Shek

A few explanations off the top of my head.

1. Growth. Real GDP increased from $10.5 trillion to nearly $11.7 trillion (some of this could be attributed to the incentives provided by the tax cuts, but definitely not all of it).
2. Think about all the dot com busts from 2000-2001. Deductions on these capital losses would have been used up either just at the start of the period or during the period, meaning an "artificial" increase in tax liabilities simply due to timing.
3. Housing boom. The increased volume of home sales meant more taxable transactions during a time of great appreciation, along with more people incurring capital gains due to selling assets to finance a down payment.
4. Baby boomer retirement boom. Once you retire, you start divesting assets to fund retirement. As more and more baby boomers retire, this means greater tax revenue.

__________________
"So little pains do the vulgar take in the investigation of truth, accepting readily the first story that comes to hand." Thucydides 1.20.3

Shek

Look at the timing of some of the more prominent tax policy changes.

ERTA 1981. The Fed had just finished strangling inflation after pushing interest rates to over 20% and the oil shock of 1979 had just finished propagating through the economy. The tax package was passed and phased in at nearly the bottom of the business cycle.

EGTRRA 2001. Decreasing tax revenues until 2005. Passed during a recession that is no longer a recession, but nonetheless, the bottom of the business cycle.

JGTRRA 2003. Passed on the upswing of the business cycle.

The Administration’s message has been that they would pay for themselves and have paid for themselves, but the Administration’s Chairman of the Council of Economic Advisors stated at the time that this was an incorrect argument (and this is a position taken by the vast majority of economists, although there are still a few diehard supply-siders out there).

Shek

Even after accounting for tax-incentive induced growth, the tax cuts we have seen do not pay for themselves. However, because of the dynamic nature of the response, what you don’t see over time is that a 25% cut in taxes results in a 25% decrease in tax revenues, ceteris paribus (this is the fancy Latin way of saying everything else held constant). The decrease in tax revenue is less than that because of tax-incentive induced growth.

This is not the opposite of what I’ve been stating, and it looks at the question/problem from the wrong angle.

First, in general (given a relatively small change), you’d probably see the opposite of what the tax-cuts saw. Most likely, there’d be an initial increase in revenues, but it’d tamp down growth and so you wouldn’t see a directly proportionally increase in tax revenues, but something less over time.

Second, this is really an empirical question where we must analyze behavior on the margin. Are we looking at Kennedy changing the top tax bracket from 90%, or Reagan from 70%, or Bush from 39.6%? A drop from 90 to 70 or 70 to 39.6 is going to change my behavior a great deal as opposed to 39.6 to 35 (or we can look at the opposite scenarios where you increase rates from 35 to 39.6, etc.). I could come up with equally silly scenarios on the extremes of both directions. If tax cuts are so good, why not drop the tax rates to 0%? If tax raises are so good, why not increase the rate to 100%? The point is that the magnitude of the impact of a change in taxes is not going to be same across all the potential rates so it be based on numbers to get the analysis correct.

Next, to explore the supply-side argument a little bit more in depth (warning, I use some basic terminology from econ 101, although it’s part that people love to hate the most), let’s think through the example of labor taxes, i.e., an income tax on your annual earnings. The supply-side argument is that if you tax at a lower rate, then people will substitute away from leisure time towards the now relatively cheaper work time. In other words, less taxes induce me to work more since I get to keep more of it. This is correct; however, it is only half of the story. Because the tax rate is less, my income actually increases without me working a single minute longer, and so I am richer. Thus, I may actually work even less.

It now becomes a matter of empirics, but it’s clear that while some may work more, there will also be some that work the same and some that work less. It will depend on whether a person’s goal is to make as much money as possible or to live a certain lifestyle.

The problem with this construction is that you’ve created a false dichotomy. In fact, you can use the conservative playbook, which is to lower taxes and cut spending. Unfortunately, we’ve seen the lower of taxes and an increase in spending. The real issue out there is the massive and looming deficits as a result of huge “mandatory” social programs passed under the FDR, LBJ, and Bush 43 Administrations, with the former two being the primary culprits.

glyn

The reason congressmen try so hard to get re-elected is
that they would hate to have to make a living under the
laws they've passed.

__________________
Semper in excretum. Solum profunda variat.

Bluesman

Okay, shek, I actually followed all that (I labor under the conceit that I'm a purty smart guy ), and I still have problems with it.

For instance, it IS a corrollary that an increase in rates equals an increase in revenue, according to what you're saying. Sure, not 1:1, all other things being equal, but STILL: jack up the rate (but not too high), and see a corresponding increase in revenue. So, why don't we do that when the Federal spending increases? Find that magic number that will equal the deficit, (rate increase times the coefficient of whatever percentage we're likely to lose), and just like that, we're back in the black.

And then we're on a track to stand economic rationality on its head: in those times when economic activity falls and federal spending is going up, we increase taxation to cover our shortfall...and the following year, we have to do it AGAIN, and at a faster rate, because as we go along this road, we're destroying economic activity. And the downward South American death-spiral takes us into an uncontrolled descent into terrain.

I dunno, man; I'm a convinced supply-sider, and I think Arthur Laffer had the right idea: people are rational beings that can be expected to behave in their own economic self-interest when faced with confiscatory marginal rates, and they'll be as creative as they feel they have to be to shelter that last dollar earned.

Also, I'm purty sure that we CAN grow our way into self-financed tax cuts. I mean, look at the way the American economy out-performs those places that have MUCH higher rates (I acknowledge all the other factors that contribute: productivity/work ethic, light regulatory regime, cheap and plentiful capital, etc.), and you can see that growth rates are tracking along with low taxation. Over a span of time, that extra one percent (or whatever) rate-of-growth is going to be DECISIVE in making our economy the 800-pound gorilla, and I am absolutely convinced that it starts with a relatively low rate of taxation. And when you tax THAT behemoth, even at low rates, you get more money than if you'd kept the tax-screws on tight and made certain that we were like some wheezing, sclerotic Euro-state with a rate that is higher, and a economy that was lower as a result.

I guess I need to read more economic theory, but it feels too much like training for a marathon I know I'll never run in: hard work, painful, and ultimately of no lasting value.

__________________
"The quickest way of ending a war is to lose it, and if one finds the prospect of a long war intolerable, it is natural to disbelieve in the possibility of victory."
- George Orwell

Shek

The problem here is that you are thinking on the average and not on the margin. Would a change from 35% to 36.9% really change behavior all that much? Also, think through some various scenarios.

Did you change your working hours to adjust your income based on the Bush tax cuts (not a trick question, I know the answer is no because you income wasn't tied to hours worked or productivity - there are others like you out there who can't respond to tax incentives in the short-run, and unless the tax bracket rates are the make/break for a job, they may not respond in the long-run, either).

I'd be curious to see what Confed did as another example. I suspect he probably worked 50-60 hours as a master electrician and probably didn't change his # of hours worked (or maybe would have decreased them due solely to being able to keep more income from the hours that he did work). Of course, maybe he increased them because there was finally enough demand to be able to work more due to the housing boom. I'm sure there are some who increased, but if you're already maxing out hours, you're probably more likely going to cut back. For some, it's not a matter of trying to work as much as possible, but simply work just enough to make enough to live the lifestyle they desire.

This is a slippery slope fallacy and it also calls for way more government intervention than most economists would call for. Also, South American economies self-destruct not because of high taxes, but because of high spending that is financed through printing more money, creating (hyper) inflation, which is bad for your economy. The underlying cause isn't taxes, but out of control government spending.

I think that the Laffer curve is a great thought experiment and provides some insight. However, because it looks only at the substitution effect (work is now cheaper since I keep more income, so I will work more) and ignores the income effect (because I keep more of my current income, I am now richer, and so I may not even need to work as much or I may work just the same), it doesn't have very strong predictive powers, making it a weak model (it also requires you to know which side of the Laffer Curve you are on - if you are a total believer in it, then you should be perfectly fine with the argument that increasing taxes increases revenue, up to a point -- and so you shouldn't be describing your slippery slope scenario).

The true policy issue here that is looming is what our expected expenditures are, and that is what is scary. We have the flexibility now to debate tax rates because while we carry debt, it isn't yet an overwhelming burden that threatens solvency.

However, while your compounding growth is a correct argument, it cuts both ways in the current fiscal environment. That growth rate (due solely to tax cuts) must result in revenues that increase faster than interest that compounds on the debt created from the initial drop in tax revenues.

In the end, the empirics of tax cuts have fallen on the side that they don't pay for themselves.

Shek

Here's an example that is purely correlative and doesn't control for various factors that can change income, but it does demonstrate that the impact of taxes is really not that big in grand scheme of causation. I'm sure you won't like the fact that it was printed by the Gray Lady and written by Obama's advisor, but keep in mind that I started out by using the CEA Chairman under Bush 43 from '03 to '05. As an aside, you'll find that economists that are liberal will tend to fall on the conservative spectrum of the left, although you do get the occasional Paul Krugman.

leo

I agree why it it all ways one or the other - most people will only look at one party - I look at EVERY candidate...

We need to do both... more importantly we WASTE so much of our tax dollars w/ too much BS and special interest groups stopping progress in many many areas of our great country.... IT'S WRONG and they are wasting our money like they just won the lottery and went to a strip joint !!!!

Shek

The Laffer Curve's big screen debut

Shek

An actual informative video on the Laffer Curve (although the numbers in the graph are simply placeholders for now).

Bluesman

That was AWESOME.

And my take-away was that lower tax rates are GOOD, in almost (not all!) cases.

That's what I was a-sayin'. A big, burly, robust, and mostly-tax-unburdened economy is BETTER, all other thangs bein' equal. I got the part about the margins, and I think you'll see that I stipulated that my own bad self. High, SUPER-high MARGINAL rates are simply destructive.

Cut rates, and we're better off. Not always, I grant you, but I never said that. A bigger economy - a product of the right kind of tax cuts - gives a bigger revenue base.

CUT RATES! It pays...unless it doesn't, like from a low rate to a nominally lower rate. But...CUT RATES ENOUGH!

Shek

Remember, the question is an empirical one, which is where are we on the Laffer Curve - between A and B or B and C, and the studies out there that I've seen indicate that we are between A and B, e.g., "In the long run, about 17 percent of a cut in labor taxes is recouped through higher economic growth. The comparable figure for a cut in capital taxes is about 50 percent."

So, the question of tax cuts paying for themselves, while theoertical possible, is not the reality for recent tax cuts.

Thus, it comes back to the need to fund expenditure levels, and simply cutting taxes without cutting spending by a similar amount is bad unless you have plenty of growth occur outside the incentives provided by the tax cuts.

astralis

bluesman,

sounds about right. one other thing to consider- and shek mentioned it in passing- is government spending rates, as well.

while i am for lower taxes, which creates more economic efficiency, the problem with the idea of lower taxes at all costs is that an increase in deficit spending may very well have economic disadvantages that outweigh the economic benefits from the tax cuts.

this depends on the level of deficit spending done, and as you mentioned earlier, the relative size of the tax cut. but this is one of the reasons why i think the bush tax cut (both today and in the first administration) was inadvisable- the negative impact on our fiscal debt (considerable) outweighed the positive impact of cutting (marginal).

now, had bush managed to cut, say, social security or medicare, then i would have been all for it.

incidentally, this is why i'm more for a free-trade president as opposed to a tax-cutting one. given the absolute difficulty of even slowing down government growth (reagan could barely do even this- he didn't even shrink it), and the relatively small impact of further tax cuts (as measured against a $14 trillion economy), the most beneficial economic impact that a president can do is to pass as many free-trade bills as possible, which has the dual benefits of making the economy more competitive and more efficient.

__________________
Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you against the present.

-Marcus Aurelius, Meditations

astralis

annnnd i see shek has come in with THAT air-strike same time as i did, and in fewer words.

Shek

The problem is Congress. They failed to renew fast-track authority (bye bye Doha) and American sentiment is turning against globalization (biting the hand that feeds it), meaning that even a gain by the GOP in Congress may not result in forward progress, at least until fears over a recession pass.

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