Bush Tax Cuts and Economic Growth

By Rok Spruk, on November 22nd, 2010

In 2001 and 2003, former U.S president George W. Bush signed Economic Growth and Tax Relief Act (EGTRAA) and Jobs and Growth Tax Relief Reconciliation Act (JGTRAA). EGTRAA reduced personal income tax rates, increased child tax credit, decreased estate tax and introduced a various range of tax-favored retirement savings plans. In 2003 when EGTRAA was enacted, the Congress cut the top capital gains tax rate from 20 percent to 15 percent while the individual dividend tax rate was reduced from 35 percent to 15 percent.

Bush tax cuts are set to expire in 2011. Hence, a bold increase in marginal tax rates is expected. David Leonhardt recently asked whether the Bush tax cuts were good for economic growth amid the fact that under Bush administration, the U.S economic growth was the lowest since the World War II. Eight years of Bush administration were known for the largest expansion of federal government spending compared to the six preceding presidents. In eight years, President Bush increased discretionary federal outlays by 104 percent compared to 11 percent increase under President Clinton.

Under Bush tax cuts, the reduction in personal income tax rates was imposed across all income brackets. Tax Policy Center estimated that extending Bush tax cuts in 2011 would increase the after-tax income across all income quintiles but it differed substantially. For instance, the increase in after-tax income in the lowest quintile would represent 12.19 percent of the increase in after-tax income of the highest quintile. The average federal tax rate would decrease by 2.5 percentage points. The reduction in average federal tax rate would be the most significant for top 1 percent and 0.1 percent cash income percentile, -3.8 percentage points and -4.4 percentage points respectively. Assuming the extension of the Bush tax cuts, the average federal tax rate, which includes individual income tax rate, corporate income tax rate, social security, Medicare and estate tax, would be substantially lower compared to Obama Administration’s FY2011 Budget Proposal. The increase in the average federal tax rate would be roughly proportional across the cash income distribution. The federal tax rate would increase by 1 percentage point for the lowest quintile and 3.1 percentage point for the top quintile. The federal tax rate would for earners in top 1 percent of cash income distribution would increase by 4.2 percentage point. The chart shows the distribution of average effective tax rates and current law and current policy of Bush tax cuts not assumed to expire in 2011. The current proposal would increase the effective tax rate across all income quintiles. The highest increase (3.3 percentage points) would hit the earners in top 20 percent of income distribution.

Effective Tax Rates: A Comparison
Source: Urban-Brookings Tax Policy Center Microsimulation Model

The expiration of the Bush tax cuts would substantially increase the effective tax burden across the cash income distribution. Recently, Center on Budget and Policy Priorities estimated that letting the Bush tax cuts expire would create a net gain of $22 billion in economic activity. Hence, allowing high-income tax cuts expire would, on impact, result in a net gain of $42 billion in economic activity which is about five times the economic stimulus from extending high-income tax cuts.

The years of the Bush administration were earmarked by the escalation of federal government spending both in absolute and relative terms. The growth in federal government spending was driven mostly by discretionary defense spending while non-discretionary federal outlays increased as well. Since 2001, the federal government spending in the Bush administration increased by 28.8 percent with a 35.7 percent growth in non-defense discretionary spending. The growth of the federal government under Bush administration was the highest since the presidency of Lyndon B. Johnson and Richard Nixon. The Independent Institute compared the growth of federal government spending from Lyndon B. Johnson onwards.

Letting the Bush tax cuts expire would probably not impose a negative effect on small businesses since less than 2 percent of tax returns in the top 2 income brackets are filed by taxpayers reporting small business. William Gale contends that the Bush tax cuts significantly raised the government debt. The economic consequences of the 9/11 and wars in Iraq and Afghanistan were detrimental. William Nordhaus estimated that the total cost of war in Iraq between 2003 and 2012 could exceed $1 trillion in 2002 dollars considering unfavorable and protracted cost scenario. To a large extent, the wars in Iraq and Afghanistan have added substantially to the increase in government spending. However, even after excluding defense outlays from the spending structure, the increase in non-defense discretionary spending exceeded the growth of the federal government spending by 5.6 percentage points. Between 2000 and 2008, the number of federal subsidy programs increased from 1,425 to 1,804 – a 26 percent increase compared to 21 percent increase during Clinton years.

The Bush tax cuts failed to result in a Laffer curve effect mostly because they were implemented alongside a bold and significant increase in federal government spending. Had a substantial reduction in government spending been enforced, the tax cuts would not place should an enormous weight in the growth of federal debt. Higher federal debt would inevitably ponder the structural fiscal imbalance. Since debt interest payments would increase, a combination of tax cuts and spending growth would stimulate investment demand, creating an upward pressure on interest rates, especially during the economic recovery when the difference between potential output and real output is expected to diminish.

Critics of the Bush tax cuts often claim that cuts amassed a growing fiscal deficit. However, in 2007, the fiscal deficit stood at 1.2 percent of the U.S GDP while in 2009, the deficit increased to 9.9 percent of the GDP as a result of $787 billion fiscal stimulus from Obama Administration. Since tax cuts were enacted in 2001 and 2003 respectively, something else is to blame for the deficit.

U.S Federal Debt: Long-Term Forecast
Source: Office of Budget and Management; author’s own estimate


The main premise of the economic policy of the Bush administration had been a significant increase in federal government spending. Spending policies were mostly aimed at covering the growing cost of the Iraqi war. In addition, domestic non-defense outlays on social security and domestic priorities grew significantly, creating an upward pressue on federal debt. The growth of entitlments such as Social Security and Medicare poses a serious long-term risk regarding the sustainability of federal government spending. In the upper chart built a simple forecasting framework to estimate the long-run level of U.S federal government debt as a percent of the GDP. Surprisingly, time trend accounts for 85 percent of the variability of the share of federal debt in the GDP. A more robust framework would include the lagged dependent variable and several regressors in the set of explanatory variables to increase the share of variance explained by independent effects of regressors. The results indicate that by 2020, the federal debt could easily reach the 90 percent thresold.

The growing stock of entitlements such as Social Security and Medicare are central to understanding the looming pressure on federal budget to tackle the challenges of ageing population and demand for health care. The tax cuts imposed by the Bush administration reduced average federal tax rates across quintiles in cash income distribution. However, tax cuts were no supplemented by the reduction in federal government spending. Consequently, the growth of federal government spending increased future interest debt payments and failed to take into account the long-term pressure of Medicare and Social Security on federal budget set. Extending the Bush tax cuts would be superior to letting them expire. But lowering tax burden should nevertheless be comprehended by the reduction in federal government spending.



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The 10 Worst Presidents (from a free-market perspective): Part 1

By J.D. Seagraves, on January 21st, 2009

Now that the 2008 election is history, and George W. Bush’s presidential tenure has come to an end, historians will begin to evaluate where Bush-43 ranks among the best and worst chief executives in America’s history. My prediction: Ultimately, they’ll rank him highly. That’s because, if you look at traditional presidential rankings, the presidents who advocated and achieved the biggest increases in government are typically ranked the highest, and few presidents have ever grown the government like George W. Bush.

There is a shared consensus among conservatives and liberals about who the greatest presidents were. This consensus is not shared by free-market libertarians. With an emphasis on their economic policies, I have compiled a list of the 10 Worst Presidents from a libertarian perspective. I will share #s 6-10 in this blog entry, and #s 1-5 in a future post. So, without further ado:

10. Theodore Roosevelt : Selecting #10 was difficult, and T.R. just narrowly edged out the “dishonorable mentions” of John Adams, James K. Polk, and Herbert Hoover. Like historian Thomas E. Woods says, we’ve had better presidents than Theodore Roosevelt, and we’ve had worse presidents — but we’ve never had a crazier president.

T.R., says Austrian economist Thomas DiLorenzo, was obsessed with war and killing. He was the first president who totally eschewed the foreign policy of Washington and Jefferson and said that the U.S. needed to be the world’s policeman — he even warned of the “menace of peace.” He imposed price controls and unprecedented regulation, and championed “progressive” reforms that came into being with the 16th (income tax) and 17th (direct election of senators) amendments.

The only thing that saves Roosevelt from ranking “higher” on this list is that he (thankfully) presided over a relatively calm period of American history. After leaving office for four years, he campaigned for the White House as a third-party candidate in 1912. If he had won, America would have certainly plunged into the unnecessary World War I much earlier, and who knows what the outcome would have been.

9. Ronald Reagan : Although the Gipper mouthed libertarian rhetoric, the facts are that he imposed one of the greatest tax increases in U.S. history (taking away many tax deductions and raising the payroll tax), ramped up the disastrous War on Drugs, and accumulated more debt than all of the previous 39 presidents combined. His fiscal policies, along with his appointment of Alan Greenspan to chair the Fed, sowed the seeds of America’s monetary ruin.

8. George W. Bush : Bush-43 was not “the worst president ever” by any objective standard. But he was among the worst and, by his own stated objectives, a total failure. After all, this is a president who began his second term by trying to privatize Social Security and ended it by socializing the banking sector. Bush’s two terms were characterized by massive federal-government growth, huge deficits, expensive and immoral wars, the Medicare prescription drug benefit (which is bigger than Social Security and will eventually bankrupt the nation), the loss of civil liberties (i.e., the Patriot Act), and the nationalization of “education” (No Child Left Behind). Bush will leave the White House by turning it over to Democrats with huge congressional majorities. Fail.

7. George Washington : The first truly sacred cow on the list, George Washington is typically above criticism. But it was he who appointed the initial federal judiciary, and he stocked it with Federalists to the exclusion of his political adversaries. This meant that anyone who was skeptical of the new Constitution — which increased central power over the states from the original Articles of Confederation — was automatically disqualified. In practice, this led to a judicial monopoly of monarchists and nationalists that lasted well into the long Jeffersonian reign of 1800-1860. Also, Washington signed the (unconstitutional) first Bank of the United States into law, and led an army against his own citizens to crush the Whiskey Rebellion. Imagine George W. Bush doing that!

6. Richard Nixon : In addition to his well-known criminality, lying, and illegal warring, Nixon truly deserves our ire for his imposition of price and wage controls and “closing of the gold window” — making the U.S. dollar into a pure fiat currency. In fact, it was in protest to these things that the Libertarian Party was founded in 1971.

So there’s the list: Four Republicans and one Federalist. But if you think I’m letting the Democrats off the hook, you have another thing coming — four of the five Worst are Democrats. Check back next week to see who they are.



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