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Monday, July 17, 2006

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. ...

    Posted by on Monday, July 17, 2006 at 12:03 AM in Budget Deficit, Economics, Policy, Taxes | Permalink  TrackBack (0)  Comments (2)


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