The charges lodged against the 2001 and 2003 tax cuts are deceptively simple: They have dramatically reduced government revenues, causing big, long-term deficits that will hurt the economy by driving up interest rates.
But this charge doesn’t withstand scrutiny. This is partly because of the tenuous relationship between deficits and interest rates. (If deficits have such an adverse effect on interest rates, why are the rates lower today than they were during the surplus years?) But it’s mostly because long-run deficits are caused by the growth of government spending.
Tax cuts certainly aren’t to blame. From 1951 to 2000, federal tax revenues averaged 18.1 percent of gross domestic product. Tax-cut opponents frequently imply that Bush’s tax cuts have emptied government coffers and created long-term fiscal chaos, but the Congressional Budget Office projects that tax revenues for 2012 to 2014 will average 18.1 percent of gross domestic product. You don’t have to be a math whiz to realize how absurd it is to claim that tax cuts cause long-run deficits when tax revenues will mirror their long-term average. (This analysis, by the way, assumes that the tax cuts are made permanent.)
Critics note that tax revenues currently fall below 18.1 percent of GDP. But this is a short-term phenomenon caused by the recent recession and the temporary stock market-driven collapse of tax revenues from capital gains. No one expects these short-term factors to last. The CBO, for instance, estimates that tax revenues soon will return to historical norms, averaging 18.1 percent of GDP over the 2007-09 period.
This does not mean, incidentally, that tax revenues should always be 18.1 percent of GDP. It is just a coincidence that average revenue collections and future revenue projections are identical as a share of national economic output. It does mean, however, that we can’t truthfully pin blame for future deficits on the tax cuts.
Deficits, however, are not the issue. The real problem is government spending, and we should view rising deficits as a symptom of Washington’s profligacy. The spending crisis is both a short-term and a long-term problem. Federal spending has jumped dramatically in recent years, climbing from 18.4 percent of GDP in 2000 to more than 20 percent of GDP in 2004 (and less than half of that increase can be attributed to national defense or homeland security).
But this short-term expansion of the federal government’s burden is minor when compared to what will happen after the baby-boom generation begins to retire. Without reform, huge unfunded promises for Social Security and Medicare benefits will cause federal spending to rise sharply. (And lawmakers last year made the problem worse by creating a new entitlement for prescription drugs under Medicare.)
Bigger government, though, is economically harmful. When politicians spend money, regardless of whether they get it from taxes or through borrowing, they’re taking it from the productive sector of the economy. This might not be so bad if lawmakers used strict cost-benefit analysis to determine if the money was being well-spent — particularly when compared with the efficiency of private-sector expenditures. Unfortunately, that rarely happens. Instead, politicians allocate funds on the basis of political rather than economic considerations. This inevitably weakens economic performance.
Lower spending would be a good idea even if we had a giant surplus. Government programs deprive the private sector of resources that could be used to boost jobs and create growth. This is why we should cut “discretionary” spending and re-examine entire programs, agencies, and departments. Lawmakers also should reform entitlement programs, in part to reduce long-term budget pressures but also because the private sector is better at providing health care and retirement income.
Today’s deficit debate is largely a charade. The proponents of big government shed crocodile tears about the deficit because they want higher taxes. Yet historical evidence clearly shows that higher taxes tend to encourage more government spending and hurt the economy — and both of these factors can cause the deficit to climb still higher. Worse, higher taxes would hurt U.S. competitiveness, making America more like France and other European welfare states.
To save our children and our grandchildren from such a fate, we should keep cutting taxes and finally get serious about reducing the burden of government spending. That may not carry the political allure of vilifying tax cuts — but at least it’s accurate.
– Daniel J. Mitchell is the McKenna fellow in political economy at the Heritage Foundation