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Economic Sense

RSS By: Matt Bogard,

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

Evidence on Tax Cuts

Feb 22, 2009
It is unfortunate that certain policies often get categorized as being either 'liberal' or 'right wing'. As a result, good policies are often neglected, or are never considered based on their actual merits. There are many cases where this is true, but one in particular has to do with marginal tax cuts that include tax cuts for the wealthy.

The basic argument for cuts in marginal taxes is that lower tax rates provide an incentive for increased economic activity. In addition, lower taxes reduce the incentive for the wealthiest Americans to engage in activities to avoid paying taxes . Why pay high management fees, and risk lower returns if a reduction in taxes will lead to higher after tax returns than what you will get in a tax shelter?

Is there any evidence for these supply side effects? Do we actually see increases in economic activity and increases in revenue in the face of cuts in marginal tax rates?

In his book 'Vision of the Annointed,' Thomas Sowell provides data from the US Budget Historical tables ( I checked these ) indicating that with the Regan tax cuts, we saw revenue increases.

This is corroborated by Lawrence Lindsey ( 1987) who found that for those earning > $200K per year, we saw the following increases in collections:

1982 – 3%
1983 – 9%
1984 – 23%

( see Lindsey, Lawrence B. 1987. “Individual Taxpayer Response to Taxcuts, 1982-1984.” J. of Public Economics 33 (July) 173-206 , also noted in: Robert Barrow. Macroeconomics- 5th Edition MIT Press 1997 )

And for the recent Bush tax cuts: ( see this from the  Wall Street Journal

"Taxes paid by millionaire households more than doubled to $274 billion in 2006 from $136 billion in 2003. No President has ever plied more money from the rich than George W. Bush did with his 2003 tax cuts. These tax payments from the rich explain the very rapid reduction in the budget deficit to 1.9% of GDP in 2006 from 3.5% in 2003." ( see historical tables link above )

Also, straight from the historical tables provided by the office of management and budget you will see that from 2004-2007 there was a 25% surge in tax revenues, ( in face of tax cuts) which was the largest 3 yr surge since 1966. ( again I checked the math)

Further evidence is given by President Obama's chief of the council of economic advisers, Christina Romer. She finds that a dollar of tax cuts raises the G.D.P. by about $3. According to this research the benefit from tax cuts is more than twice what other researchers say we get from spending increases.

The evidence indicates that ‘marginal’ tax cuts may lead to increased economic activity and therefore increased tax revenues. It is certainly something to consider for the next stimulus package.
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COMMENTS (7 Comments)

'The cases sited represent growing and expanding economies. Today we have lost Trillions of dollars of value.'
So would you propose raising taxes during the 'worst economic crisis since the great depression'? How is penalizing productivity a good thing in a time when capital is on strike (as a result of the current administrations policies)? Putting more people out of work would seem to make the collections pinch worse.
10:52 PM Feb 26th
Actually the Regan tax cuts did not take place during an expanding economy. At that time we actually were in the worst economy since the great depression.The unprecedented expansion came only after the tax cuts and lasted through the Clinton years. Without this growth, Clinton would not have been able to raise taxes and still balance the budget without detriment to the economy as he did. Tax cuts will provide the incentive to put people back to work, alleviating the collections pinch.
10:18 PM Feb 26th

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