Tax cut myths and realities

• Article
• Comments ()
• Click-2-Listen
• Videos

By

President Bush's tax cuts provide a convenient scapegoat for the nation's budget and economic challenges. Demagogued as "tax cuts for the rich," they've been blamed for everything from "runaway" deficits to "drastic" cuts in anti-poverty programs.

Fortunately, virtually all of the conventional wisdom on this subject is wrong. Here are 10 widely held myths about the tax cuts -- and the facts that debunk them:

Myth 1: Tax revenues are too low. Fact: Revenues in 2006 were 18.4 percent of the nation's gross domestic product (GDP), which is actually above the postwar historical average.

Myth 2: The tax cuts substantially reduced 2006 revenues and expanded the budget deficit. Fact: In 2000, before the Bush tax cuts, the Congressional Budget Office (CBO) released a 10-year budget projection that assumed a healthy surplus in 2006. Yet even after all tax cuts, revenues in 2006 came in just $58 billion below the projected level. The deficit resulted more from Washington spending $514 billion above its projected level for 2006.

Myth 3: Supply-side economics assumes all tax cuts immediately pay for themselves. Fact: What is assumed is that some, not necessarily all, lost revenues will be replenished. Reducing tax rates encourages the taxed behavior, and the increased economic activity offsets some lost revenues. Whether a tax cut fully pays for itself depends on how much new activity it generates.

Myth 4: Cuts in the capital-gains tax don't pay for themselves. Fact: Capital gains revenues doubled after the 2003 capital gains tax cuts, from $50 billion to $103 billion in 2006. Before the tax cuts, the CBO projected such revenues would rise to only $68 billion.

Myth 5: The tax cuts are to blame for projected budget deficits. Fact: Revenues are already projected to jump from 18 percent of GDP today to a record 23 percent by 2050 -- and repealing the tax cuts would nudge revenues to only 24 percent. Massive future deficits will result from Social Security, Medicare and Medicaid costs pushing projected federal spending from 20 percent of GDP to at least 38 percent, according to CBO.

Myth 6: Raising tax rates is the best way to raise revenue. Fact: Revenues correlate with economic growth, not tax rates. Since 1952, the highest marginal income tax rate has dropped from 92 percent to 35 percent. Yet revenues have remained constant at 18 percent of GDP. Thus, boosting revenues requires expanding the economy.

Myth 7: Reversing upper-income tax cuts would raise substantial revenues. Fact: The popular child tax credit expansion, marriage penalty relief, the 10 percent bracket and fix of the Alternative Minimum Tax will combine this year to lower revenues by three times as much as the maligned cuts in capital gains, dividend and estate taxes. The latter tax cuts also produce some of the most positive economic benefits.

Myth 8: Tax cuts help by "putting money in our pockets." Fact: Redistributing money between governments and taxpayers merely shifts -- and does not increase -- total spending power in an economy. So government spending does not "inject" new money into an economy, nor do tax rebates help by "putting money in our pockets." Rather, low tax rates increase incentives to work, save and invest, thereby sparking productivity and economic growth.

Myth 9: The tax cuts haven't boosted the economy. Fact: The 2003 tax cuts lowered rates for income, capital gains and dividend taxes. Business investment, the stock market, job numbers and economic growth -- all of which had been stagnant -- immediately surged.

Myth 10: The tax cuts tilted toward the rich. Fact: The rich now shoulder even more of the burden. Since 2000, the share of individual income taxes paid by the bottom 40 percent of taxpayers dropped from zero to minus 4 percent -- meaning the average family in this group got a subsidy from the refundable child tax credit or earned income tax credit. The share of income taxes paid by the top fifth of taxpayers climbed from 81 percent to 85 percent.

America faces real budget challenges. In particular, the impending retirement of 77 million Baby Boomers is set to unleash a $39 trillion tsunami of unfunded Social Security and Medicare spending.

Congress should focus on preventing that looming fiscal disaster, not on repealing the Bush tax cuts or letting them expire. Repealing the tax cuts would not increase revenues significantly. But it would discourage investors and entrepreneurs, reduce incentives to work and slow economic growth. Lawmakers would do well to remember America cannot tax itself to prosperity.

Brian M. Riedl is the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Roe Institute for Economic Policy Studies at the Heritage Foundation.