Sunday, January 01, 2006

In other news oil is lighter than water

The Big Picture: Laughing at Laffer

[quoting from the New York Times Dan Altman]
"The author of the analysis, Ben Page, estimates how an across-the-board cut in income tax rates could generate higher levels of economic activity, potentially replacing lost tax revenue. The theory behind these feedback effects is well worn: putting money back into taxpayers' pockets will let them spend more and save more, raising demand for goods and services and helping companies to invest for the future.

Mr. Page assumes that government spending will continue as planned for a decade after the tax cuts. He also creates different possibilities based on various assumptions about people's foresight, the mobility of capital and the ways in which the federal government might make up for the lost revenue when the decade is up - either by cutting spending or by raising taxes again. Finally, he compares the budget office's figures to those of two private forecasting firms, Global Insight and Macroeconomic Advisers.
The recent analysis by Mr. Page at the Congressional Budget Office dismisses the idea that tax cuts may actually improve the government's fiscal situation. Even in his most generous scenario, only 28 percent of lost tax revenue is recouped over a 10-year period. The United States, it seems, is firmly planted on the left side of the Laffer Curve.

Note this is more than mere theory. Looking at the most recent tax cuts and their impact on revenues, we learn that recent experience corroborates this prediction:

"In the second quarter of 2001, just before the first of President Bush's tax cuts took effect, federal receipts from personal taxes accounted for 10.3 percent of the economy. By the end of the post-recession slump, receipts had dropped to 6.4 percent. But in the third quarter of 2005, with the economy booming, they were still under 7.5 percent - an enormous difference. In dollar terms, federal receipts from personal income taxes, at $802 billion in 2004, are still lower than they were in 1998 ($826 billion) and much lower than in 2001 ($994 billion)."

The bad news may be even worse. Once a shortfall begins, the government does what governments always do -- Borrow more:

"Shortfalls in revenue cause the government to borrow more, so money intended for other purposes must be paid as interest instead. Even in Mr. Page's most generous picture, the federal government would probably have to pay an extra $200 billion in interest over the decade covered by his analysis."

What is the exact nature of the trade off? Mr. Page estimates that gross national product gains about 1% in exchange for higher deficits.

In other words, Supply Side Tax Cuts "borrow" growth.

Of course the "starve the beast" folk would perhaps claim that the problem is that the theory is executed incorrectly since the assumption is that spending would remain constant for 10 years where in their perfect world spending would be cut in tandem with taxes. And in a "perfect" balanced budget world pols could choose to increase taxes and increase services, to hold the taxes and services steady, or to decrease both. Higher taxes make the folks that pay them unhappy with the pols and cutting spending makes the recipients or beneficiaries of said monies unhappy. So what's a pol to do? The folks who paid his way into office want less taxes and mo' money and the voters want the same. There's not enough to go around so the pol does the same thing the consumer has picked up in the last few years, he whips out the gold card and makes up the difference between his means and his wants.

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