June 19, 2005


US deficit shrinks: a vindication for tax cuts? (David R. Francis, 6/20/05, CS Monitor)

Perhaps the most interesting speculation revolves around whether long-term effects of tax cuts are beginning to kick in. Many supply-side enthusiasts certainly believe they are. The new tax revenue numbers are "an eye-popping vindication of the Laffer Curve and the Bush tax cut's real economic value," wrote a Wall Street Journal editorial writer.

The Laffer Curve, named after Arthur Laffer, a White House economic adviser during the Reagan administration, is getting renewed attention. Briefly, it says that the tax on the last dollars earned - the so-called marginal tax rate - has a huge impact on individual effort and enterprise. So, the theory goes, substantial cuts in the marginal tax rate will generate lots of new business and, thus, boost tax revenues. An extreme version of supply-side theory says the gain in revenues could fully offset the revenues lost from the tax cut.

This isn't a new observation. Muslim philosopher Ibn Khaldun wrote in the 14th century: "It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments." Even President Kennedy in his 1963 economic report urged trimming the then 90 percent marginal tax rate, noting that "reducing taxes is the best way open to us to increase revenues."

Reagan's tax cuts in the 1980s were so large that they stimulated a decades-long debate over their economic and revenue impact. That debate was never fully resolved. The problem is that thousands of factors affect the nation's gross domestic product - its output of goods and services. Even the most sophisticated models of the economy have trouble sorting out what affects what.

Now the Bush tax cuts are stirring the same kind of debate. Is this spring's revenue surprise the start of a supply-side surge?

Start wrapping up the war at the end of this year and they keep shrinking.

Posted by Orrin Judd at June 19, 2005 6:48 PM

The war's cheap.

Posted by: David Cohen at June 19, 2005 8:04 PM

Defense spending is back up over 4% of GDP from its lows under 3% in 1999-2000.

Posted by: oj at June 19, 2005 10:38 PM

The war costs between .5 and .7 percent of GDP each year. That's not enough to make a difference. Get rid of the war, and we're still running a deficit. In fact, the President's budget request for defense for FY06 (not including the war) is $419.3 billion or about equal to the projected deficit.

Posted by: David Cohen at June 20, 2005 1:12 PM

Yes, get it back under $300 billion.

Posted by: oj at June 20, 2005 1:21 PM