Tax cuts and their consequences

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In a comment to my piece last week on supply-side economics, Dan G. of Milwaukee cast doubt on the forecasts of the Congressional Budget Office: “The CBO can’t make predictions, assumptions, or analysis any better than some far left economics professor shielded from business realities on a college campus,” he wrote. Then he declared:

History has shown, every time major individual tax cuts have gone through, tax receipts go up considerably quicker than they did during the preceding period. You can call this “coincidence” if you wish, but there is more to it than that.

I didn’t know if this was a “coincidence.” What I really wanted to know was if it was true.

I figured Dan would want me to keep the pointy-headed economists out of it, so I simply looked at the last three decades of personal income tax receipts (taken from this year’s Economic Report of the President), adjusted for inflation (measured by the Bureau of Labor Statistics). It was just me and a spreadsheet, mano a Excel. Plus a copy of C. Eugene Steuerle‘s indispensable book, Contemporary U.S. Tax Policy, so I could see when the tax cuts happened. Here’s what I found:

Several modest tax cuts were enacted in the mid-to-late 1970s. Their impact, however, was swamped by that of inflation, which bumped taxpayers into higher income brackets and made capital gains seem bigger than they really were. So, effective tax rates mostly rose during the decade. Tax receipts dropped 6% in 1975, in part because of a big tax rebate paid that year, but after that increased at a healthy clip–up 12% in 1977, 7% in 1978, and 8% in 1979 before dropping 1% in the recession year of 1980.

Then came the sweeping Reagan tax cuts, enacted in 1981 and put into effect over the next three years (the 1981 law also indexed tax brackets to inflation starting in 1984, putting an end to those bracket-creep-induced backdoor tax hikes). After that Reagan-era tax policy was marked by repeated small tax hikes and then the sweeping “revenue-neutral” reform of 1986, which reduced the top marginal rate to 28% but also raised taxes on capital gains and took away lots of exemptions.

What happened to personal income tax receipts? They rose 6% in 1981, then fell 2% in 1982, 6% in 1983, and 1% in 1984 before finally bouncing back 8% in 1985, 2% in 1986, and 9% in 1987. Then they dropped 2% in 1988 and rose 6% in 1989.

In 1990, with the federal government deep in the red, Reagan’s successor George Bush acquiesced to a tax bill that included effectively raising the top tax rate to 31%. Bill Clinton and Congress upped that to 39.6% in 1993.

What happened to personal income tax receipts? Down 1% in 1990, 4% in 1991, and 1% in 1992–but up 4% in both 1993 and 1994, 6% in 1995, 8% in 1996, and 10% in 1997.

Congress passed and President Clinton signed into law a variety of tax cuts that year, and revenues kept rising: 11% in 1998, 4% in 1999, 10% in 2000. Then came the Bush tax cuts of 2001, which included a rebate paid out that year, followed by another round of cuts in 2003. Personal income tax receipts dropped 4% in 2001, 15% in 2002 (the sharpest one-year decline since 1949), 10% in 2003, and 1% in 2004 before finally rising 11% in 2005.

Measured by decade, personal income tax receipts rose at a 2.4% annual rate in the 1970s, 1.8% in the 1980s, and 3.9% in the 1990s. So far in the 2000s they’ve fallen 3.3% a year.

To summarize, tax receipts rose more slowly after the Reagan tax cuts than before. They dropped after the 1990 Bush tax hike, rose after the 1993 Clinton hike, rose after the 1997 tax cut, then dropped after the 2001 Bush tax cut. You can call this “coincidence” if you wish. I just call it confusing.

What are the lessons here? (1) There are reasons why we let pointy-headed economists deal with this stuff, and (2) Dan’s statement that “every time major individual tax cuts have gone through, tax receipts go up considerably quicker than they did during the preceding period” is false.