Well, the numbers are in and the tax-rate cutters are basking in the political sunshine of being on the money once again: Lower tax rates have led to bulging tax revenues.
In the first nine months of fiscal 2006, tax revenues have climbed by $206 billion, or nearly 13%. As the Congressional Budget Office recently noted, ‘That increase represents the second-highest rate of growth for that nine-month period in the past 25 years’ — exceeded only by the year before. For all of fiscal 2005, revenues rose by $274 billion, or 15%.
And the source of the bulge was pinpointed by none other than the New York Times:
The main reason [for the increased tax revenues] is a big spike in corporate tax receipts, which have nearly tripled since 2003, as well as what appears to be a big rise in individual taxes on stock market profits and executive bonuses.
It’s time, in other words to celebrate. The supply-side Bush tax cuts of 2003 worked. The Laffer curve, and the notion that if you tax something less you get more of it, also worked. Hurrah!
Okay, celebration over. It’s time to get back to work.
Today’s outsized tax-revenue stream should alert knowledgeable politicians to the fact that both corporations and individuals are still overtaxed. As I discussed in my previous column, the Laffer curve (pictured below) instructs us that lowering any tax rate in the “prohibitive zone” will produce higher tax revenues. So, even though the government is now benefiting from the 2003 tax-rate cuts, further reductions in marginal tax rates will in all likelihood produce even higher tax revenues. This will be the case until we reach the point on the Laffer curve (outside of the prohibitive zone) where further tax-rate cuts produce less, not more, tax revenues.
The problem, however, is that Republicans in Congress are for some reason struggling to extend the tax cuts that President Bush pushed through in 2001 and 2003. Since the evidence suggests we are still in Laffer’s prohibitive zone, any reversion back to higher tax rates will produce dire consequences: falling tax revenues and an economic downturn. This would trap politicians in an economic quagmire of ballooning government spending, partially due to heightened payments to the unemployed in a weakening economy, and louder cries for tax-rate increases. Look back to 1933 when President Hoover got his way with a mammoth increase in personal tax rates, only to see his “conservative” tax policy accelerate the Depression.
To avoid a backward turning of this ongoing recovery, Republicans should use the Laffer curve as the basis for proposing another reduction in personal tax rates. One obvious proposal, consistent with Laffer’s theories, would be a tax-rate cut returning us to the maximum 28 percent rate that President Reagan pushed through Congress in 1986. Similar-sized tax-rate cuts also would be great for corporate America, since U.S. companies are required to compete in an ever-increasing global capitalist environment.
Politicians who today advocate the expiration of 2003 tax cuts are advocating tax increases. And tax-rate increases don’t sell well with the electorate. Presidential contenders Mondale, Dukakis, and Kerry all fell prey to the tax-increase mantra. And President Clinton, who snuck through a big tax-rate increase in 1992, experienced the retribution of voters in the 1994 midterm elections when Democrats lost control of both the House and Senate. Obviously, Democrats still haven’t learned from their past mistakes. Nancy Pelosi, theoretical speaker of the House if Democrats win the majority in November, has proclaimed a commitment to role back the Bush tax cuts — i.e., raise taxes. Independent voters, are you listening?
Juxtaposing these blunders with the first Reagan candidacy, the Gipper went for a tax-cut proposal based on the Laffer curve and eclipsed President Carter in the polls and the election. President George W. Bush, elected by the narrowest of margins, ran as a tax-cutter too. In his acceptance speech at the National Republican Convention in 2000, he said:
The last time taxes were this high as a percentage of our economy, there was a good reason; we were fighting World War II. Today our high taxes fund a surplus. Some say that growing federal surplus means Washington has more money to spend. But they’ve got it backwards. The surplus is not the government’s money; the surplus is the people’s money. I will use this moment of opportunity to bring common sense and fairness to the tax code. And I will act on principle. On principle, every family, every farmer and small-business person should be free to pass on their life’s work to those they love, so we will abolish the death tax. On principle, no one in America should have to pay more than a third of their income to the federal government, so we will reduce tax rates for everyone in every bracket. On principle, those with the greatest need should receive the greatest help, so we will lower the bottom rate from 15% to 10% and double the child credit.
Death-tax pending, President Bush followed through on his promises.
As we approach the 2006 midterm elections, Republicans have a great opportunity to gain the number of seats necessary to override the party of the tax increasers. The historical evidence is not only there to support the viability of another tax-rate cut, it is even more convincing given the recent data on tax revenues.
Republicans must rediscover the fact that a platform of cutting tax rates makes both economic and political sense.
– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc., and principal of Victoria Capital Management, Inc.