WASHINGTON, May 3, 2017 – The Congressional Budget Office (CBO) will release a report calculating the effect of President Trump’s tax plan on the overall economy and specifically the effect on the federal government’s budget. Based on their methods they will likely conclude that Trump’s tax plan will increase the deficit from $1 to $2 trillion over the next decade.
That assessment is wrong. Annual deficits will fall under the Trump administration, even with his tax plan.
Tax cuts do not cause deficits. I repeat: tax cuts do not cause deficits. Deficits occur because the federal government increases spending at a faster rate than tax revenue increases. In other words, it is the increase in spending that causes deficits.
History clearly shows this to be true.
In 1964, the Kennedy/Johnson tax cut was passed which lowered tax rates, especially for the highest income earners. There was also an agreement to limit government spending. The result was a growing economy that saw tax revenue increase every year, with some years seeing a 10% increase in tax revenue. The lower rates generated more revenue and a faster rate of growth in tax revenue.
Why then was the 1968 budget deficit four times greater than the 1964 deficit? Simply because annual spending between 1964 and 1968 increased by more than 50%. Increases in spending caused the deficit, not the tax cut.
In 1981, President Reagan proposed a similar Kennedy/Johnson type tax cut reducing rates for all taxpayers, especially the highest income earners. Although the economy was mired in stagflation, essentially recession and inflation, the tax cuts stimulated the economy so much that annual growth exceeded 7% in 1984.
The reduced tax rates were phased in over three years. In every year after the tax cut was enacted, tax revenue was greater than it was in 1981. In 1985, tax revenue increased by more than 10% over 1984. Yet, annual deficits tripled between 1981 and 1986. That’s because annual spending increased by nearly 30%.
Increases in spending caused the deficit, not the tax cut.
In 2001, the economy was in recession and we had a shock to the system on September 11. President Bush pushed a tax cut. Tax revenue did fall and didn’t return to pre-tax cut levels until 2005. But annual spending increased by 30%.
Increases in spending caused the Bush era deficits although tax cuts appear to have contributed. The reason for the short-term tax revenue decrease is that the economy did not increase growth during the Bush years the way growth increased during prior tax cuts. That’s mostly because the economy had experienced good growth for 18 of the prior 20 years, creating an environment where large increases in growth were more difficult to produce through tax cuts.
In 1997 (effective in 1998) President Clinton lowered the capital gains tax rate. From 1997 to 2000, economic growth increased and tax revenue increased by 30%. During the same period, government spending increased by only 11%. (President Clinton declared that the era of big government was over.) The result was budget surpluses.
When Trump’s tax cuts are passed, tax revenue could decline for perhaps one year, although the more likely scenario is that tax revenue increases slightly but then as economic activity accelerates tax revenue will increase.
The tax revenue increases will accelerate in ensuing years.
The CBO estimates will be wrong for two reasons. First CBO holds variables constant when calculating the impact of the tax cut. In other words, CBO assumes GDP growth will be the same with or without the change in the tax code. If growth increases from 2% to 4% another $50 billion of tax revenue will be generated annually, which is $500 billion over the next 10 years.
The CBO also assumes that projected government spending will be growing as it has in the past. President Trump will reduce government spending rather than allow it to increase as it has in the past. This action alone will reduce deficits.
Despite Democrats deciding to do victory laps, the recent passing of a spending bill indicates how Trump will react to government spending. That is, he will insist on spending increases in some areas, spending decreases in other areas and he will compromise to get at least some bipartisan support. He will not tolerate inefficiency or waste. He will in his first full budget, reduce overall government spending.
Let’s support the tax cut, get the economy growing again and watch the budget deficits fall.
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