Ten Years of GOP Tax Policy: Good News and Bad

Published February 1, 2005

Managing Editor’s note: This article is excerpted with permission from a chapter in The Republican Revolution 10 Years Later: Smaller Government or Business as Usual? to be published by the Cato Institute in March 2005.

In part 1 of this two-part excerpt, author Chris Edwards considers the good aspects of GOP tax policy. Next month’s excerpt will analyze the bad.

As a result of the 1990s economic boom and the tax rate increases of 1990 and 1993, federal tax revenues soared from 18.1 percent of U.S. gross domestic product (GDP) in fiscal 1994 to 20.9 percent by fiscal 2000, which ties the record high share of GDP set in 1944. The 2001 recession and Bush tax cuts reduced revenues to 15.8 percent of GDP by fiscal 2004. Nonetheless, even if President George W. Bush’s 2001 and 2003 tax cuts are made permanent, revenues are expected to rise to more than 18 percent of GDP later this decade.

That rise is expected to occur partly because of a growing economy and partly because of a rapid increase in alternative minimum tax (AMT) payments. Because the AMT is not indexed for inflation, it will hit an increasing number of taxpayers in future years. If made permanent, the Congressional Budget Office (CBO) estimates that the 2001 and 2003 tax cuts would reduce federal revenues by about 1.7 percent of GDP annually by 2014.

The highlights of the GOP’s tax cuts include a modest cut in personal income tax rates, a cut in the top capital gains rate from 28 to 15 percent, and a cut in the top dividend tax rate from 39.6 percent to 15 percent. Also, Republicans have substantially cut taxes on savings. IRAs and pension vehicles have been liberalized, health savings accounts were created in 2003, and partial capital expensing was (temporarily) enacted. The crucial question is whether future Congresses will act to retain these pro-growth tax cuts.

Focusing on Supply Side

Republican leaders in Congress worked hard during the decade to make sure the GOP gained a brand name as the tax-cutting party. Leading tax cutters included Dick Armey (House Majority Leader, 1995-2002), Bill Archer (Ways and Means Committee Chair, 1995-2000), Bill Thomas (Ways and Means Committee Chair, 2001-present), William Roth (Senate Finance Committee Chair, 1995-2000), and John Kasich (House Budget Committee Chair, 1995-2000). Those important party leaders kept Congress focused on pro-growth cuts. In addition, some of those leaders and other members, including Sen. Richard Shelby (R-AL) and Reps. Billy Tauzin (R-LA), Phil English (R-PA), John Linder (R-GA), and Phil Crane (R-IL), championed fundamental tax reform.

Before Bush came to office in 2001, most GOP tax-cutting efforts were focused on social-policy-oriented breaks, particularly child tax credits and marriage penalty relief. Bush changed that course and followed the supply-side tax advice of his two main economists, National Economic Council Chair Larry Lindsey and Council of Economic Advisers Chair Glenn Hubbard.

Although some of Bush’s tax proposals have been narrow tax credit provisions, the bulk of his tax cuts have been pro-growth, pro-savings, and pro-investment.

Tax Hikes Averted

Before the 1997 tax law, the six previous major tax laws either imposed tax increases (1982, 1984, 1987, 1990, and 1993) or were roughly revenue-neutral (the Tax Reform Act of 1986). (See Figure 1.) In addition, the 1983 Social Security amendments increased taxes. Without the change in policy direction that resulted from the 1994 election, Congress might have continued along the path of tax increases that had dominated recent budget policies.

Tax Bills

Indeed, there were several efforts in the 1990s led by Democrats and liberal Republicans to increase cigarette taxes, gasoline taxes, and corporate taxes. Those were mainly averted. For example, President Clinton’s fiscal 2000 budget sought a 55-cents-per-pack cigarette tax increase and proposed dozens of corporate tax increase provisions.

Tax Revenue Gusher

The economic boom of the 1990s caused income taxes, capital gains taxes, and corporate profits taxes to pour into federal coffers. Figure 2 shows that revenues were rising by roughly $100 billion every year. For a few years in the mid-1990s, spending increases were limited to about $50 billion per year, thus preventing the full gusher of rising tax revenues from being spent. Tax revenues as a share of GDP rose from 18.5 percent of GDP in fiscal 1995 to 20.9 percent in fiscal 2000.

Federal Revenue

Yet as revenues rose, federal outlays fell from 20.7 percent of GDP to 18.4 percent during that same period. Most of the reduction was in defense, but even nondefense discretionary spending fell from 3.7 percent of GDP in fiscal 1995 to 3.3 percent by fiscal 2000. By 2004, however, Bush and the Republican Congress had completely blown the party’s decent fiscal record of the 1990s. Massive spending increases pushed outlays back up to 20 percent of GDP by fiscal 2004.

Dynamic Scoring Needed

During the past two decades, tax debates in Congress have put an excessive emphasis on the revenue effects of legislation. That has unfortunately shifted the policy focus away from the effects that legislation might have on economic growth and tax complexity. To compound the problem, official revenue estimates, which are presented as if carved in stone, have often been inaccurate because they ignored the effects of tax changes on the macroeconomy.

To address that problem, the Congressional Budget Office and Joint Committee on Taxation have begun to modernize their tax estimating apparatus by bringing macroeconomic modeling into the process. One result should be to make revenue estimates more accurate.

Also, the greater focus on the economic effects of legislation should help sensitize Congress to the fact that tax changes are not just about gaining and losing money for the government budget; tax changes have serious consequences for economic growth and prosperity.

Chris Edwards ([email protected]) is director of tax policy at the Cato Institute, Washington, DC.