Tax Cuts Does Not Match Economic Reality

While President Bush has declared Social Security privatization his top priority, further reductions in taxes for the rich are a close second. As with his push for other policy initiatives, the rationale for further tax cuts does not hold up to scrutiny. The economy –and particularly the labor market, in which middle-class families have seen their incomes decline for four years – continues to need assistance. However, the favorite economic tool of the Bush administration, tax cuts for the rich, is unlikely to get the job done, as the record shows.

It is a widely cited right-wing mantra that tax cuts are good for growth and for jobs. Supposedly, the Bush tax cuts were a good economic stimulus when the economy needed it in the recession in 2001. In his radio address on March 10, 2001, President Bush argued that the economy was “sputtering” and that people needed more money to “buy products.”

To achieve the stimulus goal, President Bush could not have designed a worse tax cut. For one, the changes did not happen when the economy actually needed it. Out of a massive tax cut totaling $1.3 trillion, only $74 billion, or 5.5 percent, actually occurred in 2001, when the economy supposedly needed it the most. Instead, the vast majority of the tax cuts would happen five years later, when the economy was hopefully no longer in need of help.

The tax cuts were also top heavy; that is, most of the tax changes were targeted towards higher income earners, who are typically more likely to save money than to spend it – the opposite of what the economy needed. In the first five years of the tax cuts, those earning more than $200,000 a year received an estimated tax cut that was 12 times as large as the average. Across all tax changes enacted under President Bush, the nonpartisan Institute on Taxation and Economic Policy estimated that middle-class families saw a tax cut of 7 to 8 percent, compared to a 12 percent cut for the richest 1 percent.

Even during the period of strongest economic growth under President Bush, the tax cuts contributed about one-fifth of that growth, according to estimates by economy.com. Given the lackluster effect of the tax cuts, ingenious conservative rhetoric has identified the dividend tax cuts of 2003 as working miracles in other ways. They supposedly put “billions of dollars in cash into shareholders’ pockets,” as President Bush put it his radio address on July 19, 2003. These tax cuts, he claimed, boosted economic growth. The rationale is that dividend tax cuts boost stock prices. This makes it more attractive for people to buy stocks, which means more money for investment and ultimately, faster growth.

However, on this point the numbers tell a different story. The tax cuts were signed into law at the end of May 2003. Before dividend tax cuts became law, stock prices rose by 15 percent from their low point in February 2003 through the end of May 2003. For the remainder of 2003, stock prices grew on average 60 percent slower. In 2004, stock market gains were cut again by more than half. If anything, the introduction of dividend tax cuts went along with a slowing momentum on Wall Street, not the other way around.

Even if dividend tax cuts had something to do with higher stock prices, this did not translate into higher investment. In fact, in almost every single quarter since 1994, firms have been buying back more shares than they have issued new ones. That is, Wall Street simply was not a source of new investment financing for the past decade.

The weak rationale for the dividend tax cuts is also reflected in their estimated effect on economic growth. The consulting firm economy.com estimated that the economy would have grown by 9 cents in the near term for every dollar lost in tax revenue due to this tax cut. This is not a bang for the buck, but rather a measly whimper for the buck. In case you are counting, this is a 91 cent net loss on each dollar put towards stimulus.

Maybe the tax cuts were not the best economic aid for a struggling economy in the short term, but they may have helped the economy grow in the long run, conservatives reason. Unfortunately, there is little evidence that high tax rates hinder economic growth and that low tax rates help it. Despite massive tax cuts, President Bush’s first term had the second lowest average growth rate since the mid-1970s. Only his father did worse. In fact, economic growth accelerated in the 1990s after income taxes were raised by Presidents George Bush and Clinton. Also, numerous increases of the Social Security tax – the last one under President Reagan – did not impede growth in the U.S. in the 1980s or 1990s.

Then there are the deficits that resulted from the tax cuts. These have helped to keep the specter of rising interest rates and thus fewer investments and less consumption on the economic horizon.

The tax cuts were not an efficient way to use national resources. In fact, one would have to work hard to design policies that would have been less effective in helping the economy. Only their sheer size could lead us to see an impact, not their design. What Americans are left with are massive deficits and a labor market in which middle-class families are still struggling.

Christian E. Weller is senior economist at the Center for American Progress.