The nation’s budget deficit is finally shrinking – and to keep it that way, we should cut taxes.
Last year, for the second time in a row, the annual deficit saw a substantial reduction over its previous-year mark. To be exact: The Congressional Budget Office data reveals that it underwent an 18 percent drop, and blue skies lie ahead. Last week’s CBO outlook report forecasts that next year’s deficit will plummet a whopping 60 percent from its 2006 figure.
While certainly welcome, the news was initially a bit mystifying. How on earth could the federal government have made so much progress toward fiscal solvency in this modern era of rising government spending?
Since the turn of the century, strain after strain has been placed on Uncle Sam’s wallet: Military operations in Afghanistan. Military operations in Iraq. Hurricane Katrina relief. Increased Department of Education spending. The creation of an entirely new bureaucracy, the Department of Homeland Security.
The current administration and its allies in Congress have been
Though spending has
certainly risen of late, so has federal income stemming from tax revenues. … While the rate of income taxation has fallen, total receipts from income taxes have actually increased.
anything but penny-wise, meaning that its devotion to cutting taxes should have only exacerbated the crisis.
Right?
Not quite. Though spending has certainly risen of late, so has federal income stemming from tax revenues. According to the American Shareholders Association, a prominent fiscal policy think tank, tax revenues increased by 11.5 percent last year while spending increased by only 5.8 percent – in part explaining the deficit’s drop.
Still, it is difficult to see how cutting taxes could possibly result in any growth in tax revenues. So what gives?
Though President Bush’s Economic Growth and Tax Relief Reconciliation Act of 2001 entailed a number of tax cuts, it primarily served to reduce income tax rates. The pro-growth legislation (and subsequent Bush tax policies) therefore spurred public consumption and contributed to a vibrant economy – indirectly resulting in rising incomes (on average, 5.2 percent annually since 2003). While the rate of income taxation has fallen, total receipts from income taxes have actually increased.
Of course there are hundreds of other forms of taxation in the United States – sales, excise, capital gains, corporate income and value-added, to name only a few. Many of them are directly tied to consumption and help contribute to the nation’s record high revenues. Pro-growth tax policy (in this case the 2001 act) can lead to an increase in the amount of money brought in by these myriad forms of taxation to which we are subject.
The data certainly backs up the assumption that when it comes to taxation, less is usually more. Since 2003, federal tax revenues have averaged increases of 10.3 percent per year, and one year ago U.S. Treasury Secretary John Snow announced that in 2005, the government took in more in tax revenues than it had at any other year in the nation’s history.
Clearly, the administration has got it right – but not everyone thinks so.
In a misguided attempt to make good on their campaign promise of fighting the purported “”fiscal irresponsibility”” of the administration, Democratic congressional leaders have pledged to resurrect an old policy with a cute name: PAYGO.
The name is derived from its underlying philosophy, a “”pay-as-you-go”” approach to spending, which supposedly results in a balanced budget. According to the principle, the Democrat-controlled Congress would refuse to cut taxes without cutting spending or to increase spending without enacting a tax increase to pay for that spending.
The logic sounds basic enough, but the reality is that managing the budget of the world’s richest nation is (surprise!) not quite so simple.
Still, it shouldn’t be too hard. In high school economics we all were taught the Laffer curve, a concept that states governments can maximize tax revenue not by maximizing the rate of taxation but rather by adjusting those rates to an optimum point. Revenues, according to the Laffer curve, will fall if the tax rate is either higher or lower than this optimum.
Clearly, we as a nation are well above this level. Since tax cuts have resulted in substantial revenue gains for the federal government, it would be wise to continue to tweak our tax policy until we reach the curve’s optimum rate.
Worried about the budget deficit? Then, for now at least, let’s cut taxes – not raise them.
David Francis is a pre-business sophomore. He can be reached at letters@wildcat.arizona.edu
