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Federal Budget

Myth #2: The Bush-era Tax Cuts


Once article of faith among Republicans is that tax cuts pay for themselves over the long run. How would this operate in theory? A tax cut to individuals would lead to more consumption as people spent the extra money on goods and services; this would in term increase business profits and lead to economic growth. This in turn would lead to wage growth and to the creation of new jobs as the economy hummed along thanks to lower taxes. Eventually, the increase in wages, jobs and business profits would generate as much or more money than the government gave up in short-term tax receipts – thus paying for themselves “over the long run”. John Maynard Keynes said that “over the long run, we’re all dead”, that is a good warning note to start with.

Of course, tax rates do have an impact on the economy, on personal consumption and on business investment. This is called the tax multiplier. Without going into technical detail, this tells me if I give up $1 in taxes today, how much of it do I get back? The number can be more or less than one and there is no consensus between economists as to what the value of the multiplier actually is. Political beliefs play a part in this, as well as which “school” of economics the person in question subscribes to. On top of that, the tax multiplier is not a constant – it is influenced by other factors that radically affect its value, such as the economic climate, liquidity of credit markets, and a host of other variables. This makes basing fiscal policy exclusively on the assumed value of the tax multiplier a chancy proposition at best.

So, let’s take a look at the impact of the Bush tax cuts on the economy and government finances. I’m referring to the legislation in 2001 and 2003, as well as the extension of these in 2010. For the purposes of this investigation, I’m going to keep things simple. I’m going to look at: 1. how much the Bush tax cuts actually cost in terms of lost revenue; 2. how much it would cost to continue with them in the future; and 3. how these cuts affected economic performance – looking at personal consumption, gross business investment, new job creation, wages, and overall GDP growth.


Even in a government that loves acronyms, the 2001 Economic Growth and Tax Relief Reconciliation Act and the 2003 Jobs and Growth Tax Relief Reconciliation Act are real jawbreakers. The acts made sweeping changes to the US tax code, including the individual income tax and the estate tax. The major changes included:

  • Changes to individual tax brackets and rates. EGTRRA introduced a new 10% tax rate for the least affluent Americans and generally lowered tax rates while expanding the upper limits within tax brackets (thus effectively placing more taxable income at lower rates). JGTRRA further reduced tax rates, mainly in the upper brackets, and also expanding the upper limits within brackets. The table (1) below illustrates these changes:

  • Reduction in Capital Gains Tax.  EGTRRA reduced the capital gains tax on qualifying gains for the 15% tax bracket from 10% to 8%. JGTRRA further reduced the capital gains tax rates from 8% and 10% to 5%, and from 20% to 15%. It also reduced the tax rate on “qualified dividends” to the capital gains tax rate. (2)
  • Reduction in the Estate Tax. EGTRRA increased the estate tax exclusion from $675,000 in 2001 in 5 steps:
  • To $1,000,000 in 2002;
  • To $1,500,000 in 2004;
  • To $2,000,000 in 2006;
  • To $3,500,000 in 2009; and,
  • With a repeal of the estate tax in 2010.
  • Changes to defined contribution accounts and IRAs. EGTRRA raised limits on yearly contributions to these types of tax-deferred accounts, as well as making them more flexible in terms of benefits and withdrawals.
  •  The Sweetener. The 2001 EGTRRA also included a tax rebate to be applied to all qualified filers depending on their filing category:
  • $300 for single filers without dependents;
  • $500 for single filers with dependents;
  • $600 for married couples.
  • The rebate was capped by the maximum amount paid in taxes that year (i.e. if you paid no income tax, you received no rebate).

Winners and Losers

Like every other piece of legislation, EGTRRA and JGTRRA created winners and losers. In the short-term, most Americans got something out of either the tax rebate or lower tax liability from the new 10% bracket and the slightly higher maximum income levels within the brackets.  The changes in the IRA accounts were also popular, especially with middle income Americans.

Wealthy Americans received proportionately much more, mainly due to the reductions in the capital gains tax, estate tax and dividends, which are overwhelmingly concentrated amongst the most affluent. Not too many middle income Americans were affected by raising the estate tax exclusion from $675,000 to $1,000,000 and none at all from further increases.

Common Sense calculated the impacts of the changes in taxes between the 2000 tax year and the 2003 tax year to see who benefited the most. President Bush has said that it was middle America, so we compare three households: the “mean U.S.” household earning $49,534 in income in 2009 versus a “top 5%” household earning $295,388 per year and a “top 0.5%” household earning $1,433,640 per year.

On the left, we take all income to be regular income (i.e. no capital gains, no dividends, no investment income, no business income, just “wages”). Your “middle American” has their tax burden reduced by $1,000 or about 2% of income, which is not bad. Your “top 5%” American has their tax burden reduced by $11,000 or about 4% of income, while your “top 0.5%” American has their taxes reduced by $64,000 or just shy of 4.5% of income.

But that’s only true if we consider all income to be wages. In fact, the wealthiest Americans get more than two thirds of their yearly income from investments, dividends and capital gains, which are taxed at a different rate and which were cut considerably by the Bush tax cuts. “Middle America” earns less than 10% of total income from non-wage sources. (4) When we take this into account, the top 5% save an extra $2,000 per year for a total of $13,000 or 4.5% of income. The “top 0.5%” save an extra $4,000 per year for a total of $68,000, or 4.7% of income.

A tax cut for “middle America”? Not only did the wealthiest Americans benefit the most in absolute terms, which makes some sense since they earn so much more than average Americans, but even in proportion to their income they came off at least twice as well as Main Street. And that doesn’t consider all of the tax loopholes, shelters, deferments and other deductions that wealthy Americans have access to reduce their taxes even further.

If we ignore – for the moment – the question of how equitable a distribution that so disproportionately favors those who need it the least, the tax reduction looks like a “win-win” for the American people, doesn’t it? Everyone received something in the end, didn’t they?

In the long-run, after the $500 tax rebate was spent fixing the car and the extra $1,000 was spent paying down credit card bills, the lower 95% of Americans turned out to be the losers in the transaction. These are the Americans who are the primary consumers of state and federal government services; these are the Americans who suffered most from the appalling collapse in state finances in 2008 and their mandatory spending cuts; these are the Americans who are now suffering or will suffer from the mandatory and (Republican) proposed spending cuts to balance the federal budget. These are the Americans who depend on welfare and unemployment assistance; on Pell grants and GI Bill funding; on Medicare and Medicaid prescription drug subsidies. These are the Americans who remain ignorant, remain poor, remain sick or simply die when government is forced to make “fiscal adjustments”.

We are living the long-run today, and suffering the lack of judgment of the politicians who passed this law to reward their financiers.

In the Red

Let’s be clear: the Bush tax cuts gutted the Federal government budget.

President Clinton left office in 2000 with a budget surplus the first President to do so since Eisenhower. In a year, President Bush turned that surplus into a deficit from which we have never recovered.

How big was the swing? In the 8 years of the Bush Administration, it was over $2 trillion dollars. EGTRRA and JGTRRA alone cost the government $1.7 trillion dollars. (5)

But that’s not all, folks. Because these ruinous tax laws were due to expire in 2010, but President Obama – yes, the President for “change” – extended these tax breaks for millionaires until 2012 in order to gain another year of unemployment support for those American families hardest hit by the financial crisis. Let me repeat that: Republicans in Congress threatened to vote down assistance to Americans made jobless by the Wall Street financial crisis unless the Democrats and the President gave them more tax breaks for the same Wall Street tycoons who dropped us over a cliff. Remember that when you vote this year folks (I’m going to assume that if you make more than $250,000 per year in income, you’ll vote Republican no matter what I say.)

It’s the gift that keeps on giving! The Bush tax cuts! Yes!

Every year deprives the Federal government of about $360 billion dollars. That’s 33% of the budget deficit right there, folks.  If President Obama finally does let the tax cuts expire in 2012, as he almost certainly will, we can cap our losses at a mere $3.4 trillion dollars and count ourselves lucky. If we push them out to 2014, we rapidly approach $5 trillion dollars. That’s one third of gross domestic product. (6)

Yet the Republicans say we have no options but to cut spending. Spending for schools, for teachers, for research, for roads and bridges, for unemployment and re-education, for food stamps, for medicine. Not for their friends and contributors though, that’s where government largesse is appropriate and necessary.

When we talk about such large sums of money, most Americans tend to get a glazed look on their face. Their eyes stare out into the distance and you can see the words “millions”, “billions”, “trillions” being silently repeated in an effort to grasp their implications. They are very big numbers. So Common Sense has provided some tangible examples to bring home what these tax cuts really mean to the country in terms of lost opportunities:

With the $2.4 trillion dollars lost to the Bush tax cuts, we could have (7):

  • Gone to the moon 12.5 times (I don’t recommend partial moon shots however);
  • Built the Eisenhower Highway system 5 times over;
  • Fought 3 Vietnam Wars (one of the classic blunders) and still had enough left over for 2 years of Iraq;
  • Gone to Mars almost 4 times (3.8 to be exact).

Or we could have simply avoided the King Kong-sized national debt we are passing on to our children.

More Voodoo Than You Can Shake A Stick At

But surely this isn’t the whole story. After all, the tax cuts must have increased consumer spending, they must have spurred private investment. Don’t the wealthy invest in new businesses, which create new jobs, and thus “trickle down” to the masses? Isn’t that the whole argument behind a lower capital gains tax in the first place?

In fact, the Heritage Foundation, a conservative think tank, wrote a glowing report in praise of the EGTRRA (before its passage) that assured us:

“Under President Bush’s plan, an average family of four’s inflation-adjusted disposable income would increase by $4,544 in fiscal year (FY) 2011, and the national debt would effectively be paid off by FY 2010.
The net tax revenue reduction, after accounting for the larger tax base that would result from higher employment and faster economic growth under the Bush plan, is $1.1 trillion from FY 2002 to FY 2011,” (8)

Ah, the magic of Excel.

Were they even close in their estimates? Not hardly. Even without the 2008 financial crisis, the national debt grew in every year between 2002 and 2008. The net tax revenue reduction, which was only supposed to be a meager $1.1 trillion by 2011, was already $1.7 trillion in 2008 before the crisis hit. The rising tide of GDP which was supposed to lift all boats with it never materialized. Growth in GDP throughout the decade was anemic in every year except 2004 and was already in serious decline long before Lehman Brothers imploded. (9) (10)

Voodoo Economics Article of Faith #1: Lowering taxes leads to higher consumption in the economy. In fact, there is no evidence that the Bush tax cuts increased consumption expenditures in the economy. A comparison with the Clinton Administration’s higher tax regime shows that even though the 2001 tax rebate had temporary effects on consumer spending, they had no long-term effects on the overall level of personal consumption. They remained at or below the levels enjoyed by President Clinton through his term in office. Just as significant was the increase in Federal spending due to the start of the Second Gulf War in March 2003; (11)


Voodoo Economics Article of Faith #2: Lowering taxes on the rich will spur investment and job creation. HONK! Wrong again. There is no clear link between the Bush tax cuts and increases in domestic investment during his administration. Much, if not all, of the economic growth during the period was fueled by real estate and finance, not areas where people need to invest a lot in plant and equipment or inventories. In fact, most of the wealth handed back by the government was plowed right back into speculation, fueling the bubble; so in that sense, it was counterproductive – far better for the government to have kept it to pay down the debt. (12)

President Obama is now being blamed for the rampant deficit and enormous national debt. Republicans are saying that the President can “no longer blame Bush” after three years in office, the problems are now his own. Yet Republicans fail to mention in these same speeches that we continue to live under the same handicaps we inherit from Bush: the same tax cuts which Republican lawmakers drove down our throats again in 2010, the same burden of wars which the President is only now beginning to lift from our shoulders.

It took Bush and the Republicans eight years to ruin the country; but at least the fallacies of the his failed policies can be exposed.

  This myth has been busted.




Sources and Notes:

(1) Internal Revenue Service (www.irs.gov)
(2) “Qualified dividends” includes most income from foreign corporations, real estate investment trusts, and credit union and bank “dividends” that are nominally interest.
(3) Our example uses overall U.S. mean household income for 2009, and mean household income for top 5% of filers for 2009, based on the 2010 U.S. Census data. It also uses mean household income for top 0.5% of filers for 2009 from the IRS Statistics of Income tables. All calculations are based on a household filing as “Married filing Jointly” with one exemption and using only the standard deduction, no itemization. All capital gains income is assumed to be long-term capital gains (>1 year) and not in any special capital categories (e.g. collectibles).
(4) “The Case for the Buffett Rule in One Chart”, Marr, Chuck. Tax Policy Center (Table T11-0317) sourced from the Center on Budget and Policy Priorities. 20 September 2011. Households with incomes below $70,000 are estimated to make less than 10% of their total income from capital gains, whereas households with incomes above $1,000,000 are estimated to make greater than 66% of their income from capital gains. For purposes of the calculation, Common Sense has taken 10%, 33% and 66% as the ratios of capital gains to total income for each of the income categories.
(5) Office of Management and Budget – FY2011 Budget proposal – Historical tables
(6) Congressional Budget Office – Fiscal 2010 Budget – Scenarios
(7) Costs for the Apollo Space Program, Eisenhower Interstate Program, Vietnam War and Bush tax cuts through 2011 are from the Congressional Budget Office; Mars Space Program estimates are from NASA. All costs are in 2011 dollars using CBO deflators.
(8) Wilson, D. Mark and Beach, William W. “The Economic Impact of President Bush’s Tax Relief Plan”, The Heritage Foundation, 27 April 2001.
(9) In fairness to Republicans, their economic theories were developed in the 1970’s and 1980’s for a very different set of circumstances. To quote Stephen King, “The world has moved on”, but Republican doctrine has not moved on with it.
(10) GDP data is from Bureau of Economic Analysis; National Debt data is from US Department of the Treasury
(11) Bureau of Economic Analysis
(12) Bureau of Economic Analysis

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