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February 28, 2007

February 28, 2007 | News Releases on Taxes

10 Myths About Those Tax Cuts

WASHINGTON, FEB. 28, 2007-The left pretty well demonized the tax cuts of the past few years. Demagogued as "tax cuts for the rich," they've been blamed for everything from "runaway" deficits to "drastic" cuts in anti-poverty programs.

Fortunately, virtually all of the progressive conventional wisdom on this subject is wrong. Here are 10 widely held myths about the tax cuts -- and the facts that debunk them:

Myth 1. Tax revenues are too low. Fact: The $2.41 trillion in revenues in 2006 amounted to 18.4 percent of our gross domestic product (GDP). That's higher than historical averages going back 20, 40 and 60 years. It's simply not true that Americans are under-taxed by historical standards.

Myth 2. The tax cuts substantially reduced revenues and expanded the budget deficit. Fact:Revenues in 2006 were a relatively modest $58 billion below the amount projected before the tax cuts proposed by President Bush and approved by Congress. Yet Washington spent $514 billion more in '06 than had been projected, turning a budget surplus into a deficit.

Myth 3. Supply-side economics assumes all tax cuts immediately pay for themselves. Fact: What's assumed is that some, not necessarily all, lost revenues will be replenished. Reducing tax rates encourages the taxed behavior, and the increased economic activity offsets some lost revenues. Whether a tax cut fully pays for itself depends on how much new activity it generates.

Myth 4. Cuts in the capital gains tax don't pay for themselves. Fact: Capital gains revenues doubled after the 2003 capital gains tax cuts, from $50 billion to $103 billion in '06. Before the cuts, the Congressional Budget Office (CBO) projected such revenues would rise much less sharply, to $68 billion.

Myth 5. The tax cuts are to blame for projected budget deficits. Fact: Revenues already are projected to jump to a record 23 percent of GDP by 2050; repealing the tax cuts would push revenues a bit higher, to 24 percent. CBO projects the massive deficits based on unrestrained Social Security, Medicare and Medicaid costs pushing total spending from 20 percent of GDP to 38 percent or more.

Myth 6. Raising tax rates is the best way to raise revenue. Fact: Revenues correlate with economic growth, not tax rates. Since 1952, the highest marginal income tax rate has dropped from 92 percent to 35 percent. Yet revenues remained constant at 18 percent of GDP. Thus, a growing economy boosts revenues.

Myth 7. Reversing upper-income tax cuts would raise substantial revenues. Fact: Expansion of the popular child tax credit, marriage penalty relief, the 10 percent bracket and fix of the Alternative Minimum Tax will combine this year to lower revenues by $114 billion. The maligned cuts in capital gains, dividend and estate taxes are projected to reduce revenues by less than a third of that -- $36 billion -- while producing significant supply-side advantages.

Myth 8. Tax cuts help by "putting money in our pockets." Fact: Redistributing money between governments and taxpayers merely shifts -- and does notincrease -- total spending power. So government spending does not "inject" new money into the economy, nor do tax rebates help by "putting money in our pockets." Rather, low tax rates increase incentives to work, save and invest, sparking productivity and economic growth.

Myth 9.The tax cuts haven't boosted the economy. Fact: The 2003 tax cuts lowered rates for income, capital gains and dividend taxes. Business investment, the stock market, job numbers and economic growth -- all of which had been stagnant -- immediately surged.

Myth 10. The tax cuts tilted toward the rich. Fact: The rich now shoulder even more of the burden. From 2000 to 2004, the share of individual income taxes paid by the bottom 40 percent of taxpayers dropped from zero to minus 4 percent -- meaning the average family in this group got a subsidy from the refundable child credit or earned-income credit. The share of income taxes paid by the top fifth of taxpayers climbed from 81 percent to 85 percent. Today, the top 40 percent of filers pay a record 99 percent of all income taxes, and 85 percent of all combined federal taxes.

America faces real budget challenges. In particular, the impending retirement of 77 million baby boomers is set to unleash a $39 trillion tsunami of unfunded Social Security and Medicare costs. Congress should focus on preventing that looming fiscal disaster, not repealing the tax cuts or letting them expire.

Re-raising taxes to previous levels would not increase revenues significantly. But it would discourage investors and entrepreneurs, reduce incen­tives to work, and slow eco­nomic growth. Lawmakers would do well to remember that America cannot tax itself to prosperity.

Based on the Jan. 29, 2007 "10 Myths" paper by Brian M. Riedl, the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Roe Institute for Economic Policy Studies at The Heritage Foundation. You can find the original paper, along with additional research on taxes and the economy, at heritage.org.

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