An unanticipated surge of tax payments may push the 2005 federal budget deficit as much as $100 billion below official forecasts, leaving Republicans to claim vindication in their theory that lowering tax rates actually boosts tax receipts.
In addition, this week the Commerce Department reported a solid economic growth rate of 3.8 percent for the first three months of 2005, an improvement on the earlier 3.5 percent estimate and more ammunition for Republican boasts that their tax cuts are the cause of this performance.
"Sustained, strong . . . growth confirms that our policies continue to boost the economy and tax revenues," said Rep. Jim Nussle (R-Iowa), chairman of the House Budget Committee.
But senior budget analysts, including the Republican who heads the Congressional Budget Office, cautioned this week that higher tax revenues may be a one-time phenomenon that in no way addresses the nation's grave deficit challenge.
Much of the increase could stem from temporary factors, said CBO director Douglas Holtz-Eakin, a former Bush White House economist. The major corporate tax cut of 2004 provided a one-year "tax holiday" for multinational corporations to bring home overseas profits at a reduced tax rate, and companies may be responding aggressively. Also, a large tax break for business investment ended Dec. 31, effectively raising some corporate tax rates this year, Holtz-Eakin said.
Finally, strong stock market gains last year, coupled with lingering jitters from the market swoon of 2000, may have produced strong executive bonuses and a rush to cash in stocks and stock options, other economists said.
"I find it difficult to get as excited about this as some people" are, Holtz-Eakin said.
For longtime champions of supply-side economic theory, the excitement is palpable. Since the political rise of Ronald Reagan, such conservative economists have contended that cuts in income tax rates and in taxes on investment income would generate economic growth that would in turn produce more revenue, possibly enough to pay for the tax cuts. The theory was popularized by economist Arthur Laffer and his Laffer curve.
The government's take this tax season validates that theory, conservatives say. On a single day, June 15, the Treasury took in a record $61 billion. Through June 30, three-quarters of the way through the fiscal year, receipts indicate the Treasury will reap $80 billion to $100 billion more in taxes than the CBO predicted in January. Individual tax payments have risen 21 percent beyond their level at this time last year. Corporate tax receipts are 48 percent ahead.
Despite slightly higher-than-expected spending, the federal deficit could come in at $325 billion to $350 billion, significantly better than the White House's $427 billion projection or the CBO's $400 billion forecast. Some Wall Street economists say the deficit could be as low as $300 billion.
"The numbers are an eye-popping vindication of the Laffer curve and the Bush tax cut's real economic value," anti-tax activist Stephen Moore wrote in the Wall Street Journal.
Michael T. Darda, chief economist of the Connecticut equity firm MKM Partners LLC, estimated that economic growth generated by the Bush tax cuts would generate $1.5 trillion in tax receipts over the next decade, nearly enough to recoup all the revenue loss expected due to lower rates. Writing for the conservative National Review, Darda blasted the "no-growth neo-Malthusian Democrats" and the "root-canal contingent" of the GOP who continue to fret over the budget impact of tax cuts.
Still, if the tax cuts are now yielding a rising tax take, the effect was certainly not immediate. The major tax cut of 2001 and further cuts in each of the last three years were followed by an unprecedented three-year decline in nominal tax revenues, from $2 trillion in 2000 to $1.8 trillion in 2003. Revenues recovered last year, reaching nearly $1.9 trillion. But at 16.3 percent of the gross domestic product, last year's revenue total, measured against the size of the economy, was the lowest level since 1959.
Robert Carroll, the deputy assistant Treasury secretary for tax analysis, was cautious about attributing this year's rising tax receipts to any single factor. It will be some time before the Treasury can decipher how much of the rush is attributable to capital gains and dividend taxes directly related to the Bush tax cut of 2003, Carroll said. But he did indicate the increased tax flow will be reflected not only in the administration's updated deficit forecast for 2005 but also in its long-term forecast when that is released July 15.
That has Democrats -- and some economists -- worried.
"My concern is you're going to have exactly this kind of talk, and what it does is undermine the real need, which is to cut the deficit," said Edward McKelvey, an economist and federal budget analyst at Goldman Sachs in New York. "That's dangerous."
Even a $300 billion deficit would be the third largest ever in nominal dollars, said John M. Spratt Jr. (D-S.C.), the ranking Democrat on the House Budget Committee. Moreover, the major budget challenges are yet to come. The Medicare prescription drug benefit goes into effect next year. The alternative minimum tax, which was created to ensure that the rich pay taxes but is now taking an ever larger bite out of the middle class, has yet to be permanently fixed. And war costs have still not been counted in future deficit projections.
"It's good news," Spratt said of the improving deficit picture, "but no one should assume it's going to continue, and above all nobody should get euphoric and assume we're going to grow our way out of this deficit."
Business investment and stock-price gains have slowed from last year, Holtz-Eakin cautioned, possibly indicating that the government is not seeing the kind of sustained tax gains that drove the deficit into surplus in the late 1990s. CBO is not likely to project the 2005 gains too far into the future, Holtz-Eakin said, especially considering that the huge liabilities of Medicare and Social Security remain unaddressed.
"I do hope people are taking this with a grain of salt and not thinking this is 1998 all over again," Holtz-Eakin said. "There's simply no question if you take yourself to 2008, 2009 or 2010, that vision is the same today as it was two months ago."