Belatedly, Republicans in Congress have become concerned about the federal budget deficit. But this is making it harder for them to find the votes to extend previously enacted tax cuts, some of which expire in 2008, and all which disappear after 2010. Tax-cut supporters are now arguing that failure to extend the tax cuts will actually cause revenues to fall, thereby defeating the goal of deficit reduction.
As the Wall Street Journal put it on March 23, "The revenue data are further proof of the success of the Bush tax cuts of 2003. The fastest way to stop this revenue windfall, and blow an even larger hole in the deficit, would be to fail to extend the 15-percent tax rate on capital gains and dividends through 2010, thus assuring a huge tax increase after 2008."
The flip side of this argument is that the 2003 tax cuts are said to be raising federal revenue because of a Laffer-curve effect. The Journal cited the "astonishing" 14.6-percent increase in federal revenue in 2005 over 2004, which it rounded up to 15 percent. It also noted that revenues in the first five months of fiscal year 2006, which began last Oct. 1, are up 10.3 percent over the same period in fiscal year 2005. No other evidence was offered.
But how likely is it that the Laffer curve is causing revenues to rise, as opposed to normal operation of the business cycle? Not much, in my opinion.
First of all, the Laffer curve came to prominence during a period when the top tax rate on dividends was 70 percent, and the rate on long-term capital gains was 40 percent. Economist Arthur Laffer correctly pointed out that a 100 percent tax rate would raise no revenue and that rates close to this would reduce revenue below what a lower rate would bring in. Given the tax rates in existence, it was plausible to argue that a reduction in the top rate and capital gains tax would raise revenue.
However, when President Bush took office, the top rate on dividends was down to 39.6 percent, and the rate on long-term capital gains was just 20 percent -- far below the rates Ronald Reagan inherited. It is very implausible that these rates were in the "prohibitive" range of the Laffer curve, such that a rate reduction would raise revenue.
But even if we grant the theory, how likely is it that the recent rise in revenue owes anything to this effect? Again, not much.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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