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Economic Sense

RSS By: Matt Bogard, AgWeb.com

Matt's primary interest is in the biotech industry and ag policy.

Taxes and Deficits

Jan 08, 2011

By Matt Bogard

Prior to the financial crisis, deficits were falling drastically, while revenues to the government were on the rise. This goes hand in hand with the marginal tax cuts at the begining of the decade. As the data below shows, supply side economics, or 'trickle down' if you want to use that term, was working up until the financial crisis. The financial crisis represented a huge road block to the road to prosperity on which we were headed.


As the chart below depicts, from 2000-2009, we saw drastic increases in revenues (nearly 30% from 2001-2007) in the face of marginal tax cuts. Any deficit that resulted would have to be attributed to expenditures or outlays, and could not be attributed to cuts in marginal tax rates. As the graph shows, outlays also increased during this period, but even more drastically by 46%!

 


 

As the next graphic shows, early on we saw a fairly rapid increase in the budget deficit from 2002-2003, a tapering off from 2003-2004 and  a rapid decline from 2004-2007, by as much as 61%! This is very impressive given the large amounts of spending increases depicted above. If it were not for the large influx of tax revenues during this period (in the face of marginal tax cuts) the deficit likely would have been on the increase vs. the precipitous fall depicted below.

 

However, on the heals of the financial crisis, going into 2008 & 2009, we start to see declining revenues, and unprecedented increases in spending and the deficit. From 2007 - 2009 we saw an increase in spending by about 28%, and an 88% increase over 2001 levels.  (indicated by the drastic upturn in outlays in the first graph)

But the impacts on the deficit were even more dramatic. From 2008-2009 the deficit increased by 208%!  If you compare to the 2007 low, that is nearly an 800% increase in the deficit in just 3 years!

Looking at the data, it appears that the reduction in marginal tax rates in the 2000's did not coincide with the rapid increase in the budget deficit that occurred at the end of the decade, but in fact were in step with the very rapid reduction in the budget deficit through 2007. Most likely the deficit was the result from decreased revenues and increased expenditures associated with the financial crisis, not cuts in marginal tax rates.

The real question becomes what was the cause of the financial crisis? Can we blame 'reckless' tax cuts? (as the data above shows, they were not so reckless afterall).

There is no macroeconomic theory that I am aware of that links tax rates to business cycles. The timing of economic activity can be affected by tax rates, but not in a way that can be linked to booms or recessions. Focusing on the Federal Reserve's social planning of money and interest would be the place to start.

What about the recent extension of tax cuts? Would letting them expire devastate the economy? I'm not sure it would, but I doubt letting them expire would help at all with job growth or with actually lowering the deficit. To support long term investment and job creation, the rates need to be extended permanently or even reduced further.

Data Used: U.S. Budget Historical Tables http://www.whitehouse.gov/omb/budget/fy2009/hist.html (accessed Feb 2, 2009)

    RECEIPTS  OUTLAYS      DEFICIT
2000 ............................................................................... 2,025,198  1,788,957 236,241
2001 ............................................................................... 1,991,142 1,862,906 128,236
2002 ............................................................................... 1,853,149 2,010,907 –157,758
2003 ............................................................................... 1,782,321 2,159,906 –377,585
2004 ............................................................................... 1,880,126 2,292,853 –412,727
2005 ............................................................................... 2,153,625 2,471,971 –318,346
2006 ............................................................................... 2,406,876 2,655,057 –248,181
2007 ............................................................................... 2,568,001 2,728,702 –160,701
2008 ............................................................................... 2,523,999 2,982,554 –458,555
2009 ............................................................................... 2,104,995 3,517,681 –1,412,686

 

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