September 16, 2010

Five Myths about the Bush Tax Cuts

This op-ed was published in the Fiscal Times on Sept 15, 2010.

Myth on the Left: The Bush tax cuts were only for the rich.

For the past ten years, Democrats have convinced a large fraction of the public that the tax cuts only benefited high-income people. The talking point has been repeated so often that it seems as if it must be true. But it never was. Everyone saved, and if all the tax cuts expire at the end of this year, everyone will pay.

The quickest way to prove this point is to compare the official “score” of the president’s tax proposal—letting the Bush tax cuts expire only for high-income people raises $630 billion over 10 years—with the official score for letting all the tax cuts expire, which raises $3 trillion over 10 years.

That means some pieces did benefit those at the top of the income spectrum: changes to itemized deductions and the estate tax, and the rate cuts on high wages, dividends and capital gains. And measured in nominal dollars, a high-income taxpayer saved more than a low- or middle-income taxpayer.

Nevertheless, the Bush tax cuts sent trillions of dollars in tax relief to those beneath the president’s so-called middle-class cutoff of $200,000, and when the tax cuts are measured as a percentage of their income, or as a percentage of their previous tax payments, the Bush tax cuts provided comparable benefits to all income levels.

The most damaging result of this myth is that Democratic Party spokespeople have convinced much of the electorate that all government funding needs can be solved by just raising taxes on the rich; a dangerous misconception, especially as our nation moves ever closer to a fiscal cliff whose avoidance will require hard choices on spending and taxes that hit all Americans.

Myth on the Right: The Bush tax cuts caused revenues to go up.
Republican spokespeople and other tax-cut enthusiasts have asserted that the tax cuts passed in 2001 and 2003 actually increased revenue. They often point to rising revenues from 2004 through 2007 following the tax cuts in May 2003. Unfortunately, as any Economics 101 student will tell you, correlation doesn’t prove causation. Yes, revenue did rise, but we have to answer the question: Would it have risen anyway?

We can never be absolutely sure how the economy would have reacted if the tax cut legislation had failed for some reason in 2001 and 2003, but the consensus among experts is that the economy would have grown in the mid-2000s with or without the Bush tax cuts. That doesn’t mean the tax cuts had no feedback effect at all—people reported more taxable income than they would have—but those beneficial effects were not so great that the tax cuts could have “paid for themselves.”

The most damaging result of this myth is that Republican lawmakers feel less pressure to propose spending cuts. Why bother when cutting a tax rate will raise more revenue?

Myth on the Left: The Bush tax cuts caused the financial crisis and/or the recession.
Many Democratic leaders like to paint with a broad brush when it comes to the economic policies of the previous administration. They blame the real estate bubble, the financial meltdown and the recession on Bush administration policies generally, and then conveniently lump the Bush tax cuts in as part of the cause. As in the Republican myth above, this is a failure to distinguish correlation from causation. No authority on the economy would say that the banking crisis and the recession could have been averted by holding off on tax cuts in 2001 and 2003.

If one seeks to fix blame on the Bush administration, it’s more honest and productive to focus on the administration’s regulations (or lack thereof) pertaining to housing and banking, although even there, the Bush policies were more like a continuation of policies that go back decades.

Myth on the Right: President Obama is proposing the largest tax increase in U.S. history.
As part of their election strategy, Republican spokespeople are pretending that President Obama favors allowing the Bush-era tax cuts to expire for all taxpayers. Often that expiration is called the largest tax increase in U.S. history. Both charges are false.

In his budget, President Obama proposes extending the tax cuts for taxpayers earning less than $250,000 for married couples ($200,000 for singles). When confronted with this documentary proof, some on the right respond that the President had two years to address this expiring tax cuts issue but chose not to do so because he actually wants them all to expire. But by the same argument, Republicans could be accused of preaching spending restraint when they have no intention of cutting spending.

So is Obama’s actual tax plan—to allow tax cuts to expire for high-income people—a historically huge tax hike? No: At $630 billion over 10 years (0.4 percent of GDP), the Obama proposal raises less revenue than many past tax enactments when measured as a share of the economy. If Congress ignores the President’s request and allows all of the tax cuts to expire, will that be the largest tax hike in U.S. history? Such historical comparisons are fraught with technical difficulties, but as a percentage of GDP, total expiration would indeed be historically massive, probably bigger than any tax hikes except two enacted during World War II.

But is allowing a scheduled expiration to take place even a “tax increase” at all? All of the big tax increases in history have required explicit action by Congress. In this case, the “tax increase” was set in law by Congress in 2001 as part of the tax cut due to Senate reconciliation rules. By traditional “current law” comparisons, the Obama budget proposes a historically large tax cut, not a tax hike at all, because it raises less revenue than current law would.

On the other hand, even the president calls his plan a tax hike. That’s because his budget team adopted a “current policy” baseline. Instead of comparing its proposals to current law (the expiration), he compares it to what the policy was last year. By this measure, the Obama proposal to let high-income tax rates go up is a $630 billion tax increase over ten years, and that is significant but not huge, historically speaking. This is mostly a matter of semantics.

A Bipartisan Myth: Tax changes we like are “tax reform.”
Democratic partisans might say that the few provisions of the Bush tax cuts they supported in 2001 constituted “tax reform” because the dictionary defines “reform” as an amendment that improves some law or policy. The Democratic favorites 9 years ago were the establishment of a 10-percent tax bracket for the first few thousand dollars of taxable income, the doubling of the child tax credit from $500 to $1,000; and expansion of the earned income credit for couples.

Republican partisans say any tax cut is “tax reform” – that’s the basic principle advocated by the Americans for Tax Reform. And some academics on the right say that the true tax-reform provisions from the Bush era were the 2003 cuts to the dividend and capital gains tax rates because those reduced the double taxation of capital income.

However, “tax reform” has a more specific meaning in tax policy, expressed in the mantra “broad base, low rate.” True, the Bush tax cuts lowered rates, but they narrowed the base instead of broadening it. That is, instead of exposing previously untaxed income to taxation so that the system would be fairer, and rates could be lowered even more, the Bush tax cuts exempted even more income from taxation.

In 2005, the Bush team finally got around to fundamental tax reform, calling together a group of scholars. They published two smart tax reform proposals that would have lowered tax rates and broadened the tax base, but like the recommendations of almost every tax reform commission since 1986, the year of the last true tax reform, they were ignored by those in power. If by some movie magic, Congress could have enacted in 2001 either of the two plans proposed by the 2005 commission, the nation’s economy and tax system would be much better off.

Gerald Prante, Ph.D, is senior economist and Bill Ahern director of policy and communications at the Tax Foundation.