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

Malpass Takes Aim at Trade Grumblers

The US has a powerful, growing economy, yet we project the "wrong path" of an aging society drowning in debt and burdening the world with risk. This gloomy fiction distorts our domestic and international economic policy-making. We should reject it and launch a more energetic vision of global prosperity built on economic freedom and dynamism.

Thus David Malpass, chief economist at Bear Stearns & Co, opened his FORBES column "The Triple Deficit Paralyzes Policy Vision" last month. Being a big fan of Steve Forbes (I wish he'd landed the White House if he could have been remotely electable), this is very similar rhetoric.

The trade deficit is a terribly convenient avenue to take pot shots at free trade. Wavering support creates a notably hostile climate for free traders, as was evident in the last election. Along with other issues of baiting economic ignorance--such as previously addressed tax cuts, "negative savings rates," and "skyrocketing deficits," protectionism baits the fears of American blue-collar workers, and quickly gains clout.

While protectionism certainly wasn't a hot-button issue, there are more than a couple of disturbing signs. The Wall Street Journal reports, "Pew Research data show the sense of vulnerability among workers. A recent poll shows low-skilled U.S. workers are over 40% more likely to believe their jobs could be sent offshore."

Malprass continues:

The US is the world's biggest producer, exporter, seller, saver and innovator. On average it adds 30% more to global GDP each year than does all of Asia (45% more in 2006), with one-tenth the population. US employment, wages and profits are at record levels. We're the biggest source of foreign aid, and the only major source of its most effective component: private donations.

Despite dire fiscal predictions the federal budget is on a trend that could bring it into balance at the end of the decade, with a debt-to-GDP ratio well below the Clinton Administration's average. Talk of our recklessly low "savings rate" circles the globe yet arbitrarily excludes the economy's trillions of dollars of compound gains. Calculated properly, US households have more financial savings--and in mos years add more-- than the rest of the world combined.

The loudest hue and cry is over our trade deficit, which is blamed for dragging down our economy, as well as everyone else's. Yet the view that our trade deficit costs jobs and adds to global financial risk can't be reconciled with our 4.5% unemployment rate and the eager flow of long term, low-cost foreign capital into US investments.

Fear of fiscal, trade and savings deficits as crippled domestic policy-making..."

(emphasis added)

Steve Forbes also explains:

Anti-free-trade sentiment is being fueled by our record trade deficits. Congress is full of destructive proposals... While most economists know well the virtues of free trade, they are still tied to the notion that trade deficits or surpluses matter. A surplus is equated to a country's turning a profit and a deficit to a nation's running at a loss. But nations don't trade with each other; individual sand entities do.

FORBES has had a deficit with its paper supplier for more than 89 years. Yet this 'imbalance" persists because each side thinks the transaction is beneficial... CNN has a deficit with Lou Dobbs, it pays him far more than anything he actually buys from the network General Motors similarly has a deficit with CEO Rick Wagoner Yet the red ink continues because the parties find it advantageous for it to continue. CNN and GM each get the services of the individual employed, and each individual gets cash and other forms of compensation in return...

While preaching free trade, the economics profession helps undermine it with this zero-sum mentality focusing on so-called balance of trade. Remember, this year marks the 400th anniversary of the settlement in Jamestown, Va. Since that time, America has run trade deficits for all but some 50-odd years. Just look at what all that economic sinning has done.

Simplistic? Perhaps. True? Let me know.

Deficit and Savings Rate

110th's Deficit Worries As I've mentioned before, I remain a sharp critic of excessive spending, the federal debt, and the deficit. Glaringly simple plans such as the Republican Study Committee's "Contract with America: Renewed" present decent methods of balancing the budget over the next five years without hiking taxes.

Nonetheless, the deficit isn't going to strangle the economy anytime soon, and while numerically it's "skyrocketing," what I've repeatedly pointed out is that the quantitative examinations aren't sufficient. Taken in context of GDP growth, this year's deficit will be economically insignificant.

Heritage called the rhetoric last week, and CATO was doing it several years ago. Brian Riedl (Heritage):

• The public debt now stands at 37 percent of GDP, which is below the post-war average of 44 percent of GDP and lower than every year during the 1990s. By historical standards, the public debt is small. The much larger threat is the trillions in future costs associated with Social Security, Medicare, and Medicaid.TheThe

The real problem, and what the research was focusing on, lies in the entitlement tsunami and general spending growth. I addressthatedseds to place more focus on working its way out of entitlement disaster and hashing spending than tax hikes to alleviate the deficit.

Negative Savings and Stagnant Wages
After exhausting all other alternatives (most recently the death of "tax cuts for the rich") the criticisms have moved largely to lack of wage growth and a negative savings rate. They have a bit of a point about wage growth, it has been stunted in a statistical classification sense, yet one needs to remember the booming role of benefits in total compensation. Productivity and compensation are both substantially up, and when I'm earning more money I don't particularly care if the wealthy are earning faster.

As for the savings rate, Neil Cavuto, while a bit more of entertainer than an economist (though I still want him to run for President) summed it up succinctly and informally:

It [the negative savings rate figure] leaves out retirement plans, pension plans, 401(k) plans, stocks, mutual funds and a myriad of other investments. It leaves out the simple fact fully seven out of 10 Americans are invested in the stock market.

And it leaves out their homes — for many, an enormous source of equity, even with the recent downturn in prices. I'm not saying we Americans are wonderful savers. We're not.

But I'll tell you what: We're apparently a heck of a lot better savers than workers in France. According to an AXA Equitable Global retirement survey out this week, we save twice as much as they do.

Ditto Italy and Germany. And nearly 10 times what they do in China.

In all, we're putting away about 700 bucks a month.