The Heritage Foundation

Backgrounder #1653 on Taxes

May 9, 2003

May 9, 2003 | Backgrounder on Taxes

The 2001 Tax Cut Did Make a Difference

In a radio interview in late April 2003, a U.S. Senator opposed to President George W. Bush's proposal to cut taxes by $726 billion over the next 10 years offered a new and novel reason to reject the plan. According to the Senator, "If tax cuts encourage economic growth and prosperity, how come the tax cuts embodied in the Economic Growth and Tax Relief Reconciliation Act of 2001 have not saved the nation from a recession?"

The Senator raised an interesting challenge to advocates of the President's plan, who could respond, with justification, that the 2001 tax cuts may very well be saving the U.S. from the worst of the economic stagnation now confronting most of the world. Indeed, if recent measures of comparative economic performance among the major industrialized countries reveal anything, they reveal that the vast majority of the leading industrial countries are performing substantially worse than the United States. In fact, with only a portion of the 2001 cuts implemented, the U.S. economy grew at twice the rate of the European economy during calendar year 2002.

undefined

Table 1 provides the most recent comparative data for key macroeconomic measures of economic vitality. Using growth of the gross domestic product (GDP) during 2002 as a comparative performance measure, Table 1 reveals that the United States has outperformed 12 of the top 15 countries listed. Only Australia and Canada did better, and Canada's performance reflects its close tie to the U.S. economy, which absorbs the bulk of Canada's exports.

Surviving Severe Economic Setbacks

Particularly impressive in America's economic performance relative to the other countries' is that it occurred in an environment of severe economic setbacks and international risks that other countries managed to escape. America's stock market bubble of the late 1990s was worse than Europe's, and U.S. businesses and consumers remain unsettled by what many feared was a risky war in Afghanistan and an even riskier one with Iraq. All this occurred at a time when the legacy of the terrorist attacks of 9/11 still loomed large, leaving many Americans shaken and cautious.

Nonetheless, despite these significant setbacks unique to the American experience, over the past twelve months the American economy outperformed nearly all others, growing more than twice
as fast as the average rate of growth for Europe. America also suffered comparatively fewer job losses. As of late 2002, several European countries were experiencing unemployment rates in excess of 10 percent.

America's comparatively better-than-average performance over the past year comes as no surprise to advocates of the President's tax relief initiatives. In April 2001, Heritage Foundation experts estimated that President Bush's tax cut plan would increase the economic growth rate by an average of 0.2 percent per year and reduce the average unemployment rate over the period by 0.2 percent compared to what otherwise would have occurred in the absence of significant tax relief.1 Although the U.S. economy has yet to show signs of robust recovery, European prospects remain dim as well: The Economist reported in April that "There were further signs of recent economic weakness in the euro area."2

Tax and Growth Relationship Holds Over the Long Term

Those who doubt the benefits of tax rate cuts on economic activity might counter that one year of comparative economic performance proves little and that such differences should be analyzed over longer periods of time before inferences are drawn about how different policies influence relative growth patterns. The skeptics are, of course, correct in their concern about drawing confident conclusions from a one-year snapshot.

However, these skeptics are likely to be disappointed by the long-term comparative patterns that such a review of the data implies. As data compiled by the Organization for Economic Cooperation and Development (OECD) illustrate, an analysis of comparative performance over longer periods of time reveals essentially the same trends.

France
The post-World War II experience of France, for example, is indicative of these trends, which are common to one degree or another in many other European countries and increasingly Japan, which is now entering its second decade of economic stagnation despite the appearance of recent improvement. As revealed by the following chart comparing France's GDP per capita (adjusted for purchasing power differences) with U.S. GDP per capita, the average French citizen has seen a consistent deterioration in income vis-à-vis his or her American counterpart over the past two decades.

undefined

By 1975, when comparative data were first compiled and reported by the OECD, France's GDP per capita reached a level equal to 78 percent of America's GDP per capita; by 1982, it had risen gradually to 83 percent.3 However, this was as close as the French came to the U.S. level of production and income.

In the early 1980s, President François Mitterand embarked upon an aggressive tax-and-spend policy in the belief that France could spend its way to prosperity. As a consequence of the substantial growth in French government spending and the taxes to fund it, the gap between American and French income and production began to widen. By 2000, French GDP per capita had fallen to 71 percent of the U.S. level. With France's GDP per capita running in the 71 percent to 72 percent share range of America's during the late 1990s and into the new century, the gap between French and American production and incomes is now the widest it has ever been in the 28-year history of this OECD data series.

Behind France's lagging performance is a tax burden that has remained at exceptionally high levels over the past two decades. According to a recent OECD report,4 French taxes are expected to absorb 46.3 percent of the country's GDP in 2004, slightly higher than the 46.1 percent it reached in 1994. By way of contrast, the total tax burden in the United States in 2004 is expected to be 29.2 percent of GDP, down slightly from the 29.4 percent in 1994.

At a projected 29.2 percent in 2004, the U.S. will have the lowest tax burden of any of the 27 OECD countries. Also notable is the fact that Australia, South Korea, and Ireland, which have slightly larger tax burdens, have all had strong and prospering economies over the past several decades.

Many Others Confront the Same Stagnation

Unfortunately for most of the world's population, these low-tax countries are the exception, not the rule, and the performance of the French is more typical than that of the Irish or the Australians. According to the same OECD data:

  • In comparison to U.S. per capita GDP, German per capita GDP peaked at 81 percent in 1991 and has since fallen to 74 percent, in part due to a tax burden of 42 percent.
  • Canada reached 92 percent of U.S. per capita GDP in 1982 but has lost ground since and is now at 82 percent of our level. Canada's tax burden is now at 37 percent.
  • Sweden's tax burden has held steady at 54 percent over the past decade and is the highest of the OECD countries. By earning this distinction, Sweden has gone from being one of the most prosperous countries in Europe (84 percent of the U.S. level in 1975) to one of the poorest (70 percent of U.S. GDP in 2001).
  • Japan, which once threatened the U.S. position in first place by rising to 90 percent of U.S. per capita GDP in 1991, has fallen faster than any other country. By 2001, Japan was at only 78 percent of the U.S. per capita GDP level. While Japan's tax burden has stayed the same, deficit spending has soared. Since 1990, Japanese government spending has increased from about 30 percent to 38 percent of the economy--a rate of government spending growth unmatched by any other OECD country.

A Specter Still Haunts Europe

In the 19th century, Karl Marx famously proclaimed that "A specter is haunting Europe--the specter of Communism." After a 70-year run of haunting and assaulting much of the world, that specter has largely dissipated and now hangs by its fingernails in just a few of the world's backwaters.

But Europe is still haunted, this time by the specter of competition from low-tax countries whose economies are healthier, growing faster, and creating rising prosperity for all of their citizens. To ensure that the U.S. maintains its leadership position as the specter haunting a stagnant Europe, Congress should this year enact a significant tax relief of the type and magnitude recommended by the President.

Dr. Ronald D. Utt, is Herbert and Joyce Morgan Senior Research Fellow in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.


1. D. Mark Wilson and William W. Beach, "The Economic Impact of President Bush's Tax Relief Plan," Heritage Foundation Center for Data Analysis Report No. 01-01, April 27, 2001.

2. "Economic and Financial Indicators," The Economist, April 19, 2003, p. 88.

3. World Bank, World Development Indicators 2002, Table, "GDP per Capita," at publications.worldbank.org, available with on-line subscription. Ratios calculated by author.

4. OECD in Washington, No. 42, March 2003, p. 3.

About the Author

Ronald D. Utt, Ph.D. Herbert and Joyce Morgan Senior Research Fellow

Related Issues: Taxes