What a (Tax) Relief

What a Relief
New York Sun Editorial
May 29, 2008

The Treasury Department marked the fifth anniversary of President Bush's signing into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 by releasing two papers analyzing the effects of that and other tax cuts, and for those of us who enjoy the fine points of tax policy, they make for some fascinating reading.

We confess we stumbled a few times in making our way through the language, which seems at times to buy into left-wing assumptions. "Capital gains income, which is not captured in GDP, more than quadrupled between 1994 and 2000," says one of the papers. "Tax receipts from capital gains realizations more than tripled during this period, even though the tax rate on capital gains was reduced beginning in 1997."

Charlie Gibson, call your office. "Even though"? The tax receipts from capital gains didn't rise "even though" the capital gains tax was reduced, they rose because the capital gains tax was reduced. As the Laffer Curve graphically depicts, there is a point at which if you tax something less, you get more of it, and if you tax something more, you get less of it.

The paper makes the same rhetorical error later on, saying, "After 2004, tax revenues again grew faster than the economy. Despite the tax relief enacted earlier in the decade, the ratio of receipts to GDP was 18.8 percent in 2007, above the 40 year average."

"Despite" is the wrong word. Tax revenues did not rise "despite" the rate cuts; they rose because of the tax cuts. If we seem to be repeating ourselves, it's because it's almost impossible to overemphasize this point. It's a key to sensible tax policy. Rate reductions do not necessarily mean losses in government revenue. A portion of the revenue losses that would be predicted by a static analysis, sometimes all of them, sometimes more than all of them, are made up for by the effect of the rate cuts in spurring economic growth, work, savings, and investment.

Lest we seem too critical of the Treasury, let us say there is plenty of useful data in the papers. One point underscored is how the richest Americans shoulder more than their share of the tax burden. In 2005, most recent year for which data are available, the top 5% of taxpayers earned 35.7% of the income, but paid 59.7% of the income taxes. The top 1% of taxpayers earned 21.2% of the income, but paid 39.4% of the income taxes. The Democrats running for president, Senators Obama and Clinton, are promising to raise income tax rates on the "rich," but it's hard to see how that can be done much more without putting the burden of funding the whole federal government on a small minority of Americans and starting to raise the whole question of taxation without representation. If the persons paying for the government start to be a substantially different body than the overall population, a country begins to run the risk of serious political strains.

Such concerns are ameliorated somewhat by the data in the Treasury report on income mobility. It found substantial income mobility, with more than half of households moving to a different income quintile between 1996 and 2005. Roughly half of the households in the bottom quintile in 1996 had moved to a higher income quintile by 2005. And more than half of those in the top 1% of earners in 1996 had moved to a lower income group by 2005. Treasury analysis found that income mobility between 1996 and 2005 "was virtually the same as income mobility over the prior comparable period from 1987 to 1996."

The study also underscored that the president's tax cuts helped not only individuals but small businesses. "About 70 percent (1 million) of the 1.4 million tax returns that benefited from lowering the top two tax brackets from 39.6 percent to 35 percent and from 36 percent to 33 percent are flow-through business owners," the Treasury said. The report says that 34 million Americans own some sort of "flow-through" business, one that pays taxes via its individual owners. That includes roughly 4 million S corporations, 4 million partnerships, 22 million sole proprietorships and 2.2 million farms. In other words, the tax cuts affect not only wage-earners but employers and job creators.

One of the papers also underscores that the tax cuts are scheduled to expire at the end of 2010, which would mean significant tax increases for almost all taxpayers. As the Congress and the next administration weigh what to do about these scheduled sunsets, these Treasury reports will be worth keeping in mind.