Wednesday, July 12, 2006

Tax rates, tax revenues and reality

Simply stated, the Laffer Curve is in effect and supply side economics works. Here's the open slap of reality to the socialistic economy models used by the Democrats:

The real news, and where the policy credit belongs, is with the 2003 tax cuts. They've succeeded even beyond Art Laffer's dreams, if that's possible. In the nine quarters preceding that cut on dividend and capital gains rates and in marginal income-tax rates, economic growth averaged an annual 1.1%. In the 12 quarters--three full years--since the tax cut passed, growth has averaged a remarkable 4%. Monetary policy has also fueled this expansion, but the tax cuts were perfectly targeted to improve the incentives to take risks among businesses shell-shocked by the dot-com collapse, 9/11 and Sarbanes-Oxley.

This growth in turn has produced a record flood of tax revenues, just as the most ebullient supply-siders predicted. In the first nine months of fiscal 2006, tax revenues have climbed by $206 billion, or nearly 13%. As the Congressional Budget Office recently noted, "That increase represents the second-highest rate of growth for that nine-month period in the past 25 years"--exceeded only by the year before. For all of fiscal 2005, revenues rose by $274 billion, or 15%. We should add that CBO itself failed to anticipate this revenue boom, as the nearby table shows. Maybe its economists should rethink their models.

Remember the folks who said the tax cuts would "blow a hole in the deficit?" Well, revenues as a share of the economy are now expected to rise this year to 18.3%, slightly above the modern historical average of 18.2%. The remaining budget deficit of a little under $300 billion will be about 2.3% of GDP, which is smaller than in 17 of the previous 25 years. Throw in the surpluses rolling into the states, and the overall U.S. "fiscal deficit" is now economically trivial.

The CBO uses the zero-sum formula for tax accounting -- that is, it looks only at the current revenues and the effect of a lowered tax rate on that revenue level. The CBO makes the same mistake every time: lowered taxes that stimulate economic activity will raise tax revenues because of the economic improvements.

For example, a 15% tax on $1000 income ($150 to the Treasury) lowered to 12% does not mean that the government will only receive $120 in the future from that taxpayer -- instead, if the taxpayer increases its income thanks to the lower cost of its business (or less incentive to hide away money in tax-free investments) to say $1300, the goverment actually gains revenue (12% of 1300 = 156) thanks to the tax cut's effect on the taxpayer's prosperity. Democrats refuse to use these models, which are vastly more accurate than the CBO's zero-sum formula.

As for the tax cuts helping only the rich: that's the largest pile of horse offal possible. Americans in the top 5% of income pay proportionately more in taxes than their "fair share" (their proportion of the tax burden is higher than their proportion of the income that they receive).

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