Tuesday, August 9, 2011

The Bush Tax Cuts lower revenue by 1.7% of GDP

How big are the Bush Tax cuts? There is some confusion about these numbers. The right uses wildly overstated supply-side arguments to claim that Bush tax cuts didn’t cost anything while the left uses accounting tricks to inflate numbers and to claims that the tax cuts are the main cause of the deficit.

There are two tricks to be aware of.

1. Don’t confuse the “Bush Tax Cuts” with “Bush Tax Cuts For The Rich”. Obama’s plan to repeal the Bush Tax Cuts only for those making $250.000 per year will raise one quarter as much revenue as the entire tax cut.

2. Don’t accept analyses which add the AMT-fix to the Bush-tax cuts. This is an accounting trick. Every modern administration, including Obama, passes an AMT-fix. The Alternative Minimum Tax was designed not to allow the rich to use too many deductions, but wasn’t inflation indexed. Therefore in order to prevent it from hurting the middle class each administration has to pass a law postponing it.

Over the next decade, the Total Bush tax cuts reduce revenue by about 1.7% of GDP per year (0.4% of which represents tax cuts for the rich). During this period the deficit is expected to average about 6.7% of GDP.

Over ten years, the deficit is expected by the CBO to be about $13 trillion dollars. Repealing the Bush tax cuts on the rich as President Obama proposes will raise $0.7 trillion. Repealing *all* Bush tax cuts would raise $3.3 trillion. In addition, if all tax cuts are repealed, the U.S will save $0.7 trillion in interests on debt.

The Bush tax cuts on the rich (the part Obama wants to repeal) barely makes a dent on the deficit. If you include the cuts for the middle class the Bush tax cuts is a non-negligible cause of the deficit, but even then not the main cause.

Yet the left often inflates the role of the tax cuts, I suppose in order to give the impression that easy choices can fix the deficit. CNN;s Fareed Zakaria for instance claimed recently that allowing the Bush tax cuts to expire would:

“provide the federal government with $3.9 trillion in revenues over the next decade and basically solve the deficit problem.”

Fareed Zakaria’s revenue numbers are somewhat incorrect. I think he is mixing increased revenue with reduced deficits (which is not a major error, since he is concerned with the deficit, not revenue, though he writes "revenues").

Another example of exaggerated numbers is Obama former car szar Steven Rattner who claimed yesterday that tax cuts represented $400 billion of the current deficit. The figure for 2011 is less than half of that. My guess is that he includes the AMT fix, the Obama payroll tax cuts and some other accounting tricks to arrive at this inflated figure.

Zakaria’s claim - common among the left - that the Bush tax cuts would “basically solve the deficit problem” is an exaggeration, seventy percent of the ten year deficit and an even larger part of the long term deficit would remain even should all Bush tax cuts be repealed, since the main cause of the fiscal imbalance is expanding expenditure as a share of GDP.

For the long term deficit the Bush tax cuts are even less important. The tax cuts represent about 1.7% of GDP in increased revenue per year, while the federal deficit on its current path is projected to explode to above 10% of GDP by 2026.

Let me finish by citing the Congressional Research Service:

“The Obama Administration has proposed allowing the Bush tax cuts to expire for high income taxpayers and permanently extending the tax cuts for middle class taxpayers….this proposal is projected to increase tax revenues by … $678 billion over 10 years, but still leaves federal debt on an unsustainable path.”


UPDATE:

Reader Tim correctly pointed out that I was making a misstake by not including the interaction effect with the AMT. If we both keep the tax cuts and pass an AMT-fix (which almost certainly will happen), that adds about a quarter to the cost of the tax cuts. I have adjusted the figures.

27 comments:

  1. Suggestion: could you add a one sentence summary of what the AMT is, and why it shouldn't count? I had to go look it up.

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  2. You are making a basic mistake about the AMT, yourself. See footnote 'h' on page 43 of the CBO report your link to (Table 1-7). The interaction of extending the Bush tax cuts and the AMT 'fix' has "an additional revenue loss of $658 billion" over the next decade. (What you need to do is compare the bottom two rows on page 42.) So the total cost to the primary deficit is $3.3 trillion plus the $0.6 trillion in debt service. Gee, maybe that's where Zakaria got his $3.9 trillion number. Glad we could clear that up.

    And you should acknowledge that we are stuck now with having to pay the interest on the debt that financed the Bush tax cuts - you'd want to factor that in to be complete.

    Also, the effect of the tax cuts increases over time. So, in 2020, the tax cuts have a total cost of $623 billion, or 2.7% of GDP.

    Certainly changes to public provision of health insurance for the old and poor are also needed, but just sayin'.

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  3. Thanks Tim, you are completely right! I didn’t know about this interaction. I have now updated the numbers.

    Zakira is still wrong, but not by much, since he said $3.9 trillion in “revenues” (interest rates are lower expenditure, not revenue).

    Adding past interests rates is incorrect. We simply do not have the policy choice to go back in time and change tax rates, the decisions discussed can only affect future interest rates.

    Do you want to include the accumulated past interests costs of spending whenever we discuss social programs as well?

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  4. Oh, you're right. Zakaria was playing loose with the wording there, if not misunderstanding as you suggest (which I wouldn't put past him).

    However, I do think you should consider a more sympathetic reading of what Zakaria means by "basically solve the deficit problem." He could be talking about the "fiscal gap," in which the reference point is the deficit needed to keep debt/GDP constant (as defined by the CBO in their June document). In 2021, the fiscal gap is 4.5% (under the "alternative scenario"), and keeping the Bush tax cuts has a total cost of 2.7%. So that's still a stretch by Zakaria (though he did signal as much by throwing in the weasel word "basically"), but not as much as you make it sound.

    I grant your point about the irrelevance of past interest costs for forward-looking budget debates. But if you are talking about the "blame" for the current deficit, as Steven Rattner was, then it's only fair.

    ReplyDelete
  5. Hmm, counting inflation, the fiscal gap in 2021 may only be 2.5%, making Zakaria's claim correct? I'm not sure about that, though.

    In any case, it would be misleading not to acknowledge that spending takes off after 2020 due to health care inflation swamping everything else, so spending increases are clearly the issue in the very long run.

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  6. Isn't 1.7% of GDP a significant proportion of 6.7% of GDP?

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  7. Certainly, which is why I wrote "Bush tax cuts is a non-negligible cause of the deficit".

    Significant, but not the main cause as commentators above claim.

    In addition to the 1.7% in revenue you would get a third of a percent in lower interest costs.

    Keep in mind that President Obama only wants to repeal tax cuts on the rich, which is *not* a significant part of the deficit.

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  8. This comment has been removed by the author.

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  9. I thought Obama had banned the AMT accounting gimmick. See here.

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  10. That is from the budget, the CBO still uses the current law which people cite (though they provide numbers without gimmicks). I myself inadverdently used data which did not adjust for the ATM issue in the original post.

    ReplyDelete
  11. This is an important citation. This post picks at the crux of today's economic depression.

    Spending is the problem!

    Natural Law (physics and chemistry) place a natural cap upon the State's ability to raise revenues as a percentage of the GDP.

    The cap is about 33%/GDP. In America this revenue is split between the Fed and the State's (inc local).

    This means the natural cap upon the Fed is about 16.5%/GDP. Not surprisingly the average rate of Fed Rev/GDP since 1970 is 16.6%.

    The Fed spent an estimated 25%/GDP in 2011. The Fed budget is set to spend beyond 22% into infinity.

    The Fed has been breaking the bank since 1952. Today's revenues merely reflect a return to nature.

    The spending represents a cancer that may be out of control.

    The politicians are using the Bush Tax Cuts to create an artificial reality.

    The real money being lost from revenues can be found in the collusion formed by the Ruling Class; Big Govt & Big Wall St. They have created tax laws that lets them shed debt into the national debt (via bankruptcy laws and corp welfare).

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