In recent months, certain Bush supporters have been gloating over the recent surge in federal tax revenues and the resulting reduction in the budget deficit, claiming that it vindicates the Laffer curve.
There are however some problems with their position. First of all, why would a libertarian or small-government conservative be happy about rising tax revenues ? Perhaps they might answer that this is because higher tax revenues are a sign of increased prosperity, yet as they should know it is often the case that tax revenues fall (Like they did in 2001-2002) or rise (Like they do now) relative to GDP even without formal tax law changes due to changes in distribution of income and that tax revenues are therefore inferior to GDP (despite its shortcomings) as a measurement of that and that anyone committed to limited government should in any case regard such a effect as a negative side effect of higher growth.
Secondly, why would the validity of the Laffer Curve depend on the effects of the previous Bush tax cuts? The Laffer Curve after all, only says that tax revenues will be minimized at the tax rates of 0% and 100%, not at which point in between they are maximized. All that this dispute could prove or refute would be the issue of whether or not the revenue maximizing rate was the previous one or the present, not the Laffer Curve itself which in any case is firmly established on the theoretical ground that taxation of something will reduce the existence of whatever is taxed.
Thirdly, the strong surge in tax revenues is not based on some unprecedented wave of prosperity. GDP growth is only 3% adjusted for terms of trade changes, which is only a mediocre performance by historical American standards. Together with inflation this would only justify a 6% (i.e. nominal GDP growth) increase in tax revenues.
Instead the 13.7% surge in tax revenues is based on two sources: first the high asset price inflation which have strongly boosted capital gains tax revenues in the same way that the tech stock bubble in 1999-2000 led to a strong increase in capital gains tax revenues which then collapsed after the bubble bursted. And, of course when there is another correction in asset prices, those revenues will once again collapse.
And secondly more importantly, another source of the surge in tax revenues are a tax hike by Bush: namely the expiration of the depreciation incentives that existed between 2002 and 2004. To quote the CBO Monthly budget review:
“Tax law changes, primarily relating to the depreciation incentives enacted in 2002 and 2003, are contributing to the growth in receipts in 2005. Those incentives reduced taxable profits from 2002 through 2004 and have boosted them this year, following expiration of the incentives at the end of 2004.”
Largely as a result of this, corporate income tax revenues surged 41% as compared to the mere 6% increase in withheld individual income and payroll taxes (which tend to correlate better with economic growth). Although the higher increase in corporate tax revenues can to some extent be attributed to corporate profits rising faster than wages/salaries, the main cause is Bush’s tax hike.
Another interesting fact is that Federal government spending continues to grow fast, up 7% (adjusted for calendar effects). While this is slower than previously during Bush’s presidency it is still faster than the 6% nominal GDP growth, meaning that the Federal government continues to increase its relative burden on the American economy.
Now, what was it that people called someone who raised taxes and spending? A “tax and spend liberal [In the modern American sense of the word)”? Well, doesn’t this mean that Bush is now a “tax and spend liberal” after having previously engaged in “borrow and spend” policies.?
