Thursday, March 22, 2012

Should Congress Have Enacted George W. Bush’s Tax-Cut?

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Should The Congress of the United States have enacted what is now called the Economic Growth and Tax Relief Reconciliation Act of 001 (EGTRRA). This is an endless debate of facts, figures and various economic models. One on side, the so called “supply-siders”, and proponents of Reganomics argue that tax-cuts, even when largely benefited by only the top wealthiest in the nation, benefit all in the economy through what has been called the trickle down theory. In contrast there are some economists that think there is little to no benefit of a tax-cut. Also there are citizens who think that a tax-cut should benefit the lower class more so as not to widen the income gap any further, supported indirectly by economist who think that taxes affect demand, also known as Keynesian theory.

“The basic belief of supply-side economics is that all aspects of economic behavior-such as labor supply, saving, and investment-respond to economic incentives and, in particular, to incentives in the tax code”[1]. While other economist site Ricardian equivalence to support their argument that tax cuts offer no benefit. “The empirical evidence on Ricardian equivalence is mixed”[1].

There is little argument that there should be some sort of tax relief in the current state of the economy.

“Most Americans support Bushs tax-cut proposals. A USA Today/CNN Gallup poll yesterday showed the number rising to 67 percent, from 60 the week before. Yet polls also show a desire for more tax-cut benefits to go to lower-income taxpayers.” []

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The economy is currently in a recession and the government is running a surplus. The biggest argument is the fairness of an across the board tax-cut. This tax-cut is seen by many Americans to unfairly benefit the wealthiest in the nation.

This paper shall make no attempt to claim that one economic theory is superior to another; such a task is too great for my limited knowledge. However this paper will present arguments from both sides of the ring with supporting empirical evidence and conclude with whether or not the congress should have passed the EGTRRA. The intent of this paper is to attempt to discover what is right, without partisanship and personal biases invading the topic.

When President Bush took office the economy was stalling due to the large technology boom of the 10’s. The further reduction in the state of our economy was due in large part to bad momentary policy on behalf of the Federal Reserve chairman Allan Greenspan1. After September 11 001 the economy was further dragged down by fear and uncertainty about the future, as a note this should have been a temporary shock to the economy but with the “war on terrorism” and fears of bio-terrorism initiated by the anthrax attacks the economy never returned to steady state. The Federal Reserve around this time began an aggressive prime rate reduction schedule. To make matters worse it seemed that the Federal Reserves policy was always too little too late. Just when the economy could not seem to get worse, an explosive series of corporate frauds and scandals were uncovered.

The Federal Reserve has limited firepower when it comes to managing the demand of the economy. It would be highly undesirable to drive the interest rate to zero as happened in the Japanese economy, the world’s second largest, which has been experiencing deflation for some time now. Deflation is a serious concern to an economy, which causes people to hold out on purchasing items in hope of a lower price a later date [1]. Indeed the economy was in need of an economic stimulus, and the Federal Reserve couldn’t do it alone.

One of the biggest factors affecting the economy was consumer confidence. Basically the larger the confidence index the more likely consumers are to spend, as they anticipate future economic prosperity. At that time this number was at very low point suggesting that consumers would not spend the money they received from the tax-cut. The nations wealthiest on the other hand would invest the money they stand to gain over the next several years. The wiser investors are not as short sighted as the common person. They understand the business cycle and can afford to take more “risky” investments in the hopes of future economic improvements. Professor of economics at Florida University James D. Gwartney states that

The CBO wrote The data show considerable evidence of a very significant revenue response among taxpayers at the highest income levels.[]

These investments today are necessary for economic soundness in the future. If we focus our attention to income tax then in fact the wealthiest do bear the biggest burden.

[Lawrence Lindsey of Harvard University] found that after the tax rates were lowered, the wages and salaries of high-income taxpayers were approximately 0 percent larger than projected. Similarly, after the rate cuts capital gains were approximately 100 percent higher than projected, and high-income taxpayers business income was a whopping 00 percent higher than expected. Lindsey concluded that the main supply-side effects resulted from (a) people paying themselves more in the form of money income rather than fringe benefits and amenities, (b) increases in business activity, and (c) a reduction in tax shelter activities[]

Also when federal revenues are measured on a constant-dollar (or inflation-adjusted) basis, the rapid rise in taxes during the 10s becomes evident. Taxes peaked in 000 at $7,668 per-capita, which was up percent since 10. This is the largest run-up in federal taxes since the 4 percent increase of the 150s [5]. Furthermore, we need to look at federal income tax as a percent of GDP. In 000 this was the highest ever, which began slowly building up during the technological boom of the nineties. Now that the economy is stalling it is a time to return to some deficit spending and reduction of income tax to promote economic growth. See figure 1 and figure below which shows the income taxes and revenues since the twenties and clearly shows the steady increase over the nineties.

Figure 1 source CATO Institute www.cato.org

Figure source CATO Institute www.cato.org

Due to the nature of this tax-cut and its similarity to the Regan economic plan, much of the opposing argument is based on facts about the Regan administrations policy and the economy during that time and there after.

This kind of across-the-board tax-cut is unfairly advantageous to the rich. It will further separate the rich and the poor. “The bills benefits for the wealthy - averaging $44, a year for the top 1 percent - are proportionately a bit more than their share of the tax burden, according to the Center on Budget and Policy Priorities (CBPP), a Washington think tank” []. Under the Regan administration the top 5 percent increased their share of national income from 16.5 to 18. percent and the poorest one fifth decreased from 4. to .8 percent [6].

Just look at the Census Bureaus income distribution figures

• The latest data, for 18, show that the top 5 percent of households ranked by income received 1.4 percent of aggregate income -- an increase of .8 percent over the 18.6 percent share this group received in 1.

• By contrast, over the same period of time during the Reagan Administration, 180 to 186, the top 5 percent of households saw their share of aggregate income rise only 1.7 percent.

Thus the rich have gotten richer faster under Clinton than they did under Reagan. Yet Reagan was accused of encouraging greed, while Clinton has gotten a pass. [Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 5, 000]

Moreover during the Regan administration by 18 there were 5. million more Americans whose salaries exceeded $50,000 a year than there were in 181 (adjusting for inflation). Similarly, there were .5 million more Americans earning more than $75,000 a year, an 8 percent increase. And the number of Americans earning less than $10,000 a year fell by .4 million workers… Incredibly, a poor household in 180 was more likely to have moved all the way up to the richest income quintile by 10 (15 percent) than to still be in the poorest quintile (14 percent) [6]. Please note that the numbers and calculations are based on Bureau of the Census, U.S. Statistical Abstract, 16, p. 478, Table 740

A capitalist economy cannot always try to redistribute the income of the people. In the limit this concept approaches socialism which discourages hard work. Such a policy would drag down the economy as a whole. The across-the-board tax-cut still leaves a progressive tax system in place. It only acts to reduce the current over taxed situation, in an attempt to re-ignite the economy at a time when it is most needed. In fact most economists believe that deficit spending while in a recession, used as a tool to expedite recovery of the economy is indeed beneficial [4].

Works Cited

[1] Abel, Andrew B., Bernanke, Ben S. Macroeconomics nd edition ( New York Addison Wesley 15)

[] Francis, David R “Bush Tax Cuts Widen US Income Gap” http//www.commondreams.org/headlines01/05-0.htm

[] Gwartney, James D “Supply-Side Economics” The Library of Economics and Liberty http//www.econlib.org/library/Enc/SupplySideEconomics.html#biography

[4] Wessels, Walter J. Economics third edition (New York Barron’s 000)

[5] CATO Institute www.cato.org

[6] Niskanen, William A. and Moore, Stephen “Supply Tax Cuts and the Truth About the Regan Economic Record” 16 www.cato.org/pubs/pas/pa-61.html

[7] Bartlett, Bruce “Liberals Will Blame George W. Bush” National Center for Policy Analysis, July 5, 000 http//www.ncpa.org/pd/economy/pd070500b.html

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