Higher income tax rates have produced higher tax revenues. Is this the death of the Laffer Curve?
Lawrence Summers, the deputy Treasury secretary, thinks so. Mr. Summers gloats that the “basic fact is that people looked at the 1993 budget agreement and said there’d be a recession, the deficit would go up, and that tax collections would go down. What has happened is that there has been a boom, the deficit has gone down, and tax collections have gone way up.” Washington Post columnist Mark Shields asks pointedly: “Why won’t supply siders just admit they were wrong?”
The question is: Wrong about what?
The turning point in tax policy was not 1993. Tax rates began to rise in 1990, during the Bush administration. The top income tax rate on earned income rose from 28% to 31% after the 1990 budget deal and then to 42% in 1993 as part of President Clinton’s first budget. So we have now had a seven‐year experiment with higher income tax rates on the wealthy. From 1990 through the most recent estimates for 1997, total federal tax collections have risen from $1.03 trillion to $1.55 trillion annually. After inflation, this has been a 21.6% rise in federal receipts over seven years.
How does this stack up against the growth of tax payments during the Reagan years, when tax rates fell sharply? From 1982 (the first year of the Reagan tax cut) to 1989, the top tax rate was chopped from 70% to 28%. Despite the deep recession of the early 1980s, federal receipts grew from $618 billion in 1982 to $991 billion in 1989. After inflation, this was a 24.1% increase in tax collections.
These data contradict the assertion by Mr. Summers and others that tax policy changes account for the increase in the budget deficit in the Reagan years and the rapid fall in the deficit in the Clinton years. This could not be the case, since total federal revenues grew at a slightly faster pace in the 1980s, when rates were falling, than over an equal time period in the 1990s, when rates rose. It turns out that the primary explanation for the swing in the deficit was the Cold War military buildup during the Reagan years and the steady decline in the Pentagon budget since the fall of the Berlin Wall.
Even if we examine the path of only individual income tax collections over the past 15 years, the story is not much different. A May 23 Wall Street Journal news story, entitled “Tax on Wealthy Is Boosting U.S. Revenue,” provides a graph [omitted] of individual tax revenues from 1987 through 1997. It appears from the graph that the federal Treasury has harvested a huge revenue windfall from President Clinton’s tax rate increases. But compared with what? The graph truncates from view the soaring revenue path of the mid‐1980s, when tax rates were not rising but falling. From 1982 to 1989 income tax receipts climbed from $298 billion to $446 billion–a 50% increase. From 1990 to 1997 the income taxes rose from $467 to an estimated $710 billion–a 52% increase.
One component of income tax collections that has been the most sensitive of all to tax rate changes has been capital gains. Between 1978 and 1981 the top capital gains tax rate tumbled from 35% to 20%. Capital gains tax revenues soared by 90% in real dollars, from $20 billion in 1978 to $36 billion by 1985. After Congress lifted the rate to 28% as part of the Tax Reform Act of 1986, capital gains revenues declined by 20% by 1990 and are still (as of 1994, the most recent data available) no higher in real terms than before the rate hike. A 40% hike in the capital gains tax rate produced zero net new revenue.
Unless tax rate changes powerfully affect economic behavior–as supply siders maintain–then all of these data are puzzling in the extreme. Mr. Summers is right that tax rate hikes have generated healthy revenue growth in recent years But so did tax rate cuts. While tax rates were tumbling by two‐thirds in the 1980s, income tax receipts grew at almost precisely the same pace as when income tax rates were rising by 50%. This would be a virtual mathematical impossibility–unless there were at least some behavioral or macroeconomic responses to the tax policy changes that took place in 1981, 1990 and 1993.
But the most confounding question of all for critics of the supply‐side view is this: If tax rate changes don’t influence economic behavior, then how did overall tax receipts grow faster in the Reagan years than in the Bush and Clinton years?
Perhaps Mr. Summers could explain that one.