Income Redistribution and Tax Revenue

If Dooh Nibor, the reverse Robin Hood of the Second Gilded Age, uses his political and economic powers to take a dollar from the poor and give it to the rich, what happens to tax revenue in a progressive tax system? Greg Ip and Deborah Solomon look at the recent increase in tax revenues and note that while tax revenues and output both exceeded projections, the amount that output growth exceeded projections was small. This implies the unexpected increase in tax revenue is largely a compositional effect rather than a consequence of higher than expected economic growth:

As Bigger Piece of Economic Pie Shifts To Wealthiest, U.S. Deficit Heads Downward, by Greg Ip and Deborah Solomon: In announcing a big drop in its estimate of this year's federal budget deficit, the Bush administration was quick to credit itself. "Tax cuts worked to generate economic growth, and economic growth is now working to raise revenues," White House budget director Rob Portman said...

But this explanation falls short. While tax revenue is growing far faster than the Bush administration forecast in its budget projections in February, the nation's economy isn't. What has changed isn't the size of the economy, but how the economic pie is divided. The share of national income going to corporations and the wealthiest individuals, already large, has expanded, while the share going to typical wage earners has shrunk. Because corporations and the wealthy generally pay income tax at higher rates than does the typical wage earner, that shift benefits the federal Treasury.

U.S. tax revenue for fiscal 2006 ...  is expected to be 5% -- or $115 billion -- higher, than the administration projected in February. Largely as a result, the budget deficit is expected to be $296 billion this year, instead of $423 billion.

But total economic output is expected to be just 1% larger, before adjusting for inflation, than the White House predicted. After adjusting for inflation, it is projected to be just 0.1% larger. ...

So, the tax windfall is another piece of evidence that income inequality in the U.S. continues to grow, which in turn may explain why the average American still gives President Bush low marks on the economy despite its overall strength. ...

On the other hand, it also may be evidence that Mr. Bush's tax cuts are working as advertised. Lower tax rates were meant to encourage people to work more, and because their taxes were cut the most, ... the wealthiest may have the biggest incentive to work and earn more.

In addition, cuts in taxes on capital gains and dividends were meant to reduce the cost of capital and encourage companies to invest more, which should lead to higher profits. This is called the supply-side effect...

Rudolph Penner, a senior fellow at the Urban Institute, a Washington think tank, and a CBO director picked by Republicans in the 1980s, says a supply-side effect "doesn't come close to explaining the revenue surge." ... He notes the administration itself puts the tax cuts' maximum supply-side boost at just 0.7% of GDP, stretched over many years.

Mr. Penner says the revenue surge reflects not a supply-side effect but a replay of the late 1990s, when the 1% of richest taxpayers prospered most and "paid a huge amount of taxes," eventually driving the budget into surplus. Indeed, the CBO and the White House repeatedly raised revenue forecasts then, much as they have now. But the recession and the stock-market bust in 2001 caused revenue to fall far more rapidly than budgeted.

That experience suggests the current revenue surge could also be transient. ... Even if the wealthy and corporations maintain their larger share of national income, budgeting could become more treacherous. That's because corporate profits and the performance-based pay that makes up so much of the affluent's income are inherently more volatile than wages... Thus, the difficulty of projecting the Treasury's tax take could be long-lasting.

Update: Gene Sperling has more on the lack of evidence for supply-side claims:

Inconvenient Facts and Bush's Supply-Side Boast, by Gene Sperling, Bloomberg: ... Judging from the White House's recent economic bragging, when it comes to their tax cuts, only positive news can be allowed into evidence. They are like the student who wants to throw out all of his bad tests scores and be graded only on occasional shows of improvement. ... [I]t is hard to swallow the Bush White House's assertions of direct causation between their tax cuts and any improvement in economic projection.

You just can't ignore the fact that this recovery shows the worst job creation on record and that when you look at the complete recovery -- as opposed to its best couple of years -- growth and investment have been weak. It is also hard to ignore that since the 2001 tax cuts were passed, median family income declined every single year, and since the 2003 tax cuts were passed, typical hourly and weekly wages fell in real terms.

Finally, there is the 2006 deficit, which the administration initially projected at a $500 billion surplus. It now will be a $300 billion deficit. In other words, the Bush White House is celebrating an $800 billion deterioration. (Even in 2002 -- after factoring in the tax cut, the aftermath of recession and Sept. 11 -- the administration still projected a $127 billion surplus for 2006.)

But we are instructed to ignore all these disappointing facts and focus only on how much revenues have improved over recent projections.

Yet,  ... Revenues over the last several years have been dramatically lower than what the Bush administration projected when it took office in 2001. ... In total, revenues between 2003 and 2006 fell short of the 2001 forecast by $1.8 trillion.

So is this proof-positive that the Bush tax cuts are the sole cause of a nearly $2 trillion revenue loss over just four years? If I drew that conclusion based only on those facts I would be guilty of the same selective causation as the Bush White House. ...

Comments

[Movie Guy]

Greg Ip and Deborah Solomon:

"Mr. Penner says the revenue surge reflects not a supply-side effect but a replay of the late 1990s, when the 1% of richest taxpayers prospered most and "paid a huge amount of taxes," eventually driving the budget into surplus."

I agree with this observation.

Gene Sperling:

"In total, revenues between 2003 and 2006 fell short of the 2001 forecast by $1.8 trillion."

"So is this proof-positive that the Bush tax cuts are the sole cause of a nearly $2 trillion revenue loss over just four years?"

Or was this also the problem:

Remarks by Governor Donald L. Kohn
Federal Reserve Board
At the Forecasters Club of New York Luncheon, New York, New York
April 27, 2006
Business Capital Spending

In this speech, Don Kohn openly complained about the lack of U.S. business capital spending since 2001.

"Business fixed investment has risen at a robust annual rate of nearly 9 percent on average over the past two years, and the real level of investment at the end of last year, $1.3 trillion, was nearly 6 percent higher than the peak reached five years earlier. However, real gross domestic product (GDP) expanded nearly 14 percent over the same period. To be sure, the investment peak in 2000 was unusually high; still, the nominal share of business fixed investment in GDP, at 10-3/4 percent at the end of 2005, was well below its forty-year average."

"Business financial statements also reflect evidence of restrained business spending behavior. Normally, businesses are heavy net users of savings generated by the rest of the economy. The financing gap--the level of capital spending over the level of internal funds--is a measure of that reliance. But it was close to zero in 2002 and 2003 and remained unusually low last year (after adjustment for tax-induced flows of repatriated foreign earnings), which suggests that businesses didn't see enough profitable investment projects to warrant tapping the markets for external financing, even at low long-term interest rates. To be sure, profit margins and cash flow have been high, but that would also seem to be an environment that should encourage expansion. In fact, businesses appear to be using some of their very large holdings of cash for other purposes. Corporations have increased their share repurchases, which hit a record level last year. They have also increased share retirements through cash-financed mergers and acquisitions, which have been boosted by a surge in buyouts. Evidently, corporate managers view prospective returns from these uses of cash flow as comparing favorably with those from new capital spending projects."

"The focus in current commentary is mostly on the outlook for housing and consumption, but I suspect that business fixed investment will again play a central role in shaping the path of the economy."

[Blissex]

«Don Kohn openly complained about the lack of U.S. business capital spending since 2001.»

That to me sounds rather ridiculous: USA businesses have been doing a lot of capital spending, creating a robust and sustained jobs and wage boom, just not in the USA (never mind the Rustbelt or West Virginia), but in India/China.

When offered the chance to bring back at a very low tax rate funds held abroad they have invested that capital yes, but in buying up assets, not business investment.

To me it looks like that USA companies are rather keen on creating productive activities abroad and keeping their headquarters nationally, and never again shall the twain meet.

I'll resurrect this example of such a strategy:

http://SeattlePI.NWSource.com/business/272987_msfttexas07.html
«Microsoft Corp. is considering San Antonio for a $600 million data center that would bring the tech industry's best-recognized name to the city and generate up to 100 jobs, two local officials close to the negotiations said.»

Considering that this will be obviously a 24/7 facility, the 100 jobs probably are over 3 shifts, and are the security guards, porters, electricians, operators, cleaners, needed to run it as a building, at or near minimum wage; and the many thousand workers using the computers therein will most likely be offshore.

The only reasons why this asset is being located in the USA are that electricity and land are cheaper, and being in a different continent from the workers and in a friendly jurisdiction helps a lot...