The Heritage Foundation

WebMemo #351 on Taxes

October 17, 2003

October 17, 2003 | WebMemo on Taxes

The Economic Effect of Reversing Part of the Bush Tax Cuts

Calls to reverse the 2001 and 2003 Bush tax cuts have been increasing in number. Congress should reject any new legislation that would delay or repeal the tax cuts, instead acting to make them permanent - ensuring the strongest possible economic and employment growth.

 

Economic Rebound
The Senate was right to defeat Senator Joseph Biden's (D-DE) proposed amendment to raise taxes on the top 1 percent of income earners to pay for President Bush's Iraq appropriation requests.  The House should defeat several amendments aimed at raising taxes on the top 1 percent or the top tax bracket as well.

 

Other calls, to repeal some or all of President Bush's tax cuts in order to reduce the budget deficit or pay for new spending proposals, should be met with the same resistance.

 

Raising taxes would slow economic growth and lengthen the current period of tepid economic activity.  Furthermore, raising taxes on the top one percent would be very harmful to unemployed workers. New businesses, particularly small businesses, are responsible for a great deal of hiring.  By slowing the creation and expansion of businesses, unemployed workers will have harder time finding a job and jobs will pay lower wages because of the abundance of labor.

 

In other words, a tax increase on the top one percent, means they:

 

  • Will be less likely to create a new business or expand an existing one, and
  • Will be aware that the increased risk of starting a new business outweighs its potential returns.

To ensure the strongest possible economic and employment growth, Congress should act to make the 2001- and 2003- tax cuts permanent.

 

Economic Effects of Raising Taxes Now
CDA analysts sought to estimate the economic effect of raising taxes to pay for new spending.  Using the 2003 Global Insight U.S. Macroeconomic Model, economists at the Center for Data Analysis simulated an $87 billion tax increase in personal income taxes in 2004.  The CDA simulation increased personal income tax rates and taxes on capital gains and dividends.  The Center's study found that from 2004 to 2008:

 

  • $14.3 billion in potential economic growth would be lost each year.
  • Over 174,000 potential jobs would fail to materialize each year.
  • $52 billion less disposable personal income each year.

With the Congressional Budget Office estimating in August of 2003 a federal deficit of $480 billion in 2004, Congress and the White House are reluctant to increase the unfunded outlays. As new spending policies are proposed, several Members of Congress want to pay for them without increasing the deficit.  While Congress's newfound attachment to fiscal discipline is long overdue, raising taxes to pay for new programs is a bad public policy.

 

By raising personal income tax rates, Congress discourages saving and investing, particularly the latter among those targeted for tax increases. A tax increase would be an anchor on an economy that is showing signs of accelerated growth.  President Bush's tax cuts have benefited the economy by encouraging increased business investment, increasing disposable personal income and encouraging job growth.  Reducing the potential reward on new investments would make businesses more reluctant to expand and hire new workers.  Potential start-up businesses would not receive needed capital due to higher taxes and thus the higher return needed to make a business profitable

 

Growth = Jobs
Many people with income from small businesses would be affected.  The IRS Public Use File estimates that fifty-eight percent of the top tax bracket has small business income.  These entrepreneurs would see their income taxes increase and be less likely to expand their businesses and hire new workers.

 

Congress is right to be concerned about the effect of a large budget deficit on the economy.  However, raising taxes to pay for an $87 billion spending initiative is more harmful as 174,000 job opportunities will be lost each year.  Americans will have less disposable income and fewer opportunities for investment and saving.  Defeating the Biden Amendment was the right thing to do.  Congress should continue to reject any effort to reverse the 2001 and 2003 tax cuts and, instead, make them permanent to ensure the strong economic growth.




Methodology
The Center for Data Analysis (CDA) used the Global Insight U.S. Macroeconomic Model to find the effects of an $87 billion increase in personal income taxes on the economy. CDA economists imposed on the model an increase in personal income taxes sufficient to raise federal revenues, on a static basis, by $87 billion over the four calendar quarters of 2004. In addition, they allowed assumed that the Federal Reserve would adjust monetary policy in response to the tax increase. CDA analysts used the July 2003 Global Insight U.S. macroeconomic forecast as a baseline for comparison of results. The results and methodologies described in this analysis were implemented by CDA analysts and do not necessarily reflect the views of the owners of the model.

About the Author

Rea S. Hederman, Jr. Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis

Related Issues: Taxes