The inside story of tax cuts, revenue projections and the nation’s debt
"We all know that raising taxes would stall the rebound we all claim to want. Let's just admit we don't have a revenue problem. We have a spending problem."
— Senate Minority Leader Mitch McConnell (R-Ky.), May 4, 2011
McConnell’s comment Wednesday, made on the floor of the Senate, is a common refrain by Republicans. It is an expression of a deeply felt philosophical position.
But we deal in facts, not philosophy. We think we have found a way to demonstrate that the nation has had both a spending problem and a revenue problem, at least since the halcyon days of 2001, when the Congressional Budget Office estimated that over 10 years the government would run a $5.6 trillion surplus.
We’re not saying that the Bush-era tax cuts were the primary reason for the disappearance of the surplus; the data clearly shows that new spending exceeded the estimated revenue loss of the tax cuts. One of the biggest problems, in fact, was that the revenue estimates made by the CBO turned out to be wildly overstated — so much so that a case can be made that Bush’s tax cuts actually reduced revenue less than is conventionally assumed.
Let’s go to the video tape.
In January 2001, the CBO — the nonpartisan scorekeeper for legislation — announced that under current policy , the government would run a $5.6 trillion surplus from 2001 to 2011. The key caveat is “current policy.” The CBO is supposed to assume all sorts of things in law, such as certain tax provisions will remain in place even though Congress always waives them. The CBO also assumed that discretionary spending would continue to decline as a percentage of the overall economy, having no clue that the Sept. 11 attacks that year would put new demands on government spending.
On the revenue side, the government was helped by a gusher of new money — capital-gains taxes from the run-up in the stock market, as well as taxes paid on stock options earned by technology executives. Between 1994 and 1999, realized gains nearly quadrupled, the CBO later estimated , with taxes on those gains accounting for about 30 percent of the increased growth of individual income tax liabilities relative to the growth of gross domestic product, the broadest measure of the economy. The CBO warned that those gains couldn’t continue — but the end came much sooner than expected.
Still, it was in that context that Congress enacted a 10-year cut in individual taxes, estimated to reduce projected surpluses by $1.35 trillion. For complicated budgetary reasons, the entire tax cut package was designed to end within 10 years, but no one ever expected that to happen.
Within a year, a chagrined CBO had to come back to Congress and admit its revenue estimates were off — way off. A weakened economy, the popping of the bubble in tech stocks and other factors meant that hundreds of billions of dollars in expected revenues had turned out to ephemeral. In just a year, capital gains returns fell 20 percent; income growth from stock options fell as much as 40 percent, the CBO estimated.
We looked at every annual update issued by CBO since 2001, and compared the actual results with the original 2001 estimate. We also examined the data behind a recent report by the Pew Fiscal Analysis Initiative. Finally, we were aided by a spreadsheet of 10 years of CBO data provided by Barry Anderson, a former CBO deputy director who famously presented the 2001 estimate to Congress. This is the first time this spreadsheet has ever appeared in print. (The acronyms are explained at the bottom. The first line under revenue projections is the 2001 tax cut; the third line is the 2003 tax cut.)
What is striking about this data is that it shows that revenue fell far more sharply than the tax cut projections. For instance, in 2002, individual tax revenues were $267 billion lower than projected, or down nearly 24 percent, compared to the estimate of a decline of $31 billion from the tax cut, according to our calculations.
The spreadsheet shows that in 2002 all revenue was down nearly $308 billion for reasons unconnected to tax cuts — what the CBO calls “economic or technical reasons.” That’s shorthand for “we blew the estimate.” The estimates for individual income tax revenues were off between 18 and 34 percent each year for the next several years — until the great recession hit in 2008. Then the estimates were off by nearly 50 percent in 2009 and 2010.
In fact, we would argue that it is a misnomer to claim that Bush’s tax cut reduced revenues by $1.35 trillion. That estimate was based on the inflated revenue forecasts of 2001, so the true cost to the Treasury was probably 15 to 20 percent less. Ingrid Schroeder, director of the Pew initiative, said they wanted to use only CBO-vetted numbers; the CBO has refused to revisit the question of what the Bush tax cuts cost.
Even if one uses the original cost-estimates for the tax cuts, spending increases still account for the largest share of the decline in the nation’s fiscal position. Our research shows discretionary spending (the annual spending bills controlled by Congress) kept exceeding the original estimates by greater and greater percentages — until the economy slammed into the wall and estimates were off by as much as 60 percent in 2009 and 2010. The original CBO projections again were unrealistic — and then wars and recession further exacerbated the problem.
Here’s how it breaks down from 2001 to 2011:
Increased spending (discretionary and mandatory): $4.3 trillion (36.5 percent)
Incorrect CBO estimates: $3.3 trillion (28 percent)
Tax cuts: $2.8 trillion (24 percent)
Higher interest costs: $1.4 trillion (12 percent)
The higher interest costs on the debt should be allocated proportionally to other categories. Presumably, the CBO category could grow — and the spending increases could shrink — if one wanted to argue that the spending estimates were as unrealistically low as the revenues estimates were too high. But in any case spending increases would still likely exceed tax cuts.
So yes, the nation has a spending problem. But we do not know how anyone can look at this data and say the nation does not have a revenue problem. The Bush tax cuts were predicated on predictions of revenue that did not appear. If there had not been a projection of $5.6 trillion in surpluses, Congress never would have approved $1.35 trillion in tax cuts.
The Bottom Line
We have previously written that the current sky-high deficit exists because tax revenues are at their lowest level since 1950 and spending is at its highest level since World War II, as measured as a percent of the GDP. Moreover, as demonstrated above, revenues have consistently failed to meet the projections that prompted the original tax-cut frenzy in Congress.
Don Stewart, a spokesman for McConnell, argues, “Revenues are down because of the economy — not because Americans are undertaxed. And as the economy improves, so too does the amount of revenue at existing tax rates. As even the president has noted, raising taxes in a recession is not helpful to the economy and could have the opposite effect.”
Stewart explains McConnell’s statement as being a warning against raising taxes in a recession and says he does not believe the revenue problem can be fixed by raising taxes.
That’s obviously a philosophical point of view. But isn’t it time for the Republicans to retire this talking point? The nation has a revenue problem and a spending problem — or else there would not be a deficit.
(Similarly, Democrats need to stop suggesting there is not a spending problem.)