At the end of this year, America will be looking down both barrels of one of the biggest tax increases in history: the expiration of the 2001 and 2003 rate reductions on income and dividends/capital gains. It's seldom a good time to raise taxes, but the imposition of the old rates during a recession may guarantee a Hooverian result. The country needs further tax reductions and an even larger reduction in spending to stimulate recovery.
Though there is some disagreement about where the Laffer Curve bends, most agree that higher rates can and do reduce tax revenue and that the Curve allows for a point at which further tax rate reductions won't stimulate economic activity and create a corresponding increase in Treasury receipts. The United States hasn't found the latter point yet. Unfortunately, Democrats controlling Washington are unwilling to seek it.
Reasonable people of all political persuasions will acknowledge that tax cuts worked for Democratic President John Kennedy and Republican President Ronald Reagan. Presidents Kennedy and Reagan oversaw significant reductions of confiscatory tax rates on high earners and taxpayers generally. In both cases, records show that Treasury revenues increased with the rate of investment of the freed assets.
Often overlooked in the debate over tax policy is the success of the Clinton-era tax reductions -- reductions that, though fairly recent, are unknown to most Americans. That may be no accident.
The Clinton years provide lessons on the effects of tax increases and decreases. The American left attributes the successful economy of the Clinton years to the former and ignores the impact of the latter in order to justify their appetite for the increases they would have us believe will provide additional tax revenues today.
The effects of increasing taxes on Treasury receipts can be seen in the Clinton and Democrat-controlled congressional tax increase of 1993, one of the largest in history. Despite a more robust job market following a recession, the 1993 tax increase didn't accomplish what Democrats expected. The tax increases added very little to treasury receipts despite their magnitude. Reports from the Congressional Budget Office, the Office of Management and Budget, and the Internal Revenue Service all agree.
In fact, the balanced budgets of the Clinton years didn't occur until after a Republican Congress passed and the president reluctantly signed a 1997 tax bill that lowered the capital gains rate from 28% to 20%, added a child tax credit, and established higher limits on tax exclusion for IRAs and estates.
The Clinton tax policies of the early '90s were based on rate increases and luck -- the luck provided by a normal growth cycle that began in 1992 as America emerged from a mild recession and a communications revolution. It was tax relief that improved receipts following the disappointing outcome of the 1993 tax hikes and made the Clinton economy successful. The 1997 rate reduction on capital gains unleashed the economy, causing capital investment to more than triple by 1998 and double again in 1999. Treasury receipts for this category of tax obligation increased dramatically. Without tax relief and the internet/communications revolution, the second Clinton term would likely have seen tax revenues decline in a lagging economy.
There is no reason to believe that tax increases will perform any differently this time under a different aggregation of hopeful Democrats.
To find a pure, easily illustrated example of tax decreases boosting the economy and Treasury receipts, one need only look at the current rates on capital gains and dividends. When Congress passed the 15-percent tax rate on capital gains in 2003, and again following the 2006 extension, Democrats protested that large deficits would result.
The new leadership in Washington and those who support them would allow this tax cut to expire to "generate revenue" for the federal government. Based on data from Congress's own budgetary agency, they should consider whether expiration will have the effect they desire.
For anyone willing to read it, the January 2007 Congressional Budget Office annual report settles any debate. Citing the original CBO forecasts of capital gains tax revenue of $42 billion in 2003, $46 billion in 2004, $52 billion in 2005, and $57 billion in 2006, Democrats who opposed the rate reduction in 2003 claimed that the capital gains tax cut would "cost" the federal treasury $5.4 billion in fiscal years 2003-2006.
Those forecasts were embarrassingly wrong. The 2007 CBO report revealed that capital gains and dividends tax collections were actually $51 billion in 2003, $72 billion in 2004, $97 billion in 2005, and $110 billion in 2006, the last two years nearly doubling initial forecasts.
In other words, forecasts in earlier CBO reports were low by a total of $133 billion for the four-year period. This tax rate reduction stimulated enough additional economic activity to more than offset forecasted losses.
Reductions in tax rates for capital gains were arguably the most successful fiscal initiatives of the past thirty years.
How could the CBO and Democrats have gotten it so wrong?
It's very simple. Forecasts are guesses. When rates change in either direction, the CBO does linear forecasts on tax revenues, never estimating the stimulation or retardation of economic activity resulting from the changes. It is all policy permits them to do. Accordingly, CBO forecasts for rate changes are always wrong. CBO results, on the other hand, are facts -- the same facts that appear in reports from the OMB and the IRS. Four years of factual history on the 2003 tax rate reduction on capital gains and dividends in the CBO's own report showed that contrary to their expectation of revenue declines, the Treasury actually received record revenues from this class of tax obligation. For that matter, including the 2001 rate reductions on income, Treasury revenues set records through 2007, at that point exceeding original forecasts by roughly twice the cost of the two wars in which America was engaged. The CBO was wrong about that as well.
Politicians and their enablers who embrace old, wrong guesses and ignore newer facts are either a little stupid, or they think we are.
All of America's current deficits are the result of spending by both parties above the baseline, including spending on the costs of war, homeland security, and natural disaster. Despite those circumstances, at the rates of economic growth through 2007 and with simple spending restraint, the Bush-era 2001 and 2003 tax rate reductions should have yielded a surplus by 2009 with no increase in taxes.
Unfortunately, federal expenditures have been setting records, too, and are increasing drastically. A typical Congress has a spending problem, not a revenue problem. This Congress is no exception, except that its members are spending at exceptional rates and have no will to stop.
Millions of Americans fell off the tax rolls following the 2001 rate reductions on income. Today, the top 1% of earners pays more taxes than the bottom 95%. Who really believes that taxing this top group even more is going to pay everyone's tab for the ambitious and irresponsible spending objectives of the Democrats in Washington?
Unless clearer heads prevail, we will all pay. Hope for the best, but prepare for the worst.