Sunday, December 26, 2010

Visualizing Taxes and Deficits

There has been a lot of debate about the impact of the early decade tax cuts on economic activity and deficits.

As the chart below depicts, from 2000-2009, we saw drastic increases in revenues (nearly 30% from 2001-2007) in the face of marginal tax cuts. Any deficit that resulted would have to be attributed to expenditures or outlays, and could not be attributed to cuts in marginal tax rates. As the graph shows, outlays also increased during this period, but even more drastically by 46%!


 As the next graphic shows, early on we saw a fairly rapid increase in the budget deficit from 2002-2003, a tapering off from 2003-2004 and  a rapid decline from 2004-2007, by as much as 61%! This is very impressive given the large amounts of spending increases depicted above. If it were not for the large influx of tax revenues during this period (in the face of marginal tax cuts) the deficit likely would have been on the increase vs. the precipitous fall depicted below.



However, on the heals of the financial crisis, going into 2008 & 2009, we start to see declining revenues, and unprecedented increases in spending and the deficit. From 2007 - 2009 we saw an increase in spending by about 28%, and an 88% increase over 2001 levels.  (indicated by the drastic upturn in outlays in the first graph)

But the impacts on the deficit were even more dramatic. From 2007-2008 we saw a 185% increase in the deficit, from 2008-2009 the deficit increased by 208%! Overall, compared to the 2002 levels that was an increase in the deficit of almost 800% over 7 years. If you compare to the 2007 low, considering the drastic reductions in the deficit after the tax cuts,  that is nearly an 800% increase in the deficit in just 3 years!

From 2004-2007 there was a rapid decline followed by a spike in the deficit during 2008 & 2009

Looking at the data, it appears that the reduction in marginal tax rates in the 2000's did not coincide with the rapid increase in the budget deficit that occurred at the end of the decade, but in fact were in step with the very rapid reduction in the budget deficit through 2007.

Most likely the deficit was the result from decreased revenues and increased expenditures associated with the financial crisis, not cuts in marginal tax rates. The real question becomes what was the cause of the financial crisis? There is no macroeconomic theory that I am aware of that links tax rates to business cycles, but many competing theories on business cycles as they relate to monetary policy or shocks to the production function. Pinning the blame for the deficit on one administration or the other during this transition period seems difficult, and a political subject that I am not interested in pursuing on this blog.

This adhoc analysis however does not prove that the effect of marginal tax cuts on the economy as a whole were positive or nrgative. Looking at one or two variables at a time (I haven't even included GDP or unemployment data) leaves one subject to mistakes. Only by building and testing models that specify multiple relationships among variables can you truly gauge the impact of the tax cuts on the deficit and economic output.  Lawrence Lindsey did this in 1987, looking specifically at revenue from income taxes paid by those earning over $200,000. Others have looked at the impact of tax cuts on economic activity, in terms of multipliers, and other research has been done relating taxes, spending, and unemployment (see references below). That is the proper context to view the impact of tax cuts, and as of yet, I am not aware of any empirical work that has been done to formally evaluate the true impact of the latest cuts in marginal income taxes.

References:

Lindsey, Lawrence B. 1987. “Individual Taxpayer Response to Taxcuts, 1982-1984.” J. of Public Economics 33 (July) 173-206

WHY DO EUROPEANS WORK (MUCH) LESS? IT IS TAXES AND GOVERNMENT SPENDING
Economic Inquiry, 2008, vol. 46, issue 2, pages 197-207

Economist Greg Mankiw gives a great review of the empirical work related to tax cuts and spending multipliers here on his blog:  http://gregmankiw.blogspot.com/2008/12/spending-and-tax-multipliers.html

Data Used: U.S. Budget Historical Tables http://www.whitehouse.gov/omb/budget/fy2009/hist.html (accessed Feb 2, 2009)


RECEIPTS  OUTLAYS      DEFICIT
2000 ............................................................................... 2,025,198  1,788,957 236,241
2001 ............................................................................... 1,991,142 1,862,906 128,236
2002 ............................................................................... 1,853,149 2,010,907 –157,758
2003 ............................................................................... 1,782,321 2,159,906 –377,585
2004 ............................................................................... 1,880,126 2,292,853 –412,727
2005 ............................................................................... 2,153,625 2,471,971 –318,346
2006 ............................................................................... 2,406,876 2,655,057 –248,181
2007 ............................................................................... 2,568,001 2,728,702 –160,701
2008 ............................................................................... 2,523,999 2,982,554 –458,555
2009 ............................................................................... 2,104,995 3,517,681 –1,412,686






































































No comments:

Post a Comment

Note: Only a member of this blog may post a comment.