Saturday, June 16, 2007

Letter to Congressmen & Letter to Editor: Tax Cuts

Dear Senator/Representative,

The profound consequence of the 2001 and 2003 tax rate cuts has been felt by Arkansans, and is consistent with historical precedent dating back to Reagan and Kennedy. Over-taxation reduces economic stimulus and the elasticity of taxable income. As a fifteen-year-old policy enthusiast, I'm deeply interested in seeing our local economy continue to benefit from economic stimulus provided by these reforms. Yet, we're faced the the likelihood of their expiration, along with the tax hike associated with that and the expansion of the Alternative Minimum Tax (AMT). I would urge you to provide support to make the tax reform permanent. We all feel the positive effects of pro-growth, pro-family tax rate cuts. Low unemployment, historically high sustained GDP growth rates, as well as increasing productivity and compensation.

Reductions in the capital gains tax and income tax stimulate economic growth, alleviate unemployment, bolster incentive for capital investment, and improve the elasticity of taxable income. This was historically demonstrated in the Kennedy and Reagan administrations, where we saw economic growth without substantial reductions in revenue. We see that freeing up the economy and allowing for the added stimulus of lower marginal rates and capital gains tax, we improve output, lower unemployment, and create a more friendly environment toward enterprise. The distortion effect of taxes is large, in fact, there is some empirical literature (e.g. Romer, Berkley 2007) to suggest that each one percent increase in exogenous tax rates reduced output by three percent.

While we bemoan the increasing federal debt, which is a policy concern, we need to remember that 87% of the accrued deficit increase since 2000 has been caused by heightened spending, with only 13% viably held accountable to tax rate cuts. Additionally, if we examine the federal debt pro rata, it is consistent with historical average federal debt held by the public as a percent of the GDP (for the past forty years that figure has been around 35%).

As we attempt to maximize revenue while providing the lowest possible marginal rates across the board, and imperative economic parameter deals with the elasticity of taxable income. A recent empirical work by Gruber and Saez in The Journal of Public Economics elucidated that the elasticity of taxable income is substantially effected by marginal tax rates of higher income brackets. What this means is that the arithmetic reduction in revenue caused by lower tax rates is offset by the alleviation of the dead-weight loss the taxes had in the first place. This economic effect allows us to cut taxes more easily, and in the long run, lose little revenue. Some estimates of skyrocketing budget deficits if we make the Bush tax cuts permanent fail to account for this offset, which the economic community acknowledges. Low-end estimates come from sources such as Mankiw and Weinzierl (Journal of Public Economics 2006) which estimated a parameter of 0.5, and higher estimates by Kimball and Shapiro (Yale 2004) have been even more favorable toward tax cuts.

The final objection to making President Bush's tax cuts permanent comes in the form of objecting to "tax cuts for the rich." This uses a grossly disproportionate methodology that overlooks a couple of things. First, while the higher-income earners were quantitatively affected more by the cuts, this is in part because we're dealing with larger sums of money, and also because the necessary capital gains tax reduction disproportionately affected them. That reduction, however, proved vital in providing for job growth and economic stimulus. More importantly, the tax cuts shifted the tax burden more to the wealthy. The rich pay a larger portion of income taxes today than they did before the cuts, and the poor pay less. Everyone's taxes were cut, and everyone benefited.

I would urge you to support these pro-growth policies, and support making the bush tax cuts permanent.

Best regards,

Will Simpson

The following letter was published in the Stone County Leader.

To the editor,

If you and your spouse are an elderly couple earning $40,000 a year, your taxes will go up from $583 to $1,489 in 2011. If you’re a woman, you could be one of the 83 million American women who could see their taxes rise by an average of $2,068. The tax cuts proposed by the Bush administration drew on a long and rich history of policy precedent, empirical literature, and proven success. They bolstered a sluggish economic prognosis into a stalwart economy with stable GDP growth, historically low unemployment, and climbing productivity and compensation. Yet, today, the democratic congressional majority’s legislative agenda explicitly declares a desire to raise American’s tax burden by allowing this reform to expire.

Two common myths exist regarding this tax reform. The first is that it exacerbates budget deficits. At least in the short term, we do see a slight loss in revenue, but the arithmetic loss from the reduced rate is offset because tax cuts alleviate some deadweight loss the taxes had in the first place. In common man terms, you won’t necessarily lose significant amounts of revenue. As a matter of fact, the Congressional Budget Office (CBO) has stated revenues for FY 2007 are exceeding last year’s by nearly $250 billion, That increase represents the second-highest growth rate (13%) in the past twenty-five years; four to five times the inflation rate. April saw one of the largest surpluses in recent decades. This is called the economic effect. Estimates for a parameter of offset by Kimball and Shapiro (Yale 2004) were favorable to tax cuts, coming close to 0.7 (meaning we recover seven tenths of the loss). In the long run, some marginal rate and capital gains reductions can even increase revenue. Many models that forecast huge revenue drops if we don’t raise taxes discount not only the basic distortion effect of taxes, but also the elasticity of taxable income (how we can enlarge the economic pie so to speak). An empirical work by Gruber and Saez (Journal of Public Economics 2002) showed that marginal tax rate cuts and capital gains reform drastically improved this elasticity. In short, the current budget deficit cannot be attributed to tax cuts, but to spending.

The second popular myth is that tax cuts are only for the rich. On the contrary, the Bush tax cuts actually shifted the tax burden more toward the wealthy! CBO numbers show that pre-tax cut, the highest 20% of income earners' tax dollars accounted for 81.2% of total federal revenues collected. Post reform, the highest 20% of income earners paid 85.3% of taxes collected. The middle twenty percent dropped from contributing 5.7% to 4.7% of revenue. The numbers are antithetical to the rhetoric of the left.

The historical precedent for tax reform is undeniable. If you look at Department of Commerce statistics before and after the Reagan Administration tax cuts, in the four years prior to the cuts real annual income tax revenue growth was at -2.8%. After the cuts it was at +2.7%. Do the same thing comparing real GDP growth and you get 0.9% compared to 4.8%. We’re seeing the same scenario unfolding today. The Bush tax reform has incubated an environment for growth. Please assure our Senators and Representative that the people of Arkansas are firmly supportive of successful tax reform, and Congress cannot allow these measures to expire.

Will Simpson
Mountain View, AR

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