Do Lower Tax Rates Equal More Tax Revenue?

“Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased – not a reduced – flow of revenues to the federal government.” President John F. Kennedy, January 17, 1963, Annual Budget Message to Congress.

Was Kennedy accurate about cutting tax rates?  The answer is more complex than meets the eye.

  • There are few pure tax cuts. Marginal tax rate cuts (taxes on the highest income levels) may be combined with increases in Social Security and Medicare taxes or increased income tax rates for lower earners.
  • When measuring tax revenues, recessions and up business cycles thoroughly complicate things.
  • Measuring tax revenues isn’t cut and dried. For this article, U.S. Government Current Receipts found in the Bureau of Economic Analysis data tables are measured since this includes taxes, fees and other somewhat less transparent taxes.

The Kennedy tax cut

Kennedy correctly forecast the revenue impact from cutting tax rates. His tax cut passed after his assassination and was implemented in 1964.

image001
Table 1; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A

From 1960-1964, Current Receipts increased 4% annually. In the five years after the rate cut, (1965-1969), Current Receipts increased an average 14% annually.

What Kennedy and Johnson fixed was an incredibly high marginal tax rate. Personal income over $200,000 was subject to a 91% tax rate in 1963, a remnant of the Franklin Roosevelt presidency. This means if you made $1,000,000, you got to keep $72,000 of the last $800,000 of your income. Kennedy proposed lowering this marginal tax rate to 70%. Dropping the corporate tax rate from 52% to 48% also passed.

The Reagan tax cuts

President Ronald Reagan made much more dramatic tax cuts. The Economic Recovery Tax Cut (ERTC) of 1981 cut the top marginal tax rate from the Kennedy era 70% rate down to 50%. The Tax Reform Act (TRA) of 1986 lowered the top tax rate to 28% and increased the lowest income rate from 11% to 15%. A number of tax loopholes were closed, effectively increasing taxes for the wealthy.  Also, tax brackets were cut from eleven to four resulting in some tax increases.

Similar to the Kennedy/Johnson tax cut, tax revenues increased after the two Reagan rate cuts. Table 2 seems to tell us that cutting tax rates increases total government revenue.

tax
Table 2; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A 

However, Table 2 masks the real revenue loss from the Reagan tax cuts. In the five-year period before Reagan’s first tax cut was implemented, Current Receipts increased over 14% annually. After Reagan’s first tax cut in 1981, implemented in 1982, over the following five years, revenues only increased 6% annually. In the five years after Reagan’s second tax cut, Current Receipts increased an average of 7% annually. This lost revenue was one of the causes of the huge deficits during the Reagan/Bush years.

Without Reagan’s tax cuts, Current Receipts would have been much higher if revenue increases were allowed to continue on their trajectory. In Table 3 (below), the blue line represents actual Current Receipts from 1977-1981. The green line is projected Current Receipts if there had not been a tax cut and the Current Receipts continued increasing at the same rate they had from 1977-81. The red line is actual Current Receipts after the Reagan tax cuts.

tax
Table 3; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A 

 

 

 

 

 

 

 

 

 

 

Reagan could cut taxes, but he could also spend money like no president in history. Reagan’s 6-7% increases in revenue couldn’t cover his 8% average annual spending increases. Likewise, his successor, George Bush grew government by 7% annually. During their 12 years in office, they ran up over $2.9 trillion in debt. We could tolerate either their huge spending increases or their tax cuts, but not both.

taxes
Will lower taxes lead to more purchases like this?

The George W. Bush and Barack Obama tax cuts

Bill Clinton pushed through a significant tax increase in the Omnibus Budget Reconciliation Act (OBRA) of 1993. Changes included raising the top marginal tax rate to 39.6%, fuel taxes were raised along with the taxable limits on Social Security and Medicare. Following passage of Clinton’s tax increase, Current Receipts increased by 8.5% annually from 1994 through 2001. Clinton also cut annual spending increases down to an average 3.5% during his term in office.

Congress approved George W. Bush’s Economic Growth and Tax Relief Reconciliation Act of 2001, lowering the top tax rate back to 35% and adjusting a number of other brackets lower. Barack Obama continued these tax cuts and added some his own in 2009.

tax
Table 4; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A

Revenues took a few years to recover from the Bush tax cut. The average government revenue increase from 2001 to 2012 was 2%. Some of this was due to the resulting financial meltdown. However, even measuring Bush’s tax cut before the recession, tax revenues increased only 3.6% annually from 2001-2007.

George W. Bush was another liberal Republican big spender, running up 7% annual spending increases. The 2% annual increases in revenue after the tax cut from 2001-2012 simply couldn’t keep up with his spending.

If Bush had not cut tax rates, and assuming the 8.5% annual increases in tax revenues that occurred during the Clinton years continued, tax revenues in 2008 would have been $3.7 trillion instead of the actual $2.5 trillion. The U.S. would not have run deficits throughout the George W. Bush presidency. More than likely the debt crises and near financial meltdown in 2008 would never have happened. What’s more, we won’t have the $multi trillion deficits we have now.

Summary

Was John Kennedy correct? Do lower rates of taxation stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased – not a reduced – flow of revenues to the federal government? Kennedy and Johnson showed that when top marginal tax rates are too high, cutting them yields increased rates of government revenue, and more important, an increased rate of annual revenue for the government.

tax
Table 5; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A

The Reagan tax cuts are grayer. The 14% annual increases in Current Receipts from 1977-81 before Reagan cut taxes were too high. Achieving a 6-7% annual increase in revenues after Reagan’s tax cut is much healthier. However, the Reagan tax cuts were never able to restore the same rate of revenue increase for the government that existed before the cut.

 

 

While Kennedy’s tax cut by any measure was highly successful and Reagan’s cuts were at least justifiable, the George W. Bush/Barack Obama tax cuts were a disaster. We reached a diminishing point of returns on cutting tax rates. Lowering present tax rates does not stimulate enough economic activity to yield an adequate flow of revenue to the government.

tax
Table 6; Source: Bureau of Economic Analysis, Table 3.2 Federal Government Current Receipts and Expenditures; http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&910=X&911=0&903=87&904=1976&905=2013&906=A

 

 

 

 

 

 

 

 

Table 6 shows the impact of George W. Bush’s compounded 7% annual spending increases and Barack Obama’s 4% annual spending increases when revenues are only going up 2% annually over the same 12 years. Resulting $trillion deficits are not acceptable. Expecting tax rate cuts to solve the problem defies history and logic.


Thanks for commenting!

%d bloggers like this: