The Tax Cuts Didn't Cause the Budget Deficit

COMMENTARY Budget and Spending

The Tax Cuts Didn't Cause the Budget Deficit

May 18, 2010 3 min read

Senior Fellow, Manhattan Institute

With the 2001 and 2003 tax cuts scheduled to expire at the end of this year, President Obama and Congress face the prospect of overseeing a historic tax increase.

If nothing is done, the $1,000 child tax credit will fall to $500, and the marriage penalty will be re-imposed. Low-income families will see their income tax rate jump five percentage points, while everyone else will see increases of three to 4.6 percentage points. Capital gains and dividends tax rates — currently 15 percent for most investors — will leap to 20 percent and 39.6 percent, respectively. The death tax, which is finally gone, will be re-imposed at a 55 percent rate.

Such large tax increases would clearly hammer families and businesses. They would also severely damage the fragile economy. Virtually no economic school of thought advocates raising taxes during a recession, and this massive tax increase could shatter the modest and shaky economic recovery.

Yet among tax-increase advocates, it has become an article of faith that President Bush's 2001 and 2003 tax cuts caused the budget deficit. Newsweeks Fareed Zakaria echoed this conventional wisdom recently: "The Bush tax cuts are the single largest part of the black hole that is the federal budget deficit." Similarly, in 2004, when Sen. John Kerry , Massachusetts Democrat, accused Mr. Bush of having "taken a $5.6 trillion surplus and turned it into deficits as far as the eye can see," he focused on "Bush's unaffordable tax cuts for the wealthiest people."

These assertions are demonstrably false.

First, that $5.6 trillion surplus never actually existed (the budget surplus peaked at $236 billion in 2000). Instead, $5.6 trillion represents the cumulative 2002-2011 budget surplus that was projected by the Congressional Budget Office (CBO) in early 2001. Instead, the United States is now projected to run a $6.1 trillion deficit over those 10 years — an $11.7 trillion swing.

The surplus projection itself was completely unrealistic and wildly optimistic. It assumed that the late-1990s economic and stock market bubbles would continue forever (and bring tax revenue to record-high levels). It assumed no recessions, no terrorist attacks, no wars, and no natural disasters. And it assumed that discretionary spending as a percentage of the economy would fall to 1930s levels. There was no way this projected surplus would ever have materialized.

In its subsequent 28 budget baseline updates since January 2001, CBO has catalogued the cause of this $11.7 trillion swing from surpluses to deficits. Their data shows that at a cost of $1.7 trillion, the 2001 and 2003 tax cuts are responsible for just 14 percent of the fiscal decline. And even that excludes all positive economic effects that replenished a portion of the lost revenue.

Instead, the largest cause of the swing (33 percent) was economic and technical revisions, arising from CBOs understandable failure to anticipate two recessions and two major stock market corrections over the next decade. Other causes of the lost surplus were the 2009 stimulus (6 percent), other new spending (32 percent), new net interest costs (12 percent), and other small tax cuts and tax rebates (3 percent).

So even if the 2001 and 2003 tax cuts had never been enacted, rising spending and economic factors would have guaranteed more than $4 trillion in deficits over the decade, and kept the budget in deficit every year except 2007. Simply put, the tax cuts played a relatively minor role in the budget deficits.

Furthermore, Mr. Kerrys quote further singled out "tax cuts for the wealthiest people." On that theme, Mr. Obama has proposed ending the tax cuts only for those earning more than $250,000 annually. Yet CBO data shows that just 25 percent of the tax cuts went to those making more than $250,000. Therefore, the "tax cuts for the wealthiest" come to approximately 4 percent of the total swing from projected surpluses to actual deficits.

Read that last sentence again. Just 4 percent.

Overall, Mr. Bushs spending spree played a much a larger role in the budget deficits (even as Democrats complained that he did not expand government fast enough.)

Nor are the tax cuts driving future deficits. Even if the 2001 and 2003 tax cuts are extended, tax revenue by 2020 is projected to reach 18.2 percent of the economy — slightly above the historical average. Thus, the projected $13 trillion deficit over the next decade (assuming current tax and spending policies continue) is overwhelmingly the result of rising spending, not declining revenue.

The presidents proposal to let the tax cuts expire for the "rich" would raise just $700 billion over the decade — closing just 5 percent of the deficit — with severe negative economic consequences. And letting the tax cuts expire for everyone ($3 trillion) would close less than one-quarter of the 10-year budget deficit, while jeopardizing the fragile economic recovery.

Both past and the future budget deficits are driven substantially more by rising spending than by tax cuts. Lawmakers should tighten their belts and rein in spending before demanding more taxes from the American people.

Brian Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs at the Heritage Foundation

First appeared in The Washington Times