The Case For The Tax Cut

Policy Reports | Taxes

No. 226
Sunday, August 01, 1999
by Bruce Bartlett


Figure I - Federal Receipts as a Share of GDP

For more than two decades, Congress and the White House have been struggling to get control of federal budget deficits. In 1998, those deficits finally disappeared and the federal government ran a surplus of $69.2 billion, the first since 1969. Both the Congressional Budget Office and the Office of Management and Budget now project surpluses as far as the eye can see - roughly $3 trillion over the next decade.

This greatly improved fiscal situation is due largely to higher federal taxes. Taxes have grown by 58 percent since 1992, while the gross domestic product (GDP) has grown just 36 percent. This results from many factors, including the 1993 tax increase, one of the largest ever enacted in peacetime. But the major factor is the steeply progressive nature of our tax system, which causes people to pay more taxes as their incomes rise. Because of this, taxes rise automatically unless offset by a tax cut from time to time.

"A strong case could be made for a tax cut considerable larger than $792 billion over 10 years."

In early August, Congress took the first step toward relieving the unprecedented tax burden - a peace dividend from victory in the war against deficits. It passed a 10-year $792 billion tax cut that does not even offset the projected growth in federal taxes over the next decade. Nor does it use any of the $2 trillion of excess revenue from Social Security taxes to finance the tax cut. It is, in short, a very modest effort to give something back to those who are mainly responsible for the surplus: the taxpayers.

Figure II - Federal Revenues as a Share of GDP

Nevertheless, the Clinton Administration has strenuously attacked the congressional tax bill. "Huge tax cuts aimed disproportionately at the wealthy...that break the bank," said White House spokesman Barry Toiv. President Bill Clinton has vowed to veto it as soon as it reaches his desk.

This study argues that the administration is wrong. There is ample justification for the congressional tax cut - indeed a strong case could be made for a tax cut considerably larger than $792 billion over 10 years.

Taxes at an All-Time High. Federal receipts are now at the highest level in history as a share of GDP, and have been for more than two years. Indeed, average federal receipts as a share of GDP during the first six years of the Clinton Administration exceeded those of every year in American history except one, including World War II. And unless taxes are cut, revenues as a share of GDP will continue to rise. As Figure I illustrates:

  • Federal receipts as a share of GDP have risen every year of the Clinton Administration, increasing from 19.2 percent in 1992 to 21.7 percent in 1998.
  • The highest year ever previously recorded was 20.8 percent in 1981.
  • The World War II peak was 19.9 percent in 1943.
Figure III - Federal Receipts as a Share of GDP With and Without the Tax Cut

Receipts are forecast to remain above 21 percent of GDP for the foreseeable future, according to the Congressional Budget Office (CBO). Even with the tax cut that has passed Congress, revenues will remain well above their postwar average. If federal revenues were to average the same percentage of GDP as existed before President Clinton took office, Congress would have to cut taxes by $3.4 trillion between 1999 and 2009 - more than four times greater than the $792 billion its tax bill contemplates.

"Federal receipts are at the highest level in history as a share of gross domestic product."

According to the U.S. Census Bureau, federal income taxes have risen from 12.1 percent of the average household's income in 1992 to 14.9 percent in 1997. Reducing such taxes to their 1992 level would have given the average family a tax cut of $1,775 in 1997, or 19 percent of its income tax burden.1

"Even with the tax cut, federal revenue will average 20.7 percent of GDP."

The Tax Cut Won't Even Stop Taxes from Rising. As Figure II indicates, federal receipts as a share of GDP averaged 18.6 percent during the postwar period until Bill Clinton became president. During the first six years of his administration, receipts have averaged 20.5 percent. The CBO estimates that they will average 21.3 percent over the next 10 years in the absence of a tax cut. Even with the $792 billion tax cut that has passed Congress, receipts will average 20.7 percent of GDP between 1999 and 2009 - again, higher than any single year in American history before this administration save one.

The Clinton Administration labels the tax cut as gargantuan and some economists fret that it will overstimulate the economy. In fact, as Figure III shows:

  • The tax cut phases in very slowly and will not have any significant effect on revenues before 2002.
  • It averages just 0.6 percent of GDP over the 1999-2009 period, with a peak impact of 1.3 percent in 2008.
  • In 2008, revenues will still be far above their postwar average at 19.8 percent of GDP.
Table I - Major Tax Legislation Since 1978

"The tax cut phases in very slowly and will not have any significant effect on revenues before 2002."

Moreover, the proposed tax cut will actually be among the smallest major tax cuts ever enacted. And if, for some reason, it should turn out to be too large, it will be a simple matter for Congress to undo it. As Table I indicates, Congress has proven itself more than willing to pass tax increases when fiscal conditions demanded it. For example, it reversed one-third of the 1981 tax cut just one year later. However, it has shown itself much less willing to reverse itself on tax increases - even when their purpose no longer exists. If passed, the 1999 tax cut and the 1997 tax cut together will not even offset the impact of the 1993 tax increase, rammed through a Democratic Congress as Clinton's first major act in office, until at least 2003.2 And the 1999 tax cut that the president has labeled "huge" is actually smaller than the 1993 tax increase: 0.6 percent of GDP for the former and 0.7 percent of GDP for the latter.

"The 1999 tax cut the president labeled 'huge' is actually smaller than his 1993 tax increase."

Tax Cut Distributionally Fair. In addition to the size of the tax cut, the Clinton Administration also opposes the tax bill passed by the House and Senate as unbalanced distributionally. It alleges that too much of the benefits accrue to the wealthy and not enough to those with low incomes. This is misleading at best. Even the Clinton Administration's own figures show that Americans receive tax cuts roughly in proportion to the taxes they pay.

Tax cuts by definition only benefit those who pay them. And the fact is that those with low incomes basically pay no income taxes. Of the 65 million tax filers with incomes below $30,000 in 1998, only 22 million paid any federal income taxes at all. Overall, 48 million of the nation's 134 million tax filers paid no income taxes last year. The vast bulk of all federal income taxes are paid by those with high incomes.3 As Figure IV indicates, 62 percent of all federal income taxes this year will be paid by those with incomes above $100,000. That is why they necessarily benefit the most from an income tax cut.

Figure IV - Distribution of Federal Income Taxes%2C 1999

According to the Internal Revenue Service:

  • The top 5 percent of taxpayers now pay a majority of all income taxes and the top 25 percent - those with incomes above $45,833 in 1996 - pay more than 80 percent of all such taxes.
  • By contrast, those in the bottom 50 percent of the income distribution - with incomes below $23,160 - pay a mere 4.3 percent of all federal income taxes. [See Figure V.]

"The top 25 percent of taxpayers now pay more than 80 percent of all income taxes."

As Table II indicates, the greatest contribution to deficit reduction in recent years has been made by the wealthy, who have greatly increased their tax payments to the Treasury. Their taxes have increased much more sharply than their incomes.

Despite these figures, the Clinton Administration maintains that the benefits of the tax bill are skewed too much toward the wealthy. According to the Treasury Department, 45.3 percent of the benefits of the tax cut would go to just the top 5 percent of taxpayers. But as noted above, the top 5 percent of taxpayers now pay 51 percent of all federal income taxes. Those who pay a lot of taxes, therefore, get a bigger tax cut in dollar terms than those who pay little. The fact is that the tax bill's benefits are roughly proportional to the taxes that each taxpayer pays. As a consequence, the tax bill does virtually nothing to change the existing distribution of taxes, as shown in Figure VI. This conclusion is supported by the Clinton Administration's own analysis of the tax bill.4 As economist Martin Sullivan recently wrote in the respected journal Tax Notes:5

It may be surprising to most that even using Treasury's distributional analysis, the conference bill is not that far away from an equal percentage reduction in taxes for all income classes....This is possible because most federal taxes are paid by high-income taxpayers.

Figure V - Share of Federal Income Taxes by Percentile of Income%2C 1996

The Clinton Administration will, no doubt, continue to label the tax cut as unfair, but to most people a tax cut that is proportional to the taxes that they pay is about as fair as one can get.

Table II - High Income Taxpayers

Figure VI - Distribution of Federal Taxes Before and After Tax Cut

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