Taxes and Growth: Debunking the Myths

Published October 1, 2003

Now that President George W. Bush’s tax and growth program has been signed into law, it’s time to debunk many of the myths spread by the opponents of tax-reduction policies. The current Bush plan does not rely much on immediate consumer spending gains, but instead on increased business investment and personal savings, to create the jobs and income that will keep our economy growing long-term.

Myth One: The plan does not help the economy.

A good long-term tax plan need not be–and should not be–a short-term stimulus package.

The $400 per-child tax credit payments mailed to eligible taxpayers this year and lower withholdings will help stimulate the near-term economy. But a good tax plan should be a long-term growth package. The Bush plan does this by creating jobs through increased personal savings and increased business investment. Job creation leads to increased income, which leads to more spending, which leads to even more jobs. These benefits will be felt in late 2003, all of 2004, and beyond.

Myth Two: The tax plan will grow the deficit.

When measured against the size of the U.S. economy, the Bush tax plan is moderate. It only grows the deficit in a static environment.

The plan reduces taxes by $330 billion over 10 years. (Another $20 billion is allocated to the states, for a total package of $350 billion.) This averages about $33 billion each year in tax cuts–“peanuts” compared to a $10 trillion U.S. economy.

The major boost of the tax plan is to change the way individuals and businesses make decisions. Lower taxes and fewer regulations lead to better decisions and more economic growth in the private sector. The deficit will grow only if these decisions do not have a positive feedback effect on the economy. If the economy grows faster based on these decisions and public spending is kept in check, expect the deficit to decline, long-term, not expand.

Myth Three: The tax plan benefits only the rich.

The majority of the Bush tax cuts go to the taxpayers who pay the majority of the taxes.

According to the Tax Foundation and data released by the IRS, the top-earning 25 percent of taxpayers earned more than two-thirds of the nation’s income (67.3 percent) and paid more than five of every six dollars collected by the federal income tax (84 percent) in 2000. The bottom 50 percent of the nation’s taxpayers earned only 13 percent of all income in 2000 and paid an even smaller fraction of the federal individual income taxes collected: 3.9 percent.

The Bush tax plan (as implemented) keeps more than 6 million low-income individuals off the federal income tax rolls.

Myth Four: The tax plan takes money away from valuable government programs.

The plan provides an environment for additional economic growth, which creates additional income to tax. Tax revenues will continue to grow.

Moreover, government spending is high enough. According to the U.S. Treasury, using preliminary figures for fiscal year 2003 (October 2002-September 2003), the federal government has spent more than $2 trillion–up 7.9 percent from FY 2002. That represents about 20 percent of GDP.

Myth Five: Tax cuts do not increase economic growth.

The economic literature on this point is clear for the United States and other countries. Tax cuts do increase economic growth. Tax hikes (beyond a reasonable tax level) slow economic growth.

The National Center for Policy Analysis (in Dallas, Texas) has placed on its Web site a model that explains the growth-maximizing tax rate (the rate at which increased taxes and spending cease to increase economic growth and begin to decrease it).

For the United States, the model results indicate that combined state/federal/local taxes were at this optimal rate in 1949, when the total tax load was at 21.7 percent, a level which has not been seen since. Today’s total tax load (state/federal/local) is close to 30 percent–almost 50 percent higher than the model’s calculated “optimal level.” Today’s federal tax burden alone is close to 20 percent.

John Skorburg was senior economist for the Economic Analysis Team of the American Farm Bureau Federation. On October 1 he became managing editor of The Heartland Institute’s forthcoming Budget & Tax News. His email address is [email protected].