T Nation

Laffer Curve at Work

Here’s something for you anti-tax-cutters to chew on. Tax revenues are up significantly at both the state and federal levels since the Bush tax cuts. Spending is another side of the equation, and it’s troubling how much of it the governments are doing, but that doesn’t affect the power of the tax cuts. Oh yeah, and don’t forget: at least part – the non-speculative part – of the run-up in real-estate prices is a direct result of the change in how capital gains on real estate is taxed, which was enacted under Clinton. It amounted to a massive tax cut on real-estate cap gains.

Anyway, here are a couple articles, one opinion and one a news piece (opinion first), which show what is going on lately:

Real Tax Cuts Have Curves

June 13, 2005; Page A13

As legend has it the famous Laffer Curve was first drawn by economist Arthur Laffer in 1974 on a cocktail napkin during a small dinner meeting at the Washington Hotel attended by the late Wall Street Journal editor Robert Bartley and such high-powered policy makers as Dick Cheney and Donald Rumsfeld. The Laffer Curve helped launch the Reaganomics Revolution here at home and a frenzy of tax rate cutting around the globe that continues to this day.

The theory is really one of the simplest concepts in economics. Yet its logic continues to elude the class-warfare lobby whose disbelief is unburdened by the multiple real-life examples which validate its conclusions. The idea is that lowering the tax rate on production, work, investment, and risk-taking will spur more of these activities and thereby will often lead to more tax revenue collections for the government rather than less.

In the 1980s, President Ronald Reagan chopped the highest personal income tax rate from the confiscatory 70% rate that he inherited when he entered office to 28% when he left office and the resulting economic burst caused federal tax receipts to almost precisely double: from $517 billion to $1,032 billion.

Now we have overpowering confirming evidence from the Bush tax cuts of May 2003. The jewel of the Bush economic plan was the reduction in tax rates on dividends from 39.6% to 15% and on capital gains from 20% to 15%. These sharp cuts in the double tax on capital investment were intended to reverse the 2000-01 stock market crash, which had liquidated some $6 trillion in American household wealth, and to inspire a revival in business capital investment, which had also collapsed during the recession. The tax cuts were narrowly enacted despite the usual indignant primal screams from the greed and envy lobby about “tax cuts for the super rich.”

Last week the Congressional Budget Office released its latest report on tax revenue collections. The numbers are an eye-popping vindication of the Laffer Curve and the Bush tax cut’s real economic value. Federal tax revenues have surged in the first eight months of this fiscal year by $187 billion. This represents a 15.4% rise in federal tax receipts over 2004. Individual and corporate income tax receipts have exploded like a cap let off a geyser, up 30% in the two years since the tax cut. Once again, tax rate cuts have created a virtuous chain reaction of higher economic growth, more jobs, higher corporate profits, and finally more tax receipts.

This Laffer Curve effect has also created a revenue windfall for states and cities. As the economic expansion has plowed forward, and in some regions of the country accelerated, state tax receipts have climbed 7.5% this year already. Perhaps the most remarkable story from around the nation comes from the perpetually indebted New York City, which suddenly finds itself more than $3 billion IN SURPLUS thanks to an unexpected gush in revenues. Many of President Bush’s critics foolishly predicted that states and localities would be victims of the Bush tax cut gamble.

Alas, all of the fiscal news is not celebratory. The CBO also reports that federal expenditures are up $110 billion, or 7.2%, so far this year as the congressional Republican spending spree rolls on. Nonetheless, it now appears that the budget deficit will be at least $60 billion lower than last year and states and cities, led by California, which a few years ago were awash in debt themselves, will enjoy net surpluses of at least $50 billion. This means that total government borrowing will come in at below 2.5% of national output, which is hardly a crisis level of debt. Many of the opponents of the tax cut maintained that they would push up interest rates, but today long-term rates are so low that we have seen in recent weeks a string of nonsensical warnings from confused economists about the supposed curse of low long-term borrowing costs.

On the private-sector side of the ledger, what we are now witnessing is a broad-based investment boom. The lower capital gains and dividends taxes have been capitalized into higher stock values, and that in part explains why the Dow is up 24% since May of 2003 while the Nasdaq has risen 39%. Dan Clifton of the American Shareholder Association estimates that this rise in stock values has translated into roughly $3 trillion in added wealth holdings of American households. The severe slump in business capital spending in 2001 and 2002 has now taken the shape of a U-turn, with spending on capital purchases up an enormous 22% since 2003. Because higher wages and new job creation are highly dependent on business capital investment, the mislabeled “Bush tax cut for the rich” has in reality enormously benefited middle-income workers.

All of this brings us to the crucial policy issue of whether Congress will observe these new economic and revenue data and have the common sense to keep a good thing going by making the Bush tax cuts permanent. Thanks to inane budget rules in Congress the capital gains and dividend tax cuts are currently set to expire in 2008. (When was the last time a spending program in Washington expired?) One thing would seem certain: Raising the tax rates on capital gains and dividends would be a formula for choking off the expansion and reversing the stock market climb. Until now, the Democrats in Congress have in unison sanctimoniously charged that the government can’t afford the price tag of making the tax cut permanent. But, of course, all this new fiscal evidence points to precisely the opposite conclusion: that we can’t afford not to make the tax cuts permanent.

Whether Mr. Bush’s critics’ ideological blinders make them capable of being persuaded by facts and evidence is an altogether different issue.

Mr. Moore is a member of The Wall Street Journal’s editorial board and author of "Bullish on Bush: How the Ownership Society Will Make America Richer (Madison Books, 2004).

State Budgets Get Relief
With Surge in Revenues

Strong Corporate Profits,
Rise in Pay, Housing Deals
Give Boost to Tax Collections
June 14, 2005; Page A1

Strong gains in corporate profits, household income and home sales are swelling tax revenues for states nationwide, helping to close budget gaps and boost spending.

State-tax revenue for the July-March period of the fiscal year ending June 30 reached $387 billion, up 9.5% from the year-earlier period, according to a report soon to be released by the Nelson A. Rockefeller Institute of Government, a public research group in Albany, N.Y. Tax collections in the January-March quarter were up 11.7%, the strongest year-on-year growth for that period since at least 1991. The institute also says that if the current pace continues, states are on track to take in a record $550 billion for the full fiscal year, which ends June 30 for most states.

“We are now seeing year-over-year revenue growth” at levels last seen before the recession, says Nicholas Jenny, a senior policy analyst with the Rockefeller Institute, which will release its report later this month.

The latest numbers mark a healthy turnaround from just a few years ago when many states were struggling. After the tech bubble burst in 2000, followed by the plunge in the stock market and recession, tax collections fell sharply across the country. But how long states will enjoy the current boon is unclear.

The rise in revenues stems partly from factors that may be short-lived, such as an unusual surge in bonuses or the huge Microsoft Corp. dividend payout. And most states still face budgetary pressures. According to the National Conference of State Legislatures, as of February, 31 states reported spending overruns for some portion of the budget during the current fiscal year, compared with 23 states reporting overruns in November.

Health-care costs are one of the biggest problems. Through the first eight months of the fiscal year, July to February, Medicaid and other health-care spending is exceeding appropriation in 23 states compared with 16 in November, the National Conference says.

For now, though, the windfall has loosened purse strings, boosting spending plans for roads in Florida, teachers in New York and public transportation in California, state officials say.

In Arizona, tax revenues “are coming in much stronger than forecast,” says Gary Yaquinto, director of the Governor’s Office of Strategic Planning and Budgeting. “More people are working and earning income that’s taxable. Real-estate activity is very strong.” The state has been revising its revenue projections upward throughout the year, he says.

The large jump in tax revenue means many cities and states that were facing deficits or modest improvements in their budgets a year ago are now enjoying windfalls. New York City expects to end the fiscal year with a $3.3 billion surplus, more than $1 billion above earlier projections. In Florida, tax revenues are running 12%, or $2.6 billion, ahead of projections. Ohio expects to end the fiscal year with a $500 million budget surplus after first projecting a balanced budget.

Even California, which had at one point projected an $8.6 billion deficit for fiscal 2005, is now projecting a budget gap of $3.3 billion for the fiscal year. Similarly, economists last week began cutting projections of the size of the federal budget deficit, to $350 billion rather than the $427 billion shortfall the Bush administration forecast in January.

Economists say there are three main factors behind the improvement in government finances. Tax collections from personal income are running about 10% ahead of last year. Corporate-tax revenues – related in part to strong profits – are running 20% to 60% ahead of a year ago in many states. And real-estate taxes in some states have doubled because of the heated housing market.

Among these, the most puzzling element to analysts has been the growth in personal income. According to figures released last month by the Bureau of Economic Analysis, employee compensation rose at a seasonally adjusted annual rate of 10% during the fourth quarter of 2004 and 7.1% during the first quarter of this year. Those figures were sharply higher than earlier estimates and caught some economists by surprise when they were first reported last month. Since then, however, economists have said the gains reflect income related to bonuses.

“On the salary and bonus side, 2004 was a good year,” says Steve Gross, a principal in the Philadelphia office of Mercer Human Resource Consulting. Although base wages aren’t growing much, he says pay tied to corporate performance is rising. “More companies are reticent to increase fixed costs, which is why you’re not seeing an increase in base salaries or wages. But they are comfortable with sharing the wealth through incentives and bonuses that are variable. Because last year was a good year for corporate profits, more companies did well and therefore bonus payments were up.”

Many investors are cashing out of the stock market, paying taxes on the income gains. Even though the overall stock market has produced lackluster results so far this year – the Dow Jones Industrial Average is down 2.4% and the Nasdaq is off 4.9% – investors have slowly racked up gains during the past few years. Last year, the Dow industrials were up 3.2% and Nasdaq was up 8.6%.

Last year “was the first time since the market crashed that people could take capital gains,” says Mark Zandi, chief economist at Economy.com. “Many stock options had been underwater before then,” meaning they were trading below the price at which exercising the options could generate gains for the holder. With stocks trading lower this year, some investors continued to cash out of stocks during the first quarter.

Personal income was also boosted by unusual stock events, including Microsoft’s $32 billion dividend payout and Google Inc.'s $1.7 billion initial public offering, which doubled in price in just two months. California says it saw a 33% jump, to $63.1 billion, in capital-gains income tied to stock sales. Corporate-tax collections in California nearly doubled in the fiscal year through March to $8.8 billion, partly due to a tax amnesty program.

In addition, job growth has been strong. The economy added 2.2 million jobs in 2004 and nearly 900,000 in the five months through May, on a seasonally adjusted basis, according to the Department of Labor. Some economists suspect that job growth has actually been stronger than the government figures indicate. “One key explanation for the unexpected income jump is that the nation is generating more jobs than statistics show,” Mr. Zandi says.

The unemployment rate in New York City, for example, fell below 6% recently for the first time since the Sept. 11 terrorist attacks. For the current fiscal year, the city expects to collect nearly $5.9 billion in personal-income taxes, up from earlier estimates of $4.9 billion. But the biggest percentage gains in tax revenues for the city came from real-estate transactions. With property values soaring, New York City’s latest projection estimates that in fiscal 2005 the city will take in nearly $2.2 billion in taxes tied to mortgage fees and real-estate sales. That would be more than double earlier projections of $990 million. In Arizona, officials say a 33.5% jump in April tax collections from a year earlier reflects real-estate sales.

A strong jobs picture and real-estate market also have poured more money than expected into Florida. For fiscal 2005, the state expects to collect general tax revenues of nearly $24.7 billion, up more than $2.6 billion from an earlier estimate. Florida, which has frequently led the nation in job creation, also got an economic boost last year with the extensive repair work following four hurricanes.

With the outlook for state revenues looking bright, the drum beat to cut taxes may start to get louder, says Mr. Jenny, of the Rockefeller Institute. If the good times roll on, “there will be pressure to cut taxes next year,” he says. For now, states are planning to use the extra money next fiscal year to close budget gaps, build roads, pay the salaries of teachers and police officers, and build reserve funds.