The law of diminishing returns applies to taxes

Rich Lowry:

Who says you can’t cut taxes, increase spending, and reduce the federal budget deficit all at the same time? That’s what the Bush administration has managed to do. Two decades after then-presidential candidate George H.W. Bush characterized Ronald Reagan’s idea that tax cuts would spur revenue-generating economic growth as “voodoo economics,” the witch doctor is again at work.

When President Bush pledged in 2004 to cut the deficit in half by 2009, critics guffawed. The Boston Globe headlined a story, “Bush’s plan to halve federal deficit seen as unlikely; higher spending, lower taxes don’t mix, analysts say.” “Fanciful,” “laughable” and “all spin,” said the critics.

Well, it turns out that 2009 might be coming early this year. The 2004 deficit had been projected to hit $521 billion, or 4.5 percent of gross domestic product. Bush’s goal was to cut it to 2.25 percent of GDP by 2009—not exactly as stirring a national goal as putting a man on the moon, but one that was nonetheless pronounced unattainable. This year, the deficit could go as low as $300 billion, right around the 2009 goal of 2.5 percent of GDP.

The key to the reduction is revenue growth, which has been stoked by economic growth. Government revenues are up 12.9 percent in the first eight months of this year over the same eight-month period last year—without any tax increases. When individuals, investors, and corporations have more cash in a growing economy, they send more to the federal government in tax payments.

This, despite—or, more accurately, because of—a couple of rounds of Bush tax cuts that were supposed to have been fiscally ruinous. The Bush tax reductions played some role in the economic expansion and therefore are responsible, partly, for the increased revenues. This doesn’t mean that tax cuts “pay for themselves,” as their most fervent advocates say. But they certainly can offset some of their own cost.

In 1999, the Congressional Budget Office was projecting 2006 total federal revenues of nearly $2.4 trillion, prior to anyone foreseeing Bush’s tax cuts. This year, revenue could go as high as nearly $2.4 trillion, even after those tax cuts. In January 2003, prior to Bush’s second round of tax cuts in that year, the CBO guessed revenues would be close to $2.4 trillion this year—again, in the ballpark of where they could be this year.

According to Brian Riedl of the Heritage Foundation, if annual spending increases in the Bush years had been limited to the rate of the Clinton years, roughly 3.3 percent, there would be a federal surplus now. Instead, spending has been growing at 8 percent a year. That demonstrates that the formula for deficit reduction from the 1990s—moderate-spending restraint coupled with higher-than-expected growth-generated revenues—would work again today, if only someone could manage the moderate-spending restraint.

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Business know that the higher they price their product the fewer units they will sell. At some point the higher the price goes, the less money the business will make. The same law applies to taxes, but it is another law the Democrats ignore. It is surprising that more research has not been done on the optimum level of taxation to maximize government revenue. It is clear for example that when capital gains rates go up the government gets less revenue from the taxes, because people hang onto property and avoid creating a taxable event. Proponents of lower taxes claim that the lower overall tax rate gives people more money to invest in productivity or to spend on capital goods, which also grows the economy. The problem the Democrats have is they do not comprehend the dynamics of the economy and see it as a pie to be cut rather than an engine of growth that benefits all.