Tax Cuts and Falling Tax Revenues in the 2000s

Guest Author:  Menzie Chinn is Professor of Public Affairs and Economics, Robert M. La Follette School of Public Affairs, University of Wisconsin, Madison, WI – Vita

This article was originally posted at Econbrowser.  The original post has a lengthy discussion stream by commenters, well worth reading.

Detachment from Reality and Innumeracy as Impediments to Rational Discourse – Tax cut version

 On several occasions, I have observed that it is difficult to debate policy when facts are in dispute, and some individuals are impervious to the revelation of data. I was recently reminded of this by reader tim kemper’s repeated assertions that the “the 2001 act and 2003 act actually increased revenues” (3/1/10). Most recently, he repeated that assertion (on 10/31) and linked to this source as proof of his assertion that tax cuts raise revenues, without realizing that the series he was pointing to was total (not just income tax) revenues, and not seasonally adjusted. Below is the actual evolution of personal income tax receipts both before and after the EGTRRA (the 2001 Bush tax cut). 

egtrra1.gif
Figure 1: Personal income tax receipts, SAAR, in billions of dollars (blue, left scale) and as a ratio to GDP (red, right scale). Vertical line at 2001Q3 (EGTRRA provisions take place starting July 1, 2001; Jan 1, 2002, Jan 1, 2004, 2006). Source: BEA, GDP 2010Q3 advance release, Table 3.2, line 3 and author’s calculations.

In other words, it is hard to discern actual evidence for the extreme supply side proposition that tax rate cuts increase tax revenues, when examining the data (and knowing which data are relevant). Now, we know that many things are going on at the same time, but as a matter of fact one cannot say that income tax revenues rose immediately after the beginning of implementation of EGTRRA.

There are more sophisticated ways of analyzing this issue — in particular one could say income tax revenues would have been even lower had not EGTRRA been passed. But I do not know of any studies that make this particular assertion, and assesses it in an econometric fashion. In any case, this counterfactual-based argument is not the typical one made by extremist-supply-siders. And the fact that revenues had not returned to pre-tax-cut levels even by the time the economy had returned to potential in 2006 [0] also counters the extreme supply-sider perspective.

Additional documentation and analysis here: [1] [2].

Of course, this is a separate question from whether output will be higher with lower taxes; for an analysis, see this post discussing the 2006 (Bush) Treasury report on the issue, as well as CBO’s assessment.

I know there are some who believe argument by mantra is the way to go, but I think constructive debate should be informed by appeal to data.

Update 11:44am Pacific 11/2/10

In response to reader Steve, who has just become my new poster-child for detachment and innumeracy by writing:

With all due respect, every time a tax cut has been passed, revenues to the treasury have risen.

I post a graph of total Federal tax revenues.

egtrra2.gif
Figure 2: Federal tax receipts, SAAR, in billions of dollars (blue, left scale) and as a ratio to GDP (red, right scale). Vertical line at 2001Q3 (EGTRRA provisions take place starting July 1, 2001; Jan 1, 2002, Jan 1, 2004, 2006). Source: BEA, GDP 2010Q3 advance release, Table 3.2, line 2 and author’s calculations.

Posted by Menzie Chinn at November 2, 2010 06:21 AM

Related Article

The Bush Tax Cuts and the Economy by Thomas L. Hungerford

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