The Bush Tax Cuts were originally passed in 2001 and policies took effect from 2001 to 2003. The most dramatic effects took place in 2001, notably cutting the top income tax bracket from 39.6% to 35%. Some of these provisions have expired while some have been extended.
Much controversy remains as to whether the Bush Tax Cuts improved the economy. In this case, hindsight is not 20/20. Simply put, can can’t hit reset and replay history as if the tax cuts were never put into effect. To add complexity, the real estate bubble that lasted through 2007 made the economy appear better than it really was.
The real estate bubble caused a great wealth deception in which people generally felt secure about their financial situation. This caused people to spend more money. Since GDP’s biggest component by far is consumer spending, it rose considerably after the 2001 recession. In fact, there was a period of time in which household savings rates went negative.
Since there was considerable GDP growth between 2001 and 2007, government received more revenue from taxes. Although tax rates were lower, GDP growth more than made up the difference. In fact, tax revenue as a percentage of GDP was higher in 2007 than in 2001.
In order to give the Bush Tax Cuts a fair evaluation, one must consider what the pace of GDP growth would have been if asset prices rose at the same rate as inflation. This is impossible to do with any precision because asset bubble change consumer behavior. When people feel secure financially, they continue investing in risky assets and spend money on luxuries. When the opposite is true, no asset price seems too low when fear is prevalent.
Generally speaking, tax cuts are positive for economic growth. Since private individuals and businesses are better allocators of capital than governments, low taxes are beneficial. That being said, if a government continues to overspend when less tax revenue is coming in, problems are inevitable. This causes weakening of the dollar and the debt will need to be repaid at some point. Because of the increases in spending do to the wars in Afghanistan and Iraq, the dollar depreciated during this period while government deficits increased.
Extension of the Bush Tax Cuts and the Fiscal Cliff
If the Bush Tax Cuts were made permanent, the Congressional Budget Office (CBO) projects that an additional $3.3 trillion would be added to the national debt. Although it’s obvious, the debt would be higher, projections like this lack accuracy. This is because of the indirect effect tax policy has on human behavior. In addition, one change causes other variables to change such as future income and GDP. As a result, we can only take these projections with a grain of salt.
The effectiveness of the Bush Tax Cuts is questionable at best. This is a outcome that will be debated for many years to come.