Q: Does Cutting Taxes Raise Revenue?

A: Can you read a chart?

I got into a spirited contretempts with one Daniel Lacalle, a "Chief Economist" for a Spanish investment firm. He found his way into my feed from that of Brian Wesbury's, who is the "Chief Economist" of another investment firm, who always takes the party line no matter what the reality. I featured him in a piece called "Polluting Economics With Politics" some time ago.


In that piece, I had noted that Mr. Wesbury thought deficits were a benign thing. That is, until the very moment the Oval Office switched parties, and were immediately deemed to be wholly unacceptable- even under negative GDP.

In any case, I was berated thusly:


Except our "Chief Economist" seems to have a problem with basic statistics. First, we don't go by raw dollars, as I have pointed out in several pieces. Even assuming the $785 billion figure in revenues is correct, we go by PERCENTAGE increases, for the simple reason that we need to establish a relative baseline to prove our case, and secondly, the value of a dollar does erode over time.

There are other factors, of course. What economist worth his salt would ignore rate policy, currency fluctuations, central bank activity, two wars raging concurrently, and dozens of other factors that contribute to the mix? Trying to create a false "binary outcome" is a rookie error. But even so, the facts don't bear him out anyway.

In the chart above, receipts (stated as a percent change) take a nice jump a year after the cuts take effect in 2003. But by the first quarter of 2005, velocity is already slowing, and keeps doing so until we hit the gateway of the crisis to come, in the first quarter of 2007.

Now of course, if you want to count revenue as Mr. Lacalle does, you get a chart like this:

Revenue always goes up, provided we're not in recession. So you can see how silly this argument is. Absent from Mr. Lacalle's "analysis" is an explanation as to why the firstround of the "Bush Tax Cuts" executed in 2001, (EGTRRA) didn't have the same revenue stimulating effect, but of course, that would have killed his argument.

As I've mentioned in a previous post, "Exploring Tax Cut Myths," tax policy is probably the least effective tool for stimulating an economy, especially compared to monetary and fiscal. Moreover, looking over the tax bracket shifts executed under these initiatives, who would be gullible enough to believe that these ~3% tweaks in marginal rates would, by themselves, be responsible for generating a substantial shift in revenue?

This was an amusing episode, as Mr. Lacalle stubbornly ignored the evidence, chart after chart, statistic after statistic, but it shows how tribal even economics are. Like Mr. Wesbury, he doesn't lack credentials. What he DOES lack is intellectual honesty and a commitment to respect the evidence. And that's not a good place for anyone to be in any profession. The conversation ended with his sending me a link to the Heritage Foundation's "study" showing how tax cuts pay for themselves. Heritage tried to prove this with EGTTRA as well. Here are their predictions:

  • Under President Bush's plan, an average family of four's inflation-adjusted disposable income would increase by $4,544 in fiscal year (FY) 2011, and the national debt would effectively be paid off by FY 2010.

  • The net tax revenue reduction, after accounting for the larger tax base that would result from higher employment and faster economic growth under the Bush plan, is $1.1 trillion from FY 2002 to FY 2011, 33.4 percent less than conventional static estimates.

  • The plan would save the entire Social Security surplus and increase personal savings while the federal government accumulated $1.8 trillion in uncommitted funds from FY 2008 to FY 2011, revenue that could be used to reform the Social Security and Medicare systems and reduce the payroll tax.5

I would laugh at this public demonstration of incompetence, except for the fact we're going to execute the same folly again, and Heritage will never run out of money.

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FloMartin Securities, Inc.

Donald R. Davret, Investment Advisor Representative




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