The pro-growth benefits of the Bush tax cuts are more significant than is commonly realized. Two items, in particular, stand out — namely, the average national tax rate and the marginal federal tax rate on personal income. These two tax rates are now returning to their historic norms, having become horribly skewed during the Clinton years.
In addition, newly released IRS data refute the charge that the Bush tax cuts favored “the rich” and instead show that all income groups benefited from the reforms.
The data, taken as a whole, make a strong case for tax simplification. Unburdening the economy of excessive taxation is already helping to ensure its long-term growth. And further lightening of the tax load and eliminating often wasteful, unproductive loopholes would doubtless make for both a fairer and even more pro-growth tax code.
Also, trimming the number of income-tax brackets (to two or three at most) would ultimately benefit taxpayers, the economy, and federal coffers alike, because more money would be put to optimal use instead of merely evading the taxman’s grasp. The cumulative wisdom of America’s earners, as expressed in the countless financial decisions they make every day, is far superior to anything bureaucrats or politicians might devise.
The Bush tax reductions thus mark a return, so to speak, of power to the people. The average national tax, at 27.1 percent in the third quarter, is back to its post-World War II mean. Similarly, the marginal federal tax rate on personal income has edged closer to historic levels. At 22.6 percent in the third quarter, the rate is still above the 1947-2004 norm of 19.9 percent but significantly below the Clinton era’s 25 percent average.
During the Clinton years, especially, the federal income-tax schedule had become overly progressive. This wasn’t the fault of inflation (as had been the case in the past), because indexation had eliminated inflation-induced bracket creep. Instead, the latest form of bracket creep was the result of federal tax-code changes, notably 1993’s record tax hike, coupled with substantial gains in personal income, particularly among middle-income households, that propelled many taxpayers into stratospheric tax brackets.
Excessive progressivity expands the public sector at the expense of the private sector by causing tax receipts to rise faster than personal income. Post-tax personal income therefore grows more slowly than pre-tax income.
The effects of over-progressivity became especially evident with the economic slowdown of 2000-2001. Real GDP growth (measured year-to-year) decelerated from a 4.8 percent rate in the second quarter of 2000 to just 0.6 percent a year later, and personal income growth slowed from 8.3 percent to 4.2 percent over the same period.
The federal tax take of personal income nonetheless continued to rise, climbing from 26.4 percent in the second quarter of 2000 to more than 27.1 percent — an all-time high — a year later. (The marginal tax rate is the percentage of total personal income represented by payroll and individual income taxes, less transfer payments.) From 1947 up until 2001, the rate had averaged 19.6 percent.
When the Clinton administration started out, the marginal tax burden on income was just 23.4 percent, but it finished the year 2000 at 26.4 percent; the 1993-2000 mean was 25 percent. In comparison, the marginal rate on income averaged 22.9 percent during the Reagan years and 23.3 percent in the subsequent Bush era of 1989-1992.
Meanwhile, the average national tax rate (the share of nominal GDP represented by general government current receipts, including individual and corporate income taxes, indirect business taxes and non-tax accruals, and payroll taxes), which was 28.7 percent when Bill Clinton first took office, climbed to 31.8 percent by end of 2000. Earlier, in the first quarter of 2000, it had set an all-time high of 32.1 percent. The 1947-1999 mean was 27 percent.
Over the course of the Clinton years, the average U.S. tax rate was 30.5 percent. In contrast, during the Reagan presidency, the average tax rate was 28.9 percent. It then edged up to a mean of 29.4 percent during the subsequent Bush administration.
New IRS data for the 2002 tax year, meanwhile, provide a window into the effects of the initial Bush tax cuts on taxpayers, broken down by income. The results clearly show the across-the-board nature of the tax reductions and refute claims that the changes benefited higher-income taxpayers to the detriment of lower-income households.
Consider, for instance, that the average tax rate paid by households with adjusted gross incomes of $75,000 or more in 2002 was nearly double the rate paid by those earning less than $75,000 — i.e., 24 percent versus 12.6 percent. What’s more, the average rate of taxation for those earning under $75,000 dropped by 2.1 percentage points between 2000 and 2002, while the rate for those earning $75,000 or more declined by only 1.6 percentage points.
Earners of less than $75,000 accounted for 25.3 percent of all federal income-tax receipts in 2000; two years later, the percentage was virtually unchanged at 25.6 percent. This means, of course, that the vast bulk of federal tax revenue came from (and continues to come from) middle- and upper-income earners. For example, in 2000, households making $200,000 or more earned 33 percent of all taxable income and paid 45.8 percent of all federal income taxes. In 2002, this same income group earned just 26.4 percent of all taxable income and paid 40.7 percent of all income taxes. Nevertheless, the group’s average rate of taxation was practically unchanged at 30 percent in 2002 compared with 29.9 percent in 2000.
The first round of Bush tax cuts thus was unquestionably equitable. It eliminated the capital-draining over-progressivity of the Clinton administration’s tax schedule, yet it still managed to spread the benefits of lower tax rates to all income groups in roughly equal measure.
Additionally, the resulting increase in the availability of financial capital has underwritten productivity-enhancing investments that are propelling the economy forward at a brisk clip — and will continue to do so for as long as income-tax rates remain low or, better still, are lowered further.
– William P. Kucewicz is editor of GeoInvestor.com and a former editorial board member of the Wall Street Journal.