Myth: Tax cuts increase tax collections.
Fact: Tax cuts decrease tax collections.
Summary
There is no evidence whatsoever that tax cuts increase tax collections.
Almost always, tax cuts have seen tax collections fall in the following
years; tax hikes have seen tax collections rise in the following years.
Which is about what you would expect!
Argument
Before reviewing the statistics revealing the relationship between
tax cuts and tax collections, we should review a few important concepts.
First, the economy grows in the long run, as both our population expands
and productive technology improves. Our tax base, of course, grows along
with the economy, so if the tax rate remains the same -- say, 18 percent
-- then absolute tax collections grow as the economy grows.
Second, when comparing tax collections across the years, it is important
to distinguish between current and constant dollars. Comparing tax collections
in current dollars is deceptive, because inflation gives a false picture
of tax growth. Economists use constant dollars instead, which account for
inflation.
Third, tax collections generally fall during a recession, and rise
during a recovery. That is because during a recession, there are more unemployed
people who do not pay taxes. During a recovery, tax collections increase
as more people go to work. Since World War II, we've had only seven years
in which the economy shrank, so growth is the norm for both our economy
and our tax base.
However, there is an opposite effect at work here also. During a recession,
the government spends more because of the greater need for unemployment
and welfare benefits, as well as counter-cyclical Keynesian spending. During
a recovery, the government doesn't need to spend as much on these things,
and as a result it can afford to lower its tax rates.
With these things in mind, we can now review the historical evidence.
Tax cuts in recent history
Since World War II, federal tax receipts have fluctuated within
a few points of 18 percent of the Gross Domestic Product. Because they
have been so stable, tax collections have regularly grown with the economy.
Almost always, the only drops in tax collections have been during recession
years; otherwise, tax collections have expanded in the years that the rest
of the economy expanded.
There are a few notable exceptions to the above rule: those periods
following large tax cuts. After Reagan's income tax cuts took effect in
1982, real income tax collections took a long fall, despite the fact our
economy continued to grow. For the moment, let's ignore the fact that tax
collections could have been expected to grow after 1981. Let's simply use
1981 as a baseline, multiplying it 8 times, and compare that to what was
really collected over the next 8 years.
Individual Income Tax Collections (millions) (1)
Year Current Constant (87 dollars)
-------------------------------------------
1981 $285,917 $367,692
1982 297,744 356,366
1983 288,938 332,033
1984 298,415 328,470
1985 334,531 354,677
1986 348,959 359,307
1987 392,557 392,557
1988 401,181 387,128
1989 445,690 411,533
-----------------------------
82-89 total: 2,922,691
1981 (times 8) -2,941,536
-----------------------------
Net 8-year loss -18,845
Corporate Income Taxes (millions)
Year Current Constant (87 dollars)
-------------------------------------------
1981 $61,137 $78,623
1982 49,207 58,991
1983 37,022 42,544
1984 56,893 62,623
1985 61,331 65,024
1986 63,143 65,015
1987 83,926 83,926
1988 94,508 91,224
1989 103,291 98,092
------------------------------
82-89 total: 567,439
1981 (times 8) -628,984
------------------------------
Net 8-year loss -69,545
Combined individual and corporate income tax loss: $88 billion.
Keep in mind that this does not count the lost revenues that could
be expected from a growing economy.
Also remember that, because the economy grows in the long run, tax
collections will inevitably start rising again sooner or later as the tax
base continues to grow. Therefore, supply-siders do not have the argument
that there was a delay in increased tax collections, or that we can't expect
tax policy to have immediate effects. The simple fact is that there was
a 5 year drop in tax collections, which was extremely uncharacteristic
of a growing economy. And during that time we incurred a trillion and a
half dollars in debt, so the alleged value of such a tax policy is refuted
outright.
The above figures are for income tax collections. However, general
tax revenues also took a drop in the 80s:
Total Federal Tax Collections (billions) (2)
Year Nominal Constant (87 dollars)
---------------------------------------
1980 $517.1 $728.1
1981 599.3 766.6 < tax cut passed
1982 617.8 738.2 < drop
1983 600.6 684.3 < drop
1984 666.6 730.4
1985 734.1 776.6 < 81 level recovered
1986 769.1 790.0
1987 854.1 854.1
1988 909.0 877.3
1989 990.7 916.2
1990 1031.3 914.1
1991 1054.3 894.7
1992 1090.5 895.1
The Kennedy tax cuts are another favorite supply-side myth; many claim
that once the tax cuts went into effect in 1964, income
tax collections grew. But as you can see from the chart below, growth in
income tax collections sharply dropped off:
Federal Income Tax Collections (Constant dollars, CPI-U) (3)
Year Receipts Percent change from previous year
--------------------------------------------------
1961 $138,069 ---
1962 150,567 + 9.0%
1963 155,375 + 3.2
1964 156,804 + 0.9 < tax cut takes effect
1965 154,475 - 1.5
In 1965, the economy was in the fifth year of a nine-year expansion,
and for income tax collections to see negative growth was, again,
most uncharacteristic. Income tax collections did rise in 1966, but by
this time President Johnson was accelerating the economy with Keynesian
deficit spending on the Vietnam War. (These deficits he hid by unifying
the federal budget with Social Security.) The greater economic activity
resulted in more tax collections, and to disentangle any alleged supply-side
benefits from the Keynesian benefits is all but impossible.
Another era of tax cuts was the Roaring Twenties. At first glance,
supply-side theory seems to have worked here: taxes were cut, and revenues
climbed. But that's because only the very richest Americans paid taxes
in the 1920s, a decade which saw their incomes skyrocket. The vast majority
of Americans saw their incomes decline -- but because they paid no taxes,
this did not hurt tax collections. Of course, ordinary Americans had no
reason to celebrate increased revenues under these deteriorating conditions.
Indeed, they had every reason to oppose a tax policy that worsened income
inequality.
Specifically, between 1920 and 1925, the top rate was reduced from
73 to 25 percent. But even during the high taxes of World War I, 95 percent
of all Americans paid no income taxes. (4) By the end of the 1920s, about
80 percent of all Americans were still off the tax rolls. (5) Only
the wealthiest were taxed, but their numbers grew as inequality grew
over the decade. In fact, their ranks grew at a phenomenal pace only once
equaled this century (the Reagan years). The following chart shows by how
much:
Growth in ranks of rich, 1920-1928 (6)
Number, Number,
Income 1920 1928 Percent growth
---------------------------------------------------------
Over $1 million 33 511 1,448%
$100,000 - 1 million 3,616 15,466 328
To put this in perspective, the number of people making over $100,000
in 1928 still represented only 0.01 percent of the American population.
Their expanding numbers hardly helped out the middle class. But between
1923 and 1929, the lower 93 percent of the nonfarm population actually
experienced a 4 percent drop in real disposable per capita income. (7)
Farmers suffered an even worse decline. In one year alone -- 1927 -- the
number of Americans making a middle class income (between $2,000 and $5,000)
declined from 2.17 million to 2.09 million -- almost all of the loss to
the lower class. (8)
Against this backdrop, you can understand why a rich-only tax saw increasing
tax collections, and why the rich paid a higher share of those taxes. Between
1921 and 1928, total tax collections grew from $719 million to $1,160 million,
in a period of virtually no inflation. The share of the total tax burden
paid by the rich (those making over $50,000) rose from 44.2 percent to
78.4 percent.
But what would have happened if the poor had been paying taxes as well?
Obviously, with declining incomes, they would have paid less than before.
Because the middle class is larger than the rich, this probably would have
resulted in an overall drop in tax collections. And indeed, this is precisely
what we saw happen during the Reagan years.
Tax Hikes
By contrast, almost all tax hikes have seen dramatic and indisputable
growth in tax collections. During World War I, only the richest 5 percent
of the income earners paid taxes, and the top tax rate was hiked from 15
to 73 percent. Increases in revenues were so extraordinary that they funded
an entire war. (The war did incur a debt, but this was paid off by continuing
high taxes for a few years after the war.)
After the massive tax cuts of the 1920s, President Roosevelt raised
taxes on the rich from 25 percent to 91 percent. Even the bottom rate climbed
from 4 to 19 percent by the end of his presidency. (9) And tax collections
under Roosevelt shot up 121 percent a year, the most of any president in
U.S. history. By contrast, all subsequent presidents have seen tax collections
rise in the single digits. (10)
The one exception to this correlation is George Bush's 1990 tax hikes,
whose potential revenue increases were lost in the following recession.
For those who would like to think a cause-and-effect relationship exists
here, they should know that the recession of 1990 began in July, 1990,
four months before Bush broke his "no new taxes" pledge.
Bush signed his tax increases into law the following November. Many will
recall that this recession was also labeled the "lingering recession"
or the "jobless recovery" because it took so long for the unemployment
rate to start falling afterwards. That's because businesses were automating
instead of rehiring laid-off workers -- causing productivity to jump but
tax collections to remain flat for 1992 as well.
However, Clinton's tax increases in 1993 occurred after the recession
had passed, and the increase in tax collections is clearly visible:
Individual Income Taxes (millions) (11)
Year Current Constant (87 dollars)
-------------------------------------------
1990 $466,884 $413,355
1991 467,827 397,677 < recession year
1992 475,964 392,969
1993 509,680 411,032 < Clinton tax passes
1994 543,055 429,496 < takes effect
1995 590,244 458,300
Corporate Income Taxes (millions)
Year Current Constant (87 dollars)
--------------------------------------------
1990 $93,507 $82,786
1991 98,086 83,378 < recession year
1992 100,270 82,786
1993 117,520 94,774 < Clinton tax passes
1994 140,385 111,029 < takes effect
1995 157,004 121,907
This is in marked contrast to the Reagan tax cuts, which saw tax collections
fall, despite also occurring in a similar position in the business cycle,
namely, the start of a recovery.
In sum, supply-siders have no obvious success stories to point to.
Indeed, almost all the historical evidence runs against them.
Return to Overview
Endnotes:
1. Original data from U.S. Office of Management and Budget, Historical
Tables, Budget of the U.S. Government, FY 1996. Dollar conversions
made from tables located there.
2. Internal Revenue Service.
3. Original data from U.S. Office of Management and Budget, Historical
Tables, Budget of the US Government, FY 1996. Dollar conversions
made from CPI-U.
4. Internal Revenue Service Figures cited in Barlett and Steele,
America: Who Really Pays the Taxes (New York: Simon & Schuster,
1994) pp. 61-62.
5. Kevin Phillips, Politics of Rich and Poor (New York: Random House,
1990), pp. 76-77.
6. Barlett and Steele, pp. 66-67.
7. Charles F. Holt, "Who Benefited from the Prosperity of the
Twenties?" Explorations in Economic History, 14, July 1977,
pp. 277-89.
8. Geoffrey Perritt, America in the Twenties (New York: Touchstone
Books, 1982), pp. 321-22.
9. Barlett and Steele, p. 68.
10. Here is the growth in tax collections for all presidents since
Roosevelt:
President Years # Prev yr Last yr Increase Inflation Adjusted
Revenue Revenue average
---------------------------------------------------------------------
Roosevelt 34-46 13 $ 2.0 $ 39.3 1865.0% 50.8% 121.3%
Truman 47-53 7 39.3 69.6 77.1% 36.9% 3.7%
Eisenhower 54-61 8 69.6 94.4 35.6% 11.9% 2.4%
Kennedy 62-64 3 94.4 112.6 19.3% 3.7% 4.8%
L Johnson 65-69 5 112.6 186.9 66.0% 18.4% 6.9%
Nixon 70-75 6 186.9 279.1 49.3% 46.6% 0.3%
Ford 76-77 2 279.1 355.6 27.4% 12.6% 6.4%
Carter 78-81 4 355.6 599.3 68.5% 50.0% 3.0%
Reagan 82-89 8 599.3 990.7 65.3% 36.4% 2.4%
Bush 90-93 4 990.7 1153.5 16.4% 16.5% -0.0%
U.S. Office of Management and Budget, Historical Table 2.1, Budget
for FY 1997. Chart derived by Steve Casburn.
11. Original data from U.S. Office of Management and Budget, Historical
Tables, Budget of the U.S. Government, FY 1996. Dollar conversions
made from tables located there.