Last week, the Office of Management and Budget (OMB) released the final budget numbers for the recently ended fiscal year 2004 showing a budget deficit of $413 billion. This is the largest budget deficit in nominal dollars and opponents of tax cuts have jumped on the issue by blaming the Bush tax cuts. What these critics fail to mention is that the deficit is $100 billion lower than previously expected by the Bush administration and $68 billion lower than forecasted by the Congressional Budget Office (CBO) following passage of President Bush's 2003 tax cut.
The substantial downward revision is due to accelerating economic gains resulting from the tax cut and the dynamic revenue effects associated with cutting taxes. In short, 40.6 percent of all expected revenue losses from the tax cut have already been recouped, the result of a stronger, growing economy lifted by the Bush tax cut. Further gains are expected in the coming year as well.
On May 28, 2003, President Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), which accelerated income tax rate reductions, expanded business depreciation, increased small business expensing amounts, slashed the capital gains tax and significantly reduced the double taxation of dividends. The tax cut was implemented to correct short term imbalances in the economy, such as a downward trending stock market and lagging business investment, while improving long term economic growth.
Following passage of the tax cut, Congress's Joint Committee on Taxation (JCT) evaluated the overall tax package and "scored" how much the federal Treasury would lose in revenue, assuming tax cuts will have absolutely no impact on economic growth. As such, the JCT analysis showed the federal government "losing" $350 billion over ten years. This estimate was overly exaggerated because taxpayers often change their behavior in response to lower tax rates and the economy will expand relative to not cutting taxes.
This unrealistic process provides an inherent bias against cutting taxes and the information supplied by JCT was used by tax cut opponents, including Democratic presidential candidate John Kerry, to claim the Bush proposal would balloon the deficit. According to the analysis, the largest revenue loss of the Bush tax cut was to be in fiscal year 2004 when the most money was being returned to taxpayers. JCT claimed the federal government would lose $135 billion of revenue as a result of the tax cut.
Subsequently, CBO estimated tax revenues for the next ten years, which are generated by forecasting future economic activity. Once CBO completes its analysis, the JCT "tax loss" is subtracted from the revenue estimate. Similar to the JCT process, CBO's analysis does not consider the economic changes resulting from tax cuts. With both organizations failing to account for increased economic activity, the official estimate of tax revenues were underestimated, leading to a wide overestimation of the deficit number.
For example, four months after Bush signed the tax cut, CBO predicted the economy would grow just 2.2 percent for 2003 and 3.8 percent for 2004. Yet, since the tax cut was put into place, Gross Domestic Product (GDP), the measure of overall economic activity, is averaging a stellar 4.7 percent quarterly rate, even with skyrocketing oil prices shaving off 0.5 to 1 percent of growth. GDP finished 2003 with 3 percent growth, 80 basis points higher than CBO expected and 2004 will exceed CBO's forecast by at least another 70 basis points. The 150 basis point difference is more than $300 billion, or an additional $2,500 per household.
The same is true for employment. CBO expected the unemployment rate would average 6.2 percent in both 2003 and 2004 with limited job creation taking place in the future. CBO turned out to be very wrong as the tax cut changed the incentives to save, work, and invest. In fact, 1.7 million jobs have been tallied with more expected once the benchmark revision is finalized. As a result, the unemployment rate has declined from 6.3 percent to 5.4 percent. Moreover, the unemployment rate finished 2003 more than 20 basis points below CBO's forecast and is currently 65 basis points below CBO's forecast through the first 9 months of 2004.
This "unexpected" growth has significantly lifted federal tax revenues enough for the budget deficit, both in nominal dollars and as a percentage of the economy, to be revised downward considerably. Hence, the original CBO forecast of the budget deficit has been reduced by $68 billion since the tax cut was passed. As a percentage of the economy, the deficit has been reduced from 4.3 percent to 3.6 percent. In just 12 months, the forecasted deficit fell 70 basis points, driven entirely by new economic growth stemming from the tax cuts. President Bush is well on his way to reducing the deficit in half by 2008.
The JCT/CBO analyses predicted total federal revenues would increase a paltry 2 percent in fiscal year 2004. However, revenues increased nearly 6 percent in fiscal year 2004, leading to more than an additional $100 billion increase in tax revenues, as compared to fiscal year 2003. JCT/CBO expected income tax revenues would decline by $32 billion in fiscal year 2004 compared to the previous year. But with more people working and $2 trillion of new shareholder wealth, income tax collections increased by $16 billion, a 6 percent swing from the forecast.
These revenue gains occurred despite the third largest tax cut in history and total revenues are now $55 billion above the original baseline. As a result, 40.6 percent of the tax cut's $135 billion "cost" has already been recouped to the federal government coffers. And 2005 will see an even larger increase in tax revenue collections and a sharper reduction in the deficit as above average economic growth continues.
Put a different way, the federal government "lost" $80 billion of revenue in the past 16 months to gain an additional $300 billion of economic output. Anyone who considers this is a loss is seriously mistaken.
Clearly, President Bush's 2003 tax cut was exactly the right policy initiative at exactly the right time given the economic circumstances facing the country at that time. The tax cut not only lifted the economy out of its short term doldrums, but also put the country on a path for above average growth in the future. Repealing these tax cuts would be a grave mistake.
Sen. Kerry has sought to make the budget deficit an issue in this campaign, but he has very little credibility on this issue. Kerry has proposed spending more than $2 trillion to fund the promises he made to the Washington spending interests in this campaign. Raising the top two income brackets will generate just $600 billion of revenue over the next ten years. Keeping his campaign promises to everyone would require a massive widening of the deficit, by far larger than any change that has been made over the past four years.
But given Kerry's record and the promises he has made in this campaign, Kerry will raise taxes on more than just wealthy taxpayers to finance this new spending. Higher taxes to pay for new government spending, at a time when energy prices are historically elevated, will stifle the economic gains made in the past 16 months. And this will result in a lower standard of living for all Americans and a reversal of the sharp reductions in the budget deficit set to take place in the next year.
Daniel Clifton is executive director of the American Shareholders Association. He can be reached at dclifton@americanshareholders.com.
