The Bush Tax Cuts: A Lasting Legacy

"And I'm the one who will not raise taxes. My opponent now says he'll raise them as a last resort, or a third resort. But when a politician talks like that, you know that's one resort he'll be checking into. My opponent, my opponent won't rule out raising taxes. But I will. And the Congress will push me to raise taxes and I'll say no. And they'll push, and I'll say no, and they'll push again, and I'll say, to them,‘Read my lips: no new taxes." - George H.W. Bush, August 18, 1988 

INTRODUCTION 

The aforementioned quote has certainly gone down in history as case study in what not to promise the American people. With three small words George H.W. Bush managed to back himself into a corner that he was never to emerge from. By promising no new taxes he handcuffed his ability to remain fiscally conservative and his reelection bid ultimately suffered greatly. The impact of these words was not limited to a single member of the Bush family either, for in attendance that day was George W. Bush and he appeared to be listening. As his father was, George W. Bush was to be a tax cutter.

From the earliest moments on the campaign trail George W. Bush publicized his vision for America and central to this was his aggressive tax cuts. Following the boom of the Clinton years and the surpluses that were left in its aftermath, Bush would have the ammunition necessary to convince the nation that tax cuts were necessary. Under the cover of a brief recession and by framing his tax reform in terms of fairness and equality, George W. Bush managed to push through Congress a massive tax cut that would go on to have many long term implications to the nation’s accounts.

What will follow will be a discussion of the fiscal policy of the Bush Administration with special emphasis on his signature tax cuts. This paper will seek to analyze the cuts he signed into law and begin to assess their long-term effects including their impact on the national debt as well as the implications for future administrations. Finally, this work will discuss the role these cuts played in increasing the nation’s debt burden and how this has managed to change many American’s view of government spending, particularly in the confines of the Economic Crisis of 2007-2010.

THE BUSH TAX CUTS: 

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Passage

Without question the Bush Tax Cuts were a huge legislative victory for George W. Bush. In the course of two years, George W. Bush managed two large tax reform measures. The first measure which was passed in 2001, The Economic Relief and Tax Reconciliation Act (“EGTRRA”) revised income tax and estate tax rates. The second measure, passed in 2003, the Jobs and Growth Tax Relief and Reconciliation Act, lowered the income tax from dividends and capital gains. The total price tag for the two cuts was initially estimated at $1.35 trillion1 and has become popularly known as the “Bush Tax Cuts.”

These two measures had long been a talking point on the campaign trail, but many months prior to their respective enactments their fate was less than certain. As always, tax cuts carry some intrinsic popular support. The general public usually takes the opinion that any cut to one’s tax burden is beneficial. Put in other words, the general public usually is not concerned with the long term economic effects of tax cuts and the reality of decreasing tax receipts and the increased potential for deficits.

In addition to this intrinsic popular support, Bush masterfully marketed his tax cuts as matters of fairness and played to overly simply popular slogans in order to push his agenda through. On more than one occasion he quipped, “The surplus is not the government’s money; it’s the people’s money.”2 3 While those concerned with the financial stability of the government most likely winced at these words, the public rallied around such statements.

An example of the rhetoric used to push through his tax package was the framing of the estate tax as a “death” tax. Despite the fact the overwhelming majority of American’s will never have to pay an estate tax as the minimum threshold for taxation was nearly $1 million, the Bush Administration allowed the popular misconception that citizens were being taxed for dying to remain.

A number of factors came together to make the Bush tax cuts popular. Following the dot-com boom and economic prosperity presided over by the Clinton Administration America had been sitting on budget surpluses. Bill Clinton’s parting gift to the incoming administration was a budget surplus of $127 billion4. This allowed the Bush Administration substantial leeway in its fiscal policy options. A budget surplus could be used to absorb costs and declining tax revenues. Even if a surplus was entirely erased, with it in recent memory, it could be used to hide budget deficits or at least help to decrease the negative connotation typically associated with years upon years of budget deficits.

What also helped Bush was that he was the first president in history to have a Master’s of Business Administration. He had, prior to his time in politics, experience in the management of multiple business ventures and rightly or wrongly many believed this to be just what America needed. His supporters were optimistic that perhaps Bush would be more receptive to small business interests’ and his experience in industry would expand the economy in ways that career politicians and academics simply could not.

Finally, what also helped make tax cuts popular was the fact that economy was experiencing a brief recession in 2001. While hindsight has rendered the recession very unimportant and brief, the recession allowed the Bush Administration to frame a tax reform policy that it had been working on since the presidential campaign as a means to stimulate the economy. The recession had allowed the reduction of the dividend to be framed as an engine of stabilizing, something that the tax reduction was not when it was originally conceptualized. It was these and other brilliant marketing mechanisms that helped Bush succeed in his tax cuts.

For instance in the case of his repeal of the estate tax, Bush framed the issue as a clear cut case of double taxation. His campaign for the repeal centered on the argument that monies in an estate are taxed as capital gains and then become taxed a second time when the estate is settled and bequests are made. For those uninformed with tax issues this argument made perfect since. In common sense terms, why should money be taxed twice? The estate tax under this line of thinking seemed like pure governmental greed.

What was not made public by Bush was that in the vast majority of estates that met the minimum threshold for estate taxes, much of the value would escape being taxed as capital gains. Capital gains taxes only take effect on the sale of an investment. This means that any capital appreciation that occurs during the life of the owner of the estate, but does not get sold until after the estate is opened would effectively escape capital gains taxes and therefore could be bequest to heir tax free. So in many ways the argument that the estate tax was a “double tax”was inaccurate5.

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The argument also supposes that all double taxes are bad and clearly remains ignorant to the many double taxes that are collected in the lives of every American ranging from sales tax to different excise taxes. The fact of the matter is that if all “double taxes” were abolished the state of the public finances would be in very dismal shape.

This marketing campaign also played on a few common misconceptions. Many people believed incorrectly that the estate tax laws would affect them, when in reality the laws that Bush was reforming would ultimately affect only 2% of highest valued estates. The estate tax would simply never affect the average American and any relief from estate taxes would go to rich with little benefit to the lower and middle classes. The repeal of the estate tax managed a great victory for Bush as the general public believed it would benefit, however the reality was that denied the government an efficient stream of revenue and did more to secure familial wealth than benefit the common man.

The trend continued with Bush’s second tax reform measure on the dividend tax. Yet again, he managed to create a swell of popular support for a measure that again would be targeted at the upper class. His cut would reduce the dividend tax paid on investments and Bush argued that this increase in shareholder level money would spur increased consumption and investment. The economic reality was that such a tax cut went to a class of investors that is very much comprised of upper class Americans and the tendency at this level is not to spend this money as Bush had hoped but rather to save6. So while this measure was framed to spur economic growth, there is reason to believe it had very little effect on the economy as a whole and denied government another source of much needed tax revenue.

“Starving the Beast” 

What had also changed during this time was the approach by fiscal conservatives. Traditionally before Bush the general area of focus by fiscal conservatives was on the budget deficit. Being concerned with national debt, the fiscal conservative would enact measures to keep deficits in line. During times where government spending created a shortfall in revenues fiscal conservatives would enact measures to increase taxes and restore the appropriate fiscal balance. During the late 1970s this tendency was criticize and prominent economists such as Milton Friedman began to propose new approaches.

In Friedman’s conception, fiscal conservatives fueled the expansion of government through tax increase. He believed that as soon as the fiscal conservatives restored a balanced budget the big spenders would incur more debt and the process would continue to cycle between increased taxation and increases government spending. In response to this he proposed what would become known as “starving the beast.” As he saw it, government could be kept in line by cutting taxes and therefore reducing the amount that could be spent. Friedman proclaimed in 1978, “I have concluded that the only effective way to restrain government spending is by limiting government’s explicit tax revenue - just as a limited income is the only effective restraint on any individual’s or family’s spending.”7

Aside from the proposed goal of cutting the size government, tax cuts offered a number of ancillary benefits as well. Throughout the course of history there have seldom been unpopular tax cuts. Human nature being what it is means that any mention of reducing what one will have to pay will be popular, even if such cuts are very narrow in scope and ultimately benefit a specific section of society more so than the general public. Additionally, the if the popularity boost that tax cuts would create could be capitalized upon, this would mean the ability elect more Republican members to Congress and could help speed up the process in which the size of government is reduced or so went the thinking of many Republican fiscal conservatives8.

During its inception the theory of starving the beast seemed sound and perhaps most importantly, it was to be a good mechanism for reducing government that remained popular with the electorate. However, it is not until the closing days of the Bush Administration is there a clear case study to suggest that the theory is flawed, or at least has not lived up to its expectations as of late. While Bush managed to cut taxes, the beast continued its consumption unabated and actually grew.

Whether originally downplayed or ignored all together the proponent of the “Starve the Beast” theory failed to consider an administration that would be fiscally conservative enough to “cut taxes” without properly balancing the budget. This seems to stem from a false belief that somehow arose wherein one could be fiscally conservative, regardless of everything, if one was a tax cutter. In reality, taxes can be cut, but a benefit is not derived unless spending is controlled. It would seem that government spending is currently little influenced by tax revenues and that an unbalanced budget is not an effective barrier to the growth or breadth of government spending.

Effects of the Bush Tax Reforms

Over the short term the Bush Tax Cuts provided some increased revenue for a very narrow segment of society, mostly those residing in society’s higher ranks. However, most important to this discussion is the negative effects that the tax policy had on the state of the public finances.

In 2000, the federal government collected 20.9% of GDP in taxes. After the Bush cuts this number dropped to 15.8% of GDP in 2004, representing the lowest level of tax revenue as a percentage of GDP since 19509. In addition to the declining tax revenues, these cuts occurred during a period of increased government spending. As Figure 1 shows, government spending during this same period rose from roughly 33% in 200 to 35% in 2003. In addition this trend continued in the later part of the decade and peaked when Bush left office with spending nearly 38% of GDP.

The result of the difference between increasing government spending and declining tax revenue is of course an increase in the national deficit. The days of the Clinton surplus were gone with deficits steadily rising throughout Bush’s presidency. As Figure 2 illustrates the deficit peaked at roughly 3.5% of GDP in 2004. This left a huge void in tax revenues and all for virtually a nonexistent potential for growth or increased economic activity10. The cuts were more handouts to the rich than they were pieces of a coherent and productive economic strategy.

In many ways the rising deficits were a shock to both the Administration and the Congressional Budget Office. The increasing deficit sparked the CBO to publish a report entitled, “Where Did the Revenues Go?” The CBO reported11 that the drop in revenues was due to two factors. First the report acknowledged a recession that struck in 2001 and despite being relatively shallow and short-lived still managed to reduced GDP enough to throw off expected tax revenues. The second reason for the discrepancy was a reduced tax base as a result of the Bush cuts.

As has been noted by scholars and has been historically documented, budget deficits in themselves are not particularly dangerous. In fact from time to time, running a budget deficit can provide a Keynesian stimulus to a lagging economy. When deficits become dangerous is when they are carried over from year to year. The effect of such a course of events often begins subtly with cautious economists realizing the dangerous over the long term and then as debts mount real pressures begin to influence the economy. As deficits increase so to due interest rates and thus the typical payment that services the principle becomes more expensive. As was the case during the Bush Administration the trade deficit increased and monies that may have gone into private enterprise went instead to the Federal Government, crowding out private business12.

Aside from the long term national debt implication there are also a number of other consequences as a result of the Bush Tax Cuts. The most notable being the narrow section of society that benefited from these cuts. Even the non-partisan Congressional Budget Office released a report that included estimates that suggest that tax cuts disproportionately benefited America’s richest households. Using the data, analysts have calculated that the average tax cut for the richest 1% of households was more than 70 times greater than the benefit received by middle-income households. While not the direct topic of this paper, this information is well in line with additional evidence that suggests income inequality grew substantially during the Bush presidency.

IMPACT ON THE OBAMA ADMINISTRATION

It has been theorized that one mechanism for controlling the spending of liberal government could be amassing such an unwieldy national debt that Democrats have no choice but to control spending13. While there is no evidence to suggest that this was the goal of the Bush Administration the mechanism may very well be relevant. As a result of the increase in deficits during the Bush Administration and the economic collapse, the public has dramatically changed its attitude on deficit spending. What once was seen as a routine function of government, has become the epitome of fiscal irresponsibility.

What this has meant for the Obama Administration is that its option in dealing with the current recession have been severely reduced and made politically unpopular. Long a stable of the government have been the ability of the government to cut taxes and increase government spending during times of recession in order to help bring an economy back to growth. These Keynesian tactics call for increased government spending during recessionary times in order to prop up GDP and consumer demand.

Through the circular flow of money through the economy, a large boost in government spending could create subsequent waves of increased economic activity which in theory would increase output and government output over a longer period. This multiplier effect would mean that if the economy was returned to growth with this inject of stimulus, the deficit incurred by the maneuver could be retired as government tax revenue increased as a result of increased economic activity, or so the theory held.

What was unique about the economy Obama inherited was that such government spending was seen in very unpopular terms. Whether the product of the many bailouts to corporate America during the Bush Administration, or the early days of the Obama Administration, government spending during recessionary times was not given the traditional exemption that it has normally received. Put in another way, increased government spending during a recession was not traditionally seen as the same as government spending during more stabilized economic times.

For instance a key comparison be drawn between the Bush Tax cuts and the American Recovery and Investment Act of 2009. Both measures were designed to provide stimulus to economies in recession, however the economic times could not have been more different. Unemployment during the mini-recession during the time Bush passed his tax reforms was a mere 4%, compared to the 7.6% and rising unemployment rate Obama was faced with during the time he crafted his stimulus bill. In 2001, an estimated 12.7% of the population was living in poverty; in 2009 this number was 17%. The foreclosures rates were also different at .48% in 2001 and 1.19% in 2009.

Despite these numbers and the vast difference in the overall magnitude of their respective recessions, the Bush tax cuts proved to be incredibly popular while the Obama stimulus bill was passed on strictly party lines and was the subject of substantial political backlash. While the economic cost is often the same as far as the national accounts are concerned, somehow the political environment viewed the Bush response as responsible and the Obama response as over the top. Despite inheriting economic conditions that compared to the collapse of the 1930s, critics used Obama’s predicament as a means of framing his stimulus efforts as “traditional tax and spend liberalism.” What made matters worse, is the tendency that markets often times view Democratic Administrations much tougher than Republican ones. This often times means that Democrats are compelled to embrace fiscal austerity more zealously than their Republican counterparts.14

What Obama inherit was a unique paradox, in order to tackle the longer term of issue of the national debt, he must boost the economy out of recession. In order to get the economy out recession he must deficit spend and increase the national debt. Such a position required either a basic understanding of economics or a certain mental flexibility. The public seemed to posses neither and it provided Republicans with ammunition and the opportunity to score political points.

Realizing that the supermajorities in Congress would ensure passage of the necessary stimulus bills, the Republicans did not have to worry about the fallout that would have incurred from what may have happened to the economy had they been able to hold up the stimulus bill, but could voice their displeasure with it so when it passed and its longer term effects on the national debt could be blamed squarely on irresponsible democratic spending. So the Republicans were able to gain credibility on the issue of the national debt, without having to risk the prospect of what have happened if the government took no action to stimulate the economy.

How this connects to the Bush Administration is somewhat complex and indirect. By decreasing tax revenues through his tax cuts and by his huge increase in government spending as result of the two wars abroad and his expansion of Medicare, George Bush transformed the budget surpluses from the Clinton Administration into remarkable deficits. These deficits combined with the decrease in the public’s perception of the competence of government as result of war, Hurricane Katrina, and the economic collapse, meant that the public had little faith in government coupled with a fear of an ever rising national debt. These two elements made spending unpopular and government spending exceedingly unpopular.

A fair discussion cannot place all of the blame entirely on the Bush Administration as some does fall on Bill Clinton and his control of the economy. While scholars will long debate the standing of the Clintonian deregulation, much of the obligation of government to prop up failing financial institutions may be a direct effect of a free market that was not properly regulated. Between this deregulation and Federal Reserve Chairman Alan Greenspan’s low interest rates many of the precursors for the economic collapse were created prior to Bush’s inauguration15. However, one cannot ignore that the Bush Administration had two terms to correct this problems and failed to appreciate their destructive power.

Furthermore, what left Obama in a particularly difficult position in dealing with the economic crisis is that upon taking office the Federal Reserve had already effectively dropped its interest to 0%. While monetary policy is created by the Federal Reserve independent of the White House it is not unusually for presidents to have success in persuading Federal Reserve Chairmen in their policies. Often times during a recession, the economic activity and specifically liquidity can be increased through the reduction of interest rates. With the interest rate at zero, the only real option that Obama had at his disposal for stabilizing the economy was through government spending, something that was by that time hugely unpopular.

CONCLUSION

In sum there a few conclusions that can be drawn from the Bush Tax Cuts. The first is that as a whole they failed to prove themselves to make economic sense. Having had a substantial period to understand their effects the general consensus is that they have provided little economic incentive when compared to their cost.

Furthermore, the tax cuts ability to restrain spending seems to have failed greatly. As the theory goes, as tax revenues fall government would be forced to reduce its spending. What the Bush Tax Cuts have shown is that such a mechanism is at best not suited for certain economic times or at worst a failed theory. From the period of the Bush Cuts spending increased substantially and deficits grew. The “starve the beast” theory appeared to have not only proved ineffective as tool of fiscal conservatism, but rather encouraged deficits by allowing spending obligations to continue unabated and reducing tax revenues.

Finally, the tax package placed the Obama Administration in a very awkward position both politically and economically when dealing with the most recent financial crisis. Put simply, the Bush Administration had unnecessarily let deficit after deficit balloon the national debt to the point that made economists uneasy. This, coupled with the government’s history of deficits during the Bush Administration made the necessarily policies aimed at stimulation and stabilizing the US economy politically unpopular. The same Keynesian responses to falling GDP that other US president have utilized was no longer viewed as a necessary expenditure, but rather as examples of runaway government spending.

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