Do Tax Cuts Cause Deficits?

Commentary
By JOHN HECK

There is a false narrative circulating about the recent Trump tax cuts. This is coming mostly from his political detractors, or those who have a misunderstanding of the impact tax cuts have on the overall economy and what actually causes deficits.

As financial professionals, it is important that we understand: 1) How tax cuts work. 2) Their effects on the overall economy. 3) What causes deficit spending. This will help us provide better advice to our clients when assisting them with financial decisions.

To boil the argument down to a single sound bite, tax cut opponents say, “The tax cuts are costing the government money by benefiting wealthy business owners and leading to a higher government deficit.” This is simply not true. The raw data does not support this argument.

According to the Congressional Budget Office, in Fiscal Year 2018, which ended Sept. 30, corporate tax revenue amounted to about 7 percent of overall tax revenue to the U.S. Treasury. That is $243 billion out of $3.2 trillion in tax receipts. The April 2018 projection by the CBO  illustrates corporate income tax receipts are down approximately 2 percent from Fiscal Year 2017, a mere pittance in the overall tax revenue collected by the federal government, yet down nonetheless.

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So, where does the majority of tax revenue come from, if it isn’t coming from corporate filings? You and me. The CBO reports that personal income tax paid to Uncle Sam in FY18 totaled a staggering $1.6 trillion and payroll tax added another $1.2 trillion. That is $2.8 trillion or 87.5 percent of an approximate $3.2 trillion tax base coming from the individual taxpayer. Those figures are up more than $100 billion due to the expanded jobs and economic growth of the past year, far surpassing the roughly $50 billion reduction in corporate tax revenue year over year.

And the current tax cuts are just now beginning to work their way into the economy. So, if history teaches us anything, as you will see in a moment, these tax cuts could have a major impact on gross domestic product growth for years or even decades to come.

Federal revenues come largely from individual income taxes and payroll taxes, with corporate income taxes and other taxes playing smaller roles. – Congressional Budget Office

Tax Rate Versus Tax Revenue

So, if personal income tax and payroll tax paid by American workers have gone up and corporate income tax has gone down, how is this good for “Joe and Susie Lunchbox?” The answer is simple. There is a difference between tax rate and tax revenue. The average American worker and corporation have seen their tax rates reduced as a result of recent tax cuts. That is, the percentage of their wages or income paid to the government has gone down. Therefore, the individual worker and corporation pay less.

The cut in the corporate rate has led to reinvestment in, expansion and start-up of businesses, creating tremendous job growth. As a result, there are more American workers earning higher wages in jobs that didn’t exist only 12-18 months ago. These workers, on average, pay a lower tax rate than they would have a year or two ago, but there are millions more of them in the workforce paying taxes.

Bottom line? A cut in tax rate does not result in a cut in tax revenue to the federal government. In fact, history shows that quite the opposite is true. For example, as The Washington Times pointed out, “George W. Bush’s 2003 tax cuts generated a massive increase in federal tax receipts. From 2004 to 2007, federal tax revenues increased by $785 billion, the largest four-year increase in American history.”

During his presidency, Ronald Reagan cut the top tax rate from 70 percent to 28 percent. As The Wall Street Journal noted, “When Reagan left office, real federal revenue was more than 19 percent higher than it was the day of his first inauguration. The Reagan tax cuts laid the foundation for a quarter-century of strong, noninflationary growth, which, despite three subsequent recessions, averaged 3.4 percent” until the beginning of 2010.

Daniel Mitchell at The Heritage Foundation writes, “President John F. Kennedy proposed across-the-board tax rate reductions that reduced the top tax rate from more than 90 percent down to 70 percent. What happened? Tax revenues climbed from $94 billion in 1961 to $153 billion in 1968, an increase of 62 percent.”

The results are similar when you analyze the across-the-board tax cuts of Calvin Coolidge or the capital gains tax cuts of Bill Clinton; revenue to the federal government increases because of the economic growth it encourages. On Jan. 17, 1963, in his annual budget message to Congress, Kennedy said, “Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased – not a reduced – flow of revenues to the federal government.”

Some Historical Perspective

Historically, tax cuts have been preceded by periods of recession, stagflation and overall periods of depressed economic growth. Thus, it is not uncommon for the first several quarters or even a year or two of slightly reduced tax receipts while the added income retained by workers and corporations has time to work itself into the economy. But these periods have all proven temporary and insignificant when compared to the long-term tax revenue increases to the Treasury and explosive economic growth in GDP and wealth creation, primarily within the ranks of the middle class and lower-income workers.

So what of the argument that an increase in tax revenue should lead to reduced deficits? Well, it should. Unfortunately, the data also illustrate the problem is with government spending. In other words, the problem isn’t that we tax too little. The problem is we spend too much.

Following the Bush 2003 tax cuts, the Treasury collected $9 trillion in tax revenue in fiscal years 2004 through 2007. Remember, this amounted to $785 billion in additional tax revenue. Yet, according to the Tax Policy Center’s Federal Receipt and Outlay Summary, the federal government spent more than $10.1 trillion during the same time, resulting in a $1.1 trillion deficit.

From 1981 through 1988, the Treasury collected $5.75 trillion from U.S. taxpayers but the Reagan government spent more than $8 trillion during the same time – leaving a more than $2.2 trillion deficit.

And from 1961 through 1968, the Treasury saw $964 billion in tax receipts. During the Kennedy and Johnson administrations, expenditures totaled $1.024 trillion. Again, there was a deficit – $60 billion.

While there is zero evidence that tax cuts cause deficits, there is an abundance of evidence that each time taxes are cut, tax revenue increases, explosive economic growth occurs and wealth is created. There is also overwhelming evidence, if you look at actual tax revenue vs. government spending, that overspending is the cause of deficits, which has ultimately led us to trillions in debt.

The next time you hear someone on TV or elsewhere tell you otherwise, they are either not being truthful or they have not looked at the data. It is government spending surpassing tax revenues that causes deficits, period. Even when the government collects record levels of your tax dollars. 

John Heck is the founder of Adagio Financial Group and a member of the Project Development Team at the John Galt Institute. John may be contacted at john.heck@innfeedback.com.