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Thursday, June 30, 2005

Whoops, it happened again

Since Bret couched the recent economic good news in terms of Reagan's policy legacy, let me provide some relevant information. In this article economist Michael Darda points out the rapidly improving economy after the 2003 supply-side type tax rate cuts a providing a revenue gusher. Here is some of what he has to say:

Fiscal year to date, total government receipts are up 15.5 percent, the fastest rate of increase on a comparable FYTD basis since 1981. The difference between the growth rate of tax revenues and the growth rate of government spending has widened to 8.4-percentage points, the largest since late 2000 when the budget was in surplus.

Not surprisingly, the recent tidal wave of tax receipts has ignited a furious debate about whether or not the Bush tax cuts are responsible for stimulating economic activity enough to actually boost overall tax-revenue collections. Classical economists refer to this as the Laffer curve, or the revenue-reflow, effect. In simple terms, if a tax cut stimulates the underlying activity being taxed, a revenue reflow will result. The reflow can offset or even surpass the volume of revenues that would have been collected under the higher tax rate and smaller tax base. Pro-growth tax-rate reductions on labor and capital in the 1920s, 1960s, 1980s, and then again in 1997 and 2003 all exhibited revenue-reflow effects, although some were stronger than others.

Despite the avalanche of historical evidence, some economists and policymakers question the validity of incentive-based revenue reflows...

The 2001 tax cuts combined small, glacially phased-in reductions in income-tax rates with credits and rebates designed to “put money in peoples’ pockets.” This traditional Keynesian stimulus technique has an incredibly poor track record. Tax credits and rebates simply shift money from one place to another, which can’t “create demand” and doesn’t stimulate behavior at the margin.

Conversely, the tax cuts passed in May 2003 were focused on dropping the top rates of tax on capital. The capital-gains tax (for gains held at least one year) was cut to 15 percent from 20 percent while the maximum tax rate on corporate dividends was slashed to 15 percent from 38.6 percent.

Unfortunately, the finer points of dynamic scoring escape the “logic” of the no-growth neo-Malthusian Democrats and the root-canal contingent in the Republican party. Both would be well advised to look at the record of the Baltic states, some of which have had flat taxes for over a decade. Flat-tax countries have experienced superior macroeconomic performance and rapid tax-revenue growth despite undergoing the same unfavorable demographic trends that have plagued Western Europe and Japan. This is no accident.

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