average tax = $105,862
  • Earning $1000 more potentially cost this tax payer $330 more in taxes

There may be validity in the idea that lowering taxes will encourage people to work harder and perhaps if our nation’s finances were in better shape deciding the fate of the Bush tax cuts would not be so difficult. But that’s not the situation we face today at all. This is where all this starts to get really ugly. According to government papers and tax collection records tax revenues have typically fallen in the years following tax cuts and increased in the years following tax hikes. Two government reports one by the Department of Treasury and another by the Congressional Budget Office (CBO) seem to bear this out.

The Department of Treasury prepared a white paper “Revenue Effects of Major Tax Bills” covering all the tax changes from 1939 – 2006 and found:

  • Most of the bills enacted before 1982 were tax cuts. During this period, inflation was relatively high and the individual income tax parameters were not indexed for inflation. Without indexation, inflation can push taxpayers into higher tax brackets without any increase in real income. This phenomenon is called “bracket creep,” and it increases federal revenue as a percentage of GDP without any legislative action
  • Reagan’s ERTA enacted in 1981 provided for the indexation of the individual income tax parameters
  • The combination of indexation and relatively large federal budget deficits helped caused 9 of the 11 major tax bills enacted between 1982 and 1993 to increase federal revenue
  • Of the 9 major tax bills enacted between 1968 and 1981, 6 reduced federal revenue
  • All 8 of the major tax bills enacted after 1993 have reduced federal revenue

Access report here: USTreaRev.EffectofMajorTaxBills

This comprehensive analysis is based on the Treasury Report and includes analysis of the Kennedy, Reagan, and Bush tax cuts and incorporates the reported receipts by the Fed for the years in question and concluded:

  • The Reagan tax cuts DECREASED revenues over what they would have been, at least over the short (10-year) term
  • It seems possible…Kennedy’s tax cut was beneficial, at least in reducing [an] oppressive top tax marginal rate from 91% to 70% but Reagan’s tax cuts took the marginal [tax]rates to a level [from 70% to 50%] where the negative effects far outweighed any positive effects
  • As can be seen by the graphs, individual income tax receipts [following the Bush tax cuts] actually declined slightly from 2001 to 2007

The CBO report which analyzed a relatively simple tax proposal: a 10 percent reduction in personal income tax rates noted:

  • A [10 percent tax] reduction would lower revenues by $466 billion over the first five years and $775 billion over the second five years
  • Including additional debt service adds about 25 percent to the total budgetary impact over the first 10 years (see Table 1)
  • The reductions in ordinary and AMT rates account for almost all of the revenue loss; very little comes from reductions in taxes on capital gains and dividends

Please note the statement in that second bullet point above which is an important part of the equation most often overlooked; Interest to service the debt the government incurs from borrowing to make up the shortfall following a tax cut increases the amount of the shortfall. Recall our simple math example above? Well that $21.2 million shortfall is now much larger. Currently interest on the nation’s debt consumes about 8% of the total U.S budget.

As can be seen, the revenue trends over the last 40 years indicate less revenue not more. What the hell has happened and why?

During the 60’s and much of the 80’s when the Kennedy and Reagan cuts were enacted globalization was still in its formative years. Most products sold in the U.S at the time were mostly made here, companies invested here, and factory jobs were plentiful. The Bush tax cuts on the other hand were enacted in a globalized economy. None of the papers I’ve read so far have explored how these cuts would perform in this new economy. In order for the tax cuts to be effective each of the target points (consumer spending, production, hiring, and investments) should occur within the economy where enacted. But what happens when the majority of goods are imported as a consequence of outsourcing and companies are not investing in our own economy? Who benefits from supply side economics and consumer spending now?

It appears the tax cuts are missing their mark and I suggest this is evident in our economy’s dismal results and of those of the Bush tax cuts even before the recession began. While some claim Fed revenue was increasing in 2006 indicating the Bush cuts where effective, the chart seen here indicates revenue in relation to historical trends are far below what they were before. Actually, Fed revenue appears to be stagnant for nearly 40 years while expenses and deficit spending have soared. This data should be evaluated in context of a supposedly expanding economy during all these years. The economy is certainly bigger now than in the 1970s and 80s, right? These results are sure to look worse now since the onset of the recession in 2007. Real growth should reflect a fluctuating yet upward trend over the prior 40 years shouldn’t it?

Regarding the Bush tax cuts Fact Check wrote several articles providing numerous government reports and notes:

We found that a slew of government economists – from the Congressional Budget Office, the Treasury Department, the Joint Committee on Taxation and the White House’s Council of Economic Advisers – all disagreed with that theory, saying that tax cuts may spur economic growth but they lead to revenues that are lower than they would have been if the cuts hadn’t been enacted.

In a globalized economy these types of tax cuts may help spur economic growth but perhaps not in the marketplace where they are most needed or initially intended. Cutting taxes is only one part of the equation. As mentioned, each of the target points needs to be occurring within the same economy where they are implemented. In order to have a measurable impact on our domestic economy for example a majority of the products should be produced in the U.S otherwise increased consumer spending primarily stimulates production in the foreign country where the products were made thus creating the jobs there. Furthermore companies should be investing and expanding in our own economy to complete the circle. Otherwise, assuming the real intention was to grow OUR economy, the cuts will miss the mark.

As most know the dynamics of our national and global economy began changing in the late 1980’s when American companies began outsourcing their manufacturing and investing overseas.  In 1973 manufacturing’s share of the national outpoint was 22.9 percent and by 1985 had fallen to 18.4 percent. Today, according to a recent Bloomberg report its share is now 11 percent. This 50 percent decline is the result of outsourcing (plus automation) and today most products sold in the U.S are imported American brands. Consequentially the job base has been shrinking while the work force population continues to increase each year. This in turn has driven down wages which peaked in 1970. As seen in this chart wages, like that of Fed revenue, have been stagnant despite all the Feds stimulation efforts. The stagnant trend observed in wages nearly parallel those of the Fed Revenue charts. According to Bureau of Labor Statistics historical data for key manufacturing sectors; i.e. apparel, semiconductor, and software, auto parts, etc all show major combined declines of millions of jobs in the U.S. over the last 25 years. Granted jobs have shifted to other service sectors like retail which pay lower wages and are often part time. It’s conceivable that we’ve reached a critical mass in the number of jobs lost and the economy has been struggling to produce enough jobs to even support population growth.

Another shift in the nation’s economy is it appears to be increasingly more dependent on the spending of the affluent as the income gap widens with middle income wage earners falling further behind.  An Aug 18 article, Two Americas: The Gap between the Top 5% and the Bottom 95% Widens observes:

Economists Emmanuel Saez and Thomas Piketty have reported that the top 10% of earners took home about half of all income as of 2007.

The number of people in the highest reaches of income also fell–tax returns reporting income of $1 million or more fell by 22% to 321,294, and the number of returns that reported income of more than $10 million fell 36% to 13,480.

Put the data together and this reveals an increasing concentration of income and wealth at the top.

The U.S. economy is thus increasingly dominated by the wealthy. According to research from Moody’s Analytics, the top 5% of Americans by income are responsible for 37% of all consumer spending—about the same as the entire bottom 80% by income (39.5%).

These are rather startling statistics: out of 130 million households, 1/100 of 1% rake in $10 million or more annually. As consumers, the top 5% carry the same weight as the bottom 80%. The top 10% take in 50% of the income.

This trend has coined a new word: Plutonomy, an economy that is dependent on the spending and investing of the wealthiest slice of citizenry.

As a result, when the 5 percent in income earners–those households earning $210,000 or more annually–rein in their discretionary spending, then the U.S. economy tanks.

Most economist and government officials seem baffled as to why all these stimulates, especially in the last few years, have not produced the results as expected. I suggest the reason is U.S. companies have not been investing in our economy in any major way for years and the massive amount of imported American branded products and the dismal job situations are the results. It is also why China’s economy has exploded during the same time. This is also a contributing factor for why we have had what has been referred to as a jobless recovery since 2003. Every time there is a spike in consumer spending there is a corresponding spike in our trade imbalance. Is it really all that mysterious? I haven’t decided yet whether our leaders are really puzzled or if they’re just trying to keep the lid on things. As things currently stand, the government can cut taxes until the cows come home and the only ones (beside the bankers) to benefit are the foreign producers and the U.S. manufacturers that outsourced.

A popular mantra for keeping the Bush tax cuts is we need them to help keep America competitive in the global market by encouraging more investment to create more jobs and greater output by our economy. Now think about that for a moment in relation to what we have just discussed here. What part of America are they referring to, corporate America? Hell, through outsourcing corporate America has a corner on the global market. Investing where, here or abroad? Create jobs where, here or abroad? Create increased output where, here or abroad? Well, we know the answers to those questions. Who really needs help in competing in the global market are America’s workers. But there’s nothing in these tax cuts that will help with that.

Another mantra for the tax cuts is we need them for the affluent so they can invest. I ask you to consider this; on Sunday August 15th, CBS 60 Minutes featured Offshore Banking: A Crack in the Swiss Vault. Very briefly the story is of a whistle blower, an American working for UBS – that came forward to let the Treasury know of over 19,000 wealthy American clients he helped to shelter huge amounts of money so they could avoid taxes. One wealthy client alone owed the Fed over $52 million in back taxes. Some 14,700 have now come forward to fess up. The back taxes are in the billions. The whistle blower is serving prison time while none of the tax evaders is being persecuted. Granted, not every wealthy American is hiding money offshore but do they really need more cuts at tax payer expense if those that do will only hide it?

It’s disingenuous to claim that tax cuts are needed to spur investment and create jobs when that is not happening, at least not here in the U.S anyway. It seems pointless to argue over whether these tax cuts have worked or even argue over their virtues and who needs them and why if our government is losing money year after year and amassing huge debts in the process. What clearer evidence do we need to tell us something is seriously wrong?

Our leader’s choices are limited and ugly. But this is a situation they created and they need to get a grip on our fiscal situation. Rather than playing politics they need to become true fiscal stewards and navigate America out of this damn mess. The leader who has the balls to tackle this situation head on will unfortunately not be very popular because everyone needs to step up to the plate. More importantly Americans in general need a reality check otherwise policy makers will navigate us right over the cliff. Under current conditions we are ill suited to expect more stimuli from our government, it’s tapped out. It’s time the government put its stimulation programs in the closet and let the ‘free’ market sort it out. But we are the government and if we do not get this under control soon there will be few winners.

Mitch Gurney

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  • Depressed Libertarian

    Look, these tax cuts would be a lot more beneficial if we stop masking their effects with the huge amounts of debt we’re piling up through these ill-advised and irresponsible displays of spending such as the stimulus, health care, and all the bailouts. We have both parties to blame for the supposed “failure” of these tax cuts. I’m not a Bush fan in any way, but this was a good move on his part, just to be ruined once he left.

  • Marsh

    If government would use our taxes for there intended purpose ie) Social Security tax, and let state governements function without putting undue burdens on them ie) Federal Health Care costs, school busing for balancing schools and the like. And Congress not giving themselves raises when the economy is in trouble we wouldn’t have to be talking about tax cuts because our taxes would never have gotten this high. When 51% of all union memers are now governement employees it changes our constitution from “We the people” to “We who work for the government”.

  • orda

    If corporations didn’t ship millions of jobs overseas where millions pay taxes to other countries (billions of dollars right there), if we taxed the wealthy at rates that we used to have (more billions), if we didn’t have two wars to pay for that have created more terrorists than we’ve killed (more billions), if we lifted the social security tax ceiling (billions more dollars), if we actually made our huge multinational corporations pay any tax (billions upon billions), and other FAIR ideas, our tax problems would be solved.

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