Thursday, March 23, 2006

How Much Effect Did the Bush Tax Cuts Have?

When confronted with the reckless spending habits of President Bush and the Republican Congress, some small-government Republicans offer a mild criticism of that, while claiming that this
was compensated by the positive effect of the Bush tax cuts.

These positive effects are generally disputed by Democrats and now by conservative Bush critic Bruce Bartlett. Bartlett was for this blasted by supply-sider Donald Luskin.

Bartlett points to how the current economic boom have been no stronger than that of the 1990s, when taxes were raised. Bartlett however concedes that few if any Bush boosters (at least not now) claim that the 2001 or 2002 tax cuts had any effect as these were not focused on lowering marginal tax rates, but on boosting demand through various deductions. The 2003 cuts on capital gains and dividend taxes however certainly did lower marginal tax rates on capital investments.

Bartlett then concedes that the number of companies paying dividends rose after that, as did capital spending. But he says that this does not prove that the tax cuts were responsible for that, citing the general problem in empirical studies.

"Students of philosophy will recognize a logical fallacy usually quoted in Latin: post hoc ergo propter hoc. Basically, it means that just because B follows A, it doesn't prove A caused B. There may not necessarily be any relationship between the two. Only careful analysis can establish such a relationship."

Sure, but the positive supply effect of lower tax rates can in fact be established on a theoretical basis . As people want more money, anything which increases the monetary incentive of something will increase the existence of that.

In this day and age, when foreigners are anxious to prop up the dollar, the interest rate raising effect (the so-called "crowding out effect") of the ensuing budget deficit is likely to be highly limited, thus ensuring that supply-boosting tax cuts will raise growth. Although of course, the increased foreign purchases of U.S. government securities will lower national income somewhat because of the increased interest payments to them.

Thus, while it can be stablished that the effects of the Bush tax cuts were positive, it is far less certain that the effect will be as significant as some supply-siders claim, especially after taking into account the increased interest payments to foreigners. And they are not likely to do away the massive distortions caused by Alan Greenspan.


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