Tax receipts are low because of the mediocre economic recovery.

June 30, 2011
WSJ

President Obama was right about his audacity, if not always the hope. Six months after he agreed to a bipartisan extension of current tax rates, he is now insisting on tax increases as part of the debt-ceiling talks. At his press conference yesterday he repeated this demand, as well as his recent talking point that taxes are lower than they’ve been in generations. Let’s examine that claim because it explains Washington’s real revenue problem—slow economic growth.

Mr. Obama has a point that tax receipts are near historic lows, but the cause isn’t tax rates that are too low. As the nearby table shows, as recently as 2007 the current tax structure raised 18.5% of GDP in revenue, which is slightly above the modern historical average. Even in 2008, when the economy grew not at all, federal tax receipts still came in at 17.5% of the economy.

Today’s revenue problem is the result of the mediocre economic recovery. Tax collections in 2009 fell below 15% of GDP, the lowest level since 1950. But remarkably, tax receipts stayed that low even in the recovery year of 2010. So far this fiscal year tax receipts are growing at a healthy 10% clip, so the Congressional Budget Office (CBO) January estimate of 14.8% of GDP is probably low. We suspect revenues will be closer to 16%, but even that would be the weakest revenue rebound from any recession in 50 years, and far below the average tax take since 1970 of 18.2%.

What explains that $2.29 trillion budget reversal? Well, the direct revenue loss from the combination of the 2001 and 2003 Bush tax cuts contributed roughly $216 billion, or only about 9.5% of the $2.29 trillion. And keep in mind that even this low figure is based on a static revenue model that assumes almost no gains from faster economic growth.

After the Bush investment tax cuts of 2003, tax revenues were $786 billion higher in 2007 ($2.568 trillion) than they were in 2003 ($1.782 trillion), the biggest four-year increase in U.S. history. So as flawed as it is, the current tax code with a top personal income tax rate of 35% is clearly capable of generating big revenue gains.

CBO’s data show that by far the biggest change in its deficit forecast is the spending bonanza, with outlays in 2011 that are $1.135 trillion higher than the budget office estimated a decade ago. One-third of that is higher interest payments on the national debt, notwithstanding record low interest rates. But $523 billion is due to domestic spending increases, including defense, education, Medicaid and the Obama stimulus. Mr. Bush’s Medicare drug plan accounts for $53 billion of this unanticipated spending in 2011.

The other big revenue reductions come from the “temporary” tax changes of the Obama stimulus and 2010 bipartisan tax deal. CBO says the December tax deal—which includes the one-year payroll tax cut and the annual fix on the alternative minimum tax—will reduce revenues by $196 billion this year. The temporary speedup in business expensing will cost another $55 billion.

Getty Images/Stock Illustration

The payroll tax cut was sold in the name of stimulating growth and hiring, yet the economy has grown more slowly this year than in last year’s fourth quarter. As we’ve long argued, the “temporary, targeted and timely” tax cuts favored by Keynesians and the White House don’t do much for growth because they don’t permanently change incentives to save and invest. Mr. Obama was hawking more of those yesterday, even as he wants to raise taxes overall.

Republicans—notably George W. Bush in 2001 and 2008—have sometimes fallen for this same tax cut gimmickry. But perhaps they’re learning their lesson. Republicans have reacted with little enthusiasm to the White House trial balloon to extend the payroll tax cuts for another year. The lesson is that when it comes to growth, not all tax cuts are created equal. The tax cuts with the biggest bang for the buck are permanent, take effect immediately, and hit at the next dollar of marginal income.

All of which makes the White House debt-ceiling strategy a policy contradiction. On the one hand, Mr. Obama is saying Republicans must agree to raise taxes on business and high incomes, though he knows even many Democrats won’t vote for that. On the other hand, Mr. Obama says he wants another payroll tax cut because he is worried about slow growth.

Even orthodox Keynesian policy doesn’t recommend a tax increase with growth under 2% and the jobless rate at 9.1%. The White House game here can only be an attempt to see if he can use the prospect of a debt-limit financial panic to scare Republicans into voting to raise taxes. We doubt the GOP is this dumb.

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