Tuesday, January 31, 2017

Misinformation about Tax Cuts

Note -- On 2/10/17 I realized that the table below has an error. The error does not impact my points but it does attribute the largest tax rate to Bush 1 when it was really Clinton 2. The order of the names at the end of the table should be Bush 1, Clinton 1, Clinton 2. The order of the numbers in the column is correct.

There are two things in life that are certain: taxes and JD. Or something like that. There is a lot of buzz about coming tax changes. Most of us like tax rate cuts. They make us richer. Some of us want bigger cuts for the poor. Others want bigger cuts for corporations and the rich. Others want bigger cuts for farmers who export agricultural products. I don’t want to get into all that because it gives me a headache.

In fact, what I want to do here is to take one baby step. That step has to do with the idea of tax cuts and tax revenues. Tax revenues are important. Everything else the same (economists love to say that), a reduction in tax revenues causes the government to have a larger deficit and debt. Since our national debt is larger than a 2X T shirt at Walmart, we don’t want new policy changes that make it even larger. So policies have to be careful not to reduce government’s tax revenue.

We awaken from our slumbers when we hear politicians speak about large tax rate reductions. One proposal would reduce our corporate income tax rate to chicken feed. Another reduces rates for the average worker. Other proposals would undo tax penalties recently put onto the richest of us. This is tax rate reduction season.

But cranky old men and a few of their lady friends say, wait a minute, buddy. Tax rate cuts are going to reduce tax revenue, increase the national debt, and probably lead to higher weed consumption. And those armed with more vim than vigor point to that nasty Ronnie Reagan and his tax cuts and those tragic government deficits he caused. Never mind that Reagan was President before the Great War and no one (except Fuzzy) can actually remember 1981 – the proof is in the Key Lime Pie (with graham cracker crust).

Or is it? I decided to take out my Janis Joplin album, pour a nice JD over rocks, and look into this issue with my usual astute analysis of the data. That didn’t work since I was bowled over at how complicated it becomes to pour JD and type numbers at the same time. And I also realized that the issue has way too many dimensions. For example, tax revenues depend on how strong the economy is. And Reagan had two terms in which the composition of Congress changed. And then there is the nagging issue of how decisions about national government spending affect government deficits and debt.

So after nearly fainting I decided to limit the scope of my project. Whatever I say here, therefore, is subject to lots of ifs, ands, and buts. Nevertheless, the story is useful and perhaps adds to our discussion about tax cuts and government deficits.

One would think that if the Reagan tax cuts significantly bent tax revenues downward despite a subsequently growing economy, then we would have some good evidence against tax rate cuts. So I decided to look at historical changes in one number – tax revenues as a percent of GDP. The table below contains what I found. The table shows federal government tax revenue as a percent of GDP from 1969 to 2000. The average tax revenues as a percent of GDP during that 32-year period was 17.8%. In 2015 the number was 18.2%. The numbers in the table refer to averages over four-year presidential terms.

Table: US Government Revenues
as a Percent of GDP
Nixon            17.8
Nixon/Ford   17.4
Carter            18.0
Reagan 1       18.0
Reagan 2       17.5
Clinton 1       17.4
Clinton 2       17.7
Bush 1           19.0

Interestingly Reagan’s average for his two terms was 17.8% or exactly the average from 1969 to 2000 and was a smidge less than Obama’s rate in 2015 (not in the table). And Reagan’s tax numbers do not significantly look different from the other Presidents. Nixon/Ford and Clinton 1 managed to get tax revenues down to 17.4% of GDP while Bush 1, Carter, and Reagan 1 increased tax revenues to 18% or more.

So if Reagan cannot be identified in a mug shot of past tax rate offenders, then why were his budget deficit numbers so creepy? Why has Reagan become the poster child for tax cuts, larger deficits, and poor B-grade movies? The answer, of course, has to do with the other side of government – disco dancing. Ha! I meant to say expenditures or spending. If government deficits were larger under Ronnie R, then you need to dig out the data on spending. But why dig it out? If Batman didn’t do it, then it must have been Robin.

So if you want to be mad at Ronald Reagan for government deficits, then you need to discuss spending. During Reagan’s presidency, Congress was split. The entire eight years Reagan worked with a Democratic-controlled House and during his last two years the Democrats controlled both houses. Not to blame the Ds or the Rs, the fact remains that government with a big G let deficits swell. It was not Reagan and it was not Reagan tax policy. It was spending.

It might be fun to think about all this as we head into the next months. Many politicians have already sworn an oath on their Mickey Mantle baseball cards to not push Grandma over the cliff – that is, they are not going to reduce spending on one program by one cent. No matter how fast these programs are growing and no matter that Grandma has a rocket-propelled wheelchair with an iPhone and tablet. And don’t get me started on all this infrastructure nonsense that both parties are trying to foist on us.

Argue about tax cuts versus government spending all you want. That’s fun. But don’t for a minute think it is a slam dunk. Tax cuts are not your enemy, and if they have a way of creating more economic growth, they might be worth the risk. More government spending, however, is going to send all of us to an early grave. Cheers. 


  1. And not once did you say Laffer. What's wrong with infrastructure?

    1. Thanks Robert. I wanted to stick with the data. So no Laffer Curve. I love new bridges as much as the next guy but I can't imagine a part of the government spending that was more rife with corruption. I'd rather see a more parsimonious and gradual approach in that area...not to mention the implications of more spending on national debt.

  2. I do remember 1981, in fact! It's remembering yesterday and where I put my car keys that give me trouble. Nope, they aren't in the refrigerator! Why did I open the refrigerator?

    Great book on the Reagan economy..."The Seven Fat Years" by Robert L. Bartley, former editor of WSJ. Although it's a bit long in the tooth like moi, it goes well with your post and a tumbler of JD.

    Folks tend to forget that Tip O'Neal and his successor from TX announced every Reagan budget "DOA," and Congress then went on massive spending sprees.

    1. Thanks Fuzz. I was guessing you might remember a thing or two about 1981. I spent a year at the St. Louis Fed in 1981 -- what fun! It is interesting that people forget the stuff about spending. Thanks for recalling some of that!

  3. On the spending side...my spending. I was developing hotels in the latter part of the Reagan years...1984 to 1987. The new tax laws ruined our funding scheme through LLC type write off to our equity partners ...as they did for most other commercial developments of the time. so we had to sell out at a lower than anticipated price to be able to qualify for revolving lines of credit to operate the existing hotels.Unintended consequences? Most presidents look for the low hanging fruit...easy to pass Congress. so the impact is never what was intended. Maybe there is not way to really get government spending and waste under control. I think the romans had this problem with their military so they started using Germans and raising taxes on the villages they exploited. When they ran out of villages their system began to decay without funds to support the elaborate structure they had built.

    1. Thanks Hoot. That has a familiar ring to it. I think we may be running out of villages.

  4. Fortunately, now the economic situation is relatively stable and we can see the economic growth and prosperity. However, I think that the tax system still needs some improvements. It’s necessary to make the system fair. In some occasions individuals with low income have to pay high taxes but how people using easy and fast loan tools can do that? Thus, it’s important to make tax system for flexible so everybody will pay a fair share.

    1. Thanks Yana for your comments. Fairness should be a goal of tax policy but unfortunately fairness, like the preference for bourbon, is often as elusive as sanity at an IU tailgate party. I am guessing that US Senators have at least 100 different definitions of tax fairness.