Generally, being of a libertarian bent, I am for less government and lower taxes rather than more government and higher taxes.  However, there is a part of the political spectrum that treats tax cuts as religion, offering tax cuts as a panacea to seemingly every single ailment of the US economy. 

The leading shrill for All Tax Cuts All the Time is The Club for Deficits followed closely by the editorial page of The Wall Street Journal.  Here are exerts from today's lead editorial from The Wall Street Journal, entitled Conrad's Tax* ($)

All of this is really sleight-of-hand to disguise that Democrats are intent on repealing the Bush tax cuts. This would raise the tax on capital gains to 20% from 15%, more than double the tax rate on dividends to 39.6% from 15%, and sharply increase marginal tax rates at all levels of income.

Now, a significant part of my income derives from capital gains, so I am more than happy to keep capital gains taxes low.  However, I recall the stock market doing pretty well under President Clinton, who not only maintained high capital gains taxes but also raised taxes.

I was a stock broker trainee when Clinton was attempting to increase taxes in the early 1990s.  During our training class, portfolio managers would come and speak to us, and I had the good fortune of listening to Emilio Bassini, an emerging markets portfolio manager at the time.  I asked his opinion of Argentina's economic prospects, considering its history of disastrous economic populism, and the country's dynamic finance minister, Domingo Cavallo, who appeared to be wrestling inflation to the ground.  Mr. Bassini's response was that he had "more confidence in the guys in Buenos Aires than he did in the bozos in Washington" - that is, Robert Rubin. He also predicted that Clinton's tax increases would plunge the United States into a recession.

Well, of course the United States economy kept humming right along while Argentina plunged into a deep recession, reverting back to its status as an economic adolescent and deadbeat, stiffing bondholders 70 cents on the dollar, most of whom were European middle class retirees.

But I digress. 

The point is that taxes rose in the US and growth was strong for several more years, as was the stock market, which must have baffled the editorial board of the Wall Street Journal and all those who treat the Laffer Laughter Curve as religion.

And all of this saber-rattling about a future tax increase is coming just when the current expansion may need another tax cut to keep growth going. Investors are worried about subprime credit problems and the Federal Reserve, but this looming tax increase on capital isn't helping confidence. The market fell 200 points on the day Mr. Conrad unveiled his magic act last week.

Well, I have heard all sorts of reasons for the recent market weakness but repeal of the tax cuts is one that seems to have slipped by me.  Until I read the unbiased Wall Street Journal editorial page, that is.  Of course, the WSJ wouldn't be latching onto an exogenous event to push a political agenda, would they?

Now, we will identify "false causality," or at least "unproven causality," if there is such a thing.

As Mr. Conrad knows but also won't admit, federal revenues have returned to their historic norm as a share of the economy despite the 2001 and 2003 tax cuts. Or perhaps we should say because of them. Tax revenues have climbed by some $608 billion since the start of fiscal 2005 alone. They are now about 18.5% of GDP.

As the Wall Street Journal knows, tax receipts are cyclical.  Tax revenues as a percentage of the economy usually are at the highest at the top of the cycle.  If we are about to enter a recession, as some commentators such as Jim Rogers are asserting, then tax revenues will fall below the historical average share of GDP.  And if we do, I look forward to the paper's lead editorial on how tax cuts widened the budget deficit.

Last week the IRS released new data showing that capital gains realizations surged by 153.5% from 2003 to 2005, even with the lower capital gains tax rate. Meanwhile, dividend income rose by a little under 50% from 2002-2005.

But how do we know that is because of the tax cuts?  Maybe its because all the insiders are dumping shares because they think their stocks are too high?  Maybe its because this once in a century event of China's entry into the global economy has expanded corporate profit margins and thus corporate profits and corporate taxes to record levels?  Maybe they're right, I don't know, but there are a plethora of reasons for higher tax revenues apart from tax cuts.  To assume that tax revenues are higher simply because tax rates are lower without considering any other alternative only demonstrates that the WSJ appears to have not considered any other alternative.

Some of this is due to the stock market gains in the wake of the 2003 tax cuts, but incentive effects also seem to have played a role. Washington tax analyst Dan Clifton has crunched the numbers and found that from 1997 to 1999 dividend income rose only 27%, even though the stock market climbed faster than it did from 2003-2005. Several economic studies have shown that the lower 15% dividend rate inspired companies to pay more dividends; the feds get 15% of those increased dividend payouts, instead of 39.6% of nothing.

I have no doubt that lower dividend tax rates did cause dividend payments to rise.  But is that necessarily a good thing?  Capital expansion in the United States has been lower coming out of this recession than virtually every other recession.  Part of the lack of capital spending is due, no doubt, to the overcapacity in the economy after the Bubble imploded, as well as all the offshoring to China.  However, capacity utilization in the United States is now 82%, which is historically tight.  But rather than expanding plant in America, excess capital has been used to buy back stock, buy other companies and increase dividends.  This isn't necessarily a bad thing, but it may not be a good thing either.  America may be hurting its long-term competitiveness by not increasing its spending on capital assets. Thus, lower capital gains and dividends taxes may be hurting the long-term competitiveness of the country. (Though, to be honest, I wouldn't make this argument.)

Meanwhile, the budget deficit has steadily been falling. In the first five months of fiscal 2007, federal spending has slowed to a 2% growth rate, while revenues have climbed by 9.3% and individual tax receipts have jumped by nearly 13%. On this trend, the Congressional Budget Office says the budget deficit will decline to 1.6% of GDP this year, and will keep falling if economic growth continues.

And America ran a surplus in the 1990s after taxes rose.  Perhaps if the tax cuts were lower or nonexistent, then maybe the United States would be paying off debt rather than expanding its liabilities.  I would imagine this is what should be happening during an economic expansion.  When America falls back into a recession, the deficit will widen once again.

The proponents would argue that the tax cuts are the cause of economic growth.  I believe that argument sells the American people short.  The US economy has grown about 3% per year on average since World War II with all sorts of different tax regimes.  Though high taxes certainly are a disincentive to grow, in my opinion, I have a hard time believing taxes are a high enough impediment to growth in this country.  The strength of this country is not whether or not the marginal tax rate is 39% or 33%.  Rather, it is the nature and attitude of the American people that make this country so great and such a powerful economic force.  And I say that as an immigrant who has lived abroad and traveled to many countries.

Then we have this table

By the way, the latest IRS data also show that the wealthiest Americans continue to carry a record share of the income tax load. As the nearby chart shows, the richest 1% paid 35.6% of all income taxes in 2004, the most recent year in which data are available. The top 10% pay a remarkable two-thirds of all income taxes. The irony is that the Bush tax cuts have made the U.S. income tax code more progressive. But according to John Edwards and other class warriors, that's not enough.

Now, I haven't dug into the data, so I am more than willing to accept this argument at face value.  However, the question arises, how much income did each income strata earn and what were the growth rates of each?   For example, the growth rate in income for the richest 10% has been much faster than the poorest 10% so we'd expect the richest 10% to pay a bigger share of income taxes.  The question is, did the rate of tax growth match that of income growth?  Should the rich be paying more relative to income and the poorest be paying less due to disparities in income relative to the levels of a decade ago?  Without looking at the growth of income, this graph can paint a misleading picture.  The editorial, unsurprisingly, doesn't address the issue.

There are other issues as well.  For example, what about state income taxes?  What about sales taxes? What about property taxes?  What about tariffs?  Why look only at federal taxes?  Let's break down all taxes and see who is paying what. Maybe the rich are paying relatively more now due to lower federal taxes, but the table doesn't address the entire tax picture.

Also, deficits increase interest rates to a level higher than they otherwise would have been without deficit financing.  How does the break-down of interest costs effect income stratas?  My guess is that since the poorest are effected more negatively by higher interest rates than the richest, tax cuts which increase the deficit and interest rates, or do not allow interest rates to fall to a lower level, is a shift in income from the poorest to the richest. 

I am willing to concede that the proponents of tax cuts may be dead right.  I'm not arguing that they are necessarily wrong.  What I am arguing is that the ideological proponents of tax cuts often paint a misleading and/or incomplete picture about the effects of tax cuts. This editorial is such an example.

Average rating
(0 votes)