Is Letting the “Bush” Tax Cuts Expire the “Largest Tax Increase in History?”

August 4, 2010

Washington is home to a lot of hyperbole and when Washington is talking tax policy, it seems like it gets magnified.

Lately, we've heard a lot of conservatives argue that Americans are set to face the biggest tax increase in history come January 1. So is this true?

First off, let's assume that allowing the Bush tax cuts to expire is indeed a tax hike. It's all semantics and it technically depends on what baseline you use as to whether allowing a temporary tax cut to expire constitutes a tax increase, but let's call it a tax increase for the sake of this blog post.

Furthermore, let's assume that it would actually happen as opposed to Pres. Obama's proposal (see below).

The Numbers

Allowing all of the tax cuts to expire (assuming an AMT patch is already in place) would raise taxes by around 1.6 to 1.7 percent of GDP. I derive this by taking the administration's cost of allowing the tax cuts to expire from 2011-2020 (around $3.2 trillion after adding in the estate tax) and dividing by the administration's assumed aggregate GDP in that time period (around $196 trillion). (No discounting was done on my part.)

How does this stack up to other tax increases in U.S. history? Treasury economist Jerry Tempalski is the person of record on this issue of the relative magnitudes of tax bills over time. In 2006, Tempalski wrote this Treasury paper which showed that no tax increase since 1968 has really been close to that 1.6 percent of GDP figure. The largest tax increase since 1968 was the "Reagan" tax hike in 1982 (the Tax Equity and Fiscal Responsibility Act of 1982) that captured around 1 percent of GDP over the first four years, or 1.2 percent in the fourth year and likely hovered around that mark for each year beyond.

Between 1940 and 1968, there were two tax hikes that would be larger than the tax increase Americans would face from letting the Bush tax cuts expire when measured as a percentage of GDP. Both were large wartime taxes (1941 and 1942).

So if you restrict the analysis to peacetime tax increases, you would be technically correct to call full expiration of the Bush tax hikes the "largest tax increase in history," assuming history starts at 1940. (Tempalski's study only goes back to 1940.)

That being said, President Obama has not called for all of the tax cuts to expire, thereby leading to a $3 trillion tax hike. If Pres. Obama's actual proposed policies became law and instead of a $3.2 trillion tax increase we got a $1 trillion tax increase (even counting his proposed limitation on itemized deductions), that wouldn't even match the Reagan tax hike. If one included the tax hikes in the health care bill (another $600 billion over 2011-2020 if you trendline and assume it was fully phased-in by 2011), then the combined effects of Obama's tax hikes would still be less than the single Reagan tax hike. However, such a comparison would be comparing apples and oranges because if we are going to look at more than one piece of legislation, Reagan significantly cut taxes prior to the 1982 increase and Obama has passed other tax legislation and may propose higher or lower taxes down the road (such as a VAT).

Summary

If you assume that letting the Bush tax cuts expire constitutes a tax increase and if you ignore the wartime taxes of the 1940s, you can plausibly defend the claim that letting the cuts expire is the largest tax increase in history according to the share of GDP measure. (Of course, you can always without equivocation say that it's the largest tax increase in nominal dollars and be technically correct, but I could also compare Gone with the Wind gross sales with some mediocre movie in 2008 if I wanted to argue that Gone with the Wind isn't that popular.)

However, saying that President Obama is currently pushing for the largest tax increase in history is highly misleading. (When/if he campaigns for a 10 percent VAT, then you'll be correct.)


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