October 17, 2002

October 17, 2002 | Commentary on Taxes

Sorting Fact From Fiction

Facts often are the first casualty of any political battle, especially during election years. But sometimes the debate shifts from routine exaggeration and distortion and becomes flagrantly misleading. Exhibit A: Efforts to pin blame for our stagnant economy on the Bush tax cut.

Recent polls show that most Americans rank the economy first among political issues, so now's a good time to demolish a few myths that keep surfacing.

Myth #1: The sluggish economy proves tax cuts don't boost growth.

Fact: According to Commerce Department figures, the economy began to weaken in the middle of 2000, almost one year before the Bush tax cut was enacted. It averaged less than 1 percent growth in the final six months of 2000 and started to contract in the first three months of 2001 -- well before any tax cuts were approved.

But, some argue, shouldn't the cuts be fueling growth now? This brings us to another fact: The vast majority of the pro-growth provisions in the 2001 tax bill won't take effect until 2004, 2006 and 2010. It's preposterous to say tax cuts don't work when they have yet to take effect.

Myth #2: Tax cuts are driving interest rates higher by increasing the budget deficit.

Fact: Government budget estimates have shifted from large surpluses to large deficits, yet interest rates have dropped dramatically.

In 2000, the federal government had a record budget surplus of $236 billion dollars. The same year, the average interest rate on 10-year government bonds was 6.03 percent, according to the Federal Reserve Board.

According to the latest projections, the budget will have a $157 billion deficit in 2002, a shift of nearly $400 billion. But instead of rising, as tax-cut critics argue should have happened, interest rates have declined. The Federal Reserve Board reported that the 10-year government bond rate in August was only 4.26 percent.

Myth #3: Fiscal discipline requires a balanced budget.

Fact: Limiting government is the best way to keep the budget under control. Special-interest groups seek to fatten their wallets by convincing politicians to give them other people's money. Politicians intent on promoting fiscal discipline must be prepared to resist these demands.

They certainly shouldn't delude themselves into thinking that discipline consists of raising taxes even higher in order to fund even more excessive spending. Many European nations pursue this vision of "fiscal balance," for instance, and their tax burdens sometimes consume half of their economic output. These nations inevitably suffer from sluggish growth and high unemployment.

Countries that limit the size and growth of government, by contrast, enjoy more growth and create more jobs, regardless of whether their budgets are balanced.

Myth #4: The Bush tax cut caused the deficit.

Fact: The weak economy is the main reason the deficit has reappeared.

According to Congressional Budget Office figures, lower tax revenues from the tax cut account for just 8 percent of the change in fiscal balance. The vast majority of the change is due to the economy's sluggish performance and forecasting errors -- much as the budget surpluses of the late 1990s were caused by strong economic growth. Spending increases, primarily for domestic programs, also have contributed to deficits.

Fact: The economy drives the budget, not the other way around.

Fiscal balance shouldn't be the ultimate goal of fiscal policy. Instead, lawmakers should strive to control the size of government and to lower tax rates. In this way, they can boost growth by leaving more resources in the productive sector of the economy and giving people greater incentives to work, save and invest. As a result, the amount of taxable income will increase and government will collect additional revenue.

One other benefit of cutting tax rates: It helps control the growth of federal spending. Consider how the shift from budget deficits to budget surpluses in 1998 significantly undermined fiscal discipline. Budget surpluses were viewed as "extra" money and lawmakers dramatically increased the growth rate of federal spending. Indeed, federal spending has grown about twice as fast in the four years since 1998 as it did in the four years prior.

Indeed, clamping down on this "spendfest" is one of the best reasons for speeding up the Bush tax cut. Cutting down on the amount of money flowing into Washington makes it tough for Congress to fuel even bigger increases in government. And that's a fact even the mythmakers in Washington can't deny.

Daniel J. Mitchell, Ph.D., is the McKenna fellow in political economy at The Heritage Foundation, a Washington-based public policy research institute. A modified version of this essay appeared recently in the New York Post.

About the Author

Daniel J. Mitchell, Ph.D. McKenna Senior Fellow in Political Economy

Related Issues: Taxes

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