The Budgetary Effects of the Bush Tax Cuts

I’d like to follow up on PGL’s post from yesterday about tax cuts and GDP growth. The argument from some supply-side tax-cut advocates (see, for example this WSJ op-ed: “The deficit is shrinking, thanks to the Bush tax cuts“) is that the Bush tax cuts have increased economic growth dramatically. So dramatically, in fact, that they are responsible for the surge in tax revenues in 2005, and the corresponding fall in the budget deficit.

Yesterday AB illustrated one way in which this claim is nonsense: there is no discernable relationship between tax cuts and economic growth. The 2003 tax cut was indeed followed by economic expansion, but the 2001 tax cut was followed by economic contraction. How can we conclude from that evidence that tax cuts cause greater economic growth? Growth seems to be determined by some other factors in the economy, not by tax cuts.

To address the question of whether the Bush tax cuts can be credited with the shrinking budget deficit in 2005, what we really need to do is therefore pose the counterfactual: what would economic growth and the budget deficit have been without the tax cuts?

The best estimate of the supply-side effects of the tax cuts that I’ve seen is from the Joint Committee on Taxation, which is the Congress’s group of tax experts that provide revenue estimates of all pending legislation. In 2003 the Republican Congress directed the JCT to explicitly estimate the supply-side growth and revenue effects of their tax cuts – in other words, to use “dynamic scoring” to gauge the net impact of the tax cuts on revenue. The JCT convened a blue-ribbon panel of macroeconomists (including Alan Auerbach, David Bradford, Martin Feldstein, and Greg Mankiw) to help them develop their estimates.

What were their results? The JCT used several different macroeconomic models, and in December 2003 they published their conclusion that the supply-side effects of the tax cuts would increase real GDP by a total of 0.2%-0.3% over five years. Over ten years the effects on economic growth would be zero, or slightly negative. Such an impact on the economy is so small as to be indistinguishable from statistical noise.

This supply-side ‘boost’ to the economy would indeed increase government revenues somewhat, however, by about 5% to perhaps as high as 25% of the initial cost of the tax cuts. But there’s no estimate that even approaches 100%, which is to say that there’s no possibility that tax revenues were higher in 2005 than they would have been without the tax cuts.

The following picture compares actual and forecast tax revenues given the Bush tax cuts with what revenues would have been without the tax cuts. The heavy red line shows the true situation. The other lines show different estimates what federal tax revenues would have been without the tax cuts.

Obviously, revenues did indeed grow strongly in 2005… but they would have been even higher if the tax cuts had not happened.

The next picture shows what these estimates mean for the budget deficit.

One may like tax cuts for personal reasons, or for ideological reasons. But please let’s not pretend any longer that the economic recovery, or the improvement in the budget deficit in 2005 (which will almost certainly prove to be very temporary), are due to the Bush tax cuts. There’s simply no evidence whatsoever to support those claims, and substantial evidence against them.