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What’s Wrong With This Deficit Graph?

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by

mwkruse
in , ,

Lately, I've seen various graphs that purport to show the key components driving our budget deficit. Below is the latest one making the rounds:

Chart-of-the-day-bush-policies-deficits-june-2010

The issue that we need to pay particular attention to is the inclusion of Bush-era tax cuts. Taxation is directly related to economic growth.

A 0% tax rate is not workable. There would be no government. A 100% tax rate isn't workable either. People would starve and die, ceasing to create any income to tax. If you go from 0% to 5%, the government will generate higher revenue. You will get even more revenue if you go from 5% to 10%. But at some point, raising the tax rate generates less revenue. Resources are taken out of the private sector, slowing the growth of the economy, which means a smaller base of revenue to tax. At the extreme end of taxation, the economy contracts and dies.

Laffer-curve1

Source

So changing tax rates is ALWAYS a trade-off. The Bush-era tax cuts were made based on the assumption that lower taxes would stimulate economic growth to a higher rate. At some future date (say, five years), the revenue would be greater with lower tax rates and faster economic growth than it would have been with higher tax rates and slower economic growth. The Bush folks believed we were somewhere between the graph's Equilibrium Point and Point B. If they were correct, the tax cuts kept the deficit lower than it otherwise would have been.

Now, the big question, of course, is whether the Bush folks were right. Did the tax cuts "pay for themselves" by stimulating economic growth and creating a larger tax base? I don't know a definitive answer to that. But I know that throwing tax cuts into the chart above with no compensation for the changes in overall revenue those tax cuts generated (or failed to generate) is deceitful. The tax base does not stand still in isolation as we change tax rates. It varies in relationship to them. The comparison of tax rates AND economic growth in context "A" must be compared with context "B."

The reality of the deficit debate is that if we taxed the wealthy at 100% of their income above middle-class levels, it would make only a tiny dent in the problem. I'm not convinced that slightly higher taxes like the Democrats are proposing will hurt the economy, but tax increases won't fix the deficit. Only substantial spending reductions coupled with economic growth will have an impact.

 

 

Comments

4 responses to “What’s Wrong With This Deficit Graph?”

  1. Jordon Avatar
    Jordon

    As for what they cost, In August 2010, the Congressional Budget Office (CBO) estimated that extending the tax cuts for the 2011-2020 time period would add $3.3 trillion to the national debt, comprising $2.65 trillion in foregone tax revenue plus another $0.66 trillion for interest and debt service costs.
    The problem is that the U.S. tax rate is about 15% and according to most economists (and historians), the budget has never balanced when it is under 19%.

    Reply
  2. Mike Aubrey Avatar
    Mike Aubrey

    Michael, I’m not against deficit reduction, but I do question whether this is the right time. I am unconvinced that government spending cuts will lower the unemployment rate and I’d say that’s the bigger issue than the deficit right now.

    Reply
  3. Michael W. Kruse Avatar
    Michael W. Kruse

    Thanks Jordan. What I not clear on in graphs like these is whether this “tax cut” section of the graph is simply
    A. taking the amount of projected revenue generated in a given set of years,
    B. multiplying it by two different tax rates,
    C. subtracting the total taxes raised by the lower tax rate from the total taxes raised by the higher tax rate, and then saying the contribution to the deficit is the difference.
    If so, it is grossly flawed analysis. If you change the tax rates, then you will also change the rate of economic growth from year to year.
    It is entirely possible that Bush’s cuts generated more economic growth than would otherwise be the case but not enough to generate a total tax revenue that would have meet or surpassed the total tax revenue if taxes had been left uncut with slower economic growth.
    So hypothetically,let’s say the cuts only generated through economic growth 80% of amount that would be needed to offset the tax cuts. In that case, the Bush tax cut contribution to the deficit is 20 cents on the dollar, not the full dollar of tax cuts.
    It is not clear to me that the analysis in the graph is showing “tax cuts” as this offset analysis. It appears to view $1 of tax cuts a $1 of lost revenue. That is the point I’m pushing against.

    Reply
  4. Michael W. Kruse Avatar
    Michael W. Kruse

    Thanks Mike. I’m inclined to agree with you that deficit reduction is not the major short terms concern. Most of the spending cuts recently debated are to spending down the road. I’d say that small business is still the biggest job generator in the country and tax policy that stimulates small business is probably the best way out. Spending cuts aren’t going to have much impact one way or the other on unemployment, is my guess. They are too distant to have an immediate impact.

    Reply

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