Congressional Budget Office director Douglas Elmendorf’s term expires at the end of this year, and conservatives are debating whether or not he should be reappointed. Some say Elmendorf has been nonpartisan and that reappointing him would give CBO’s estimates credibility. Others say Elmendorf should be replaced by a director who would be more willing to use a method of analysis known as "dynamic scoring" under which the budgetary impact of policies are evaluated after taking into account the economic effects of the proposal.
The issue is especially relevant when it comes to assessing the effect of changes in taxation on federal revenue. Lowering taxes, for instance, is typically scored as reducing revenue by the amount of the tax cut. But the actual revenue effects may be different from that, because tax cuts can also spur economic growth, which creates more personal and business income from which to squeeze revenue.
Historian David Kaiser mocked Republicans for wanting to utilize dynamic scoring in a Dec. 5 Time article. “Few theories of public policy have been tested so repeatedly and failed tests so spectacularly, as the idea that tax cuts in the high brackets will ultimately increase revenue and lower deficits,” wrote Kaiser. He goes on to cite several instances in which Republicans cut taxes and the deficit increased.
In contrast to Kaiser and others who don’t believe tax cuts can ever be associated with a rise in revenue, here are three times federal taxes were cut and revenue increased.
According to the Congressional Budget Office, the average federal tax rate for the top one percent of income earners fell by 1.1 percentage points in 1997 and a further 1.5 percentage points in 1998. Despite the cut, individual income tax revenues rose by 9.8 percent in 1997 and 10.6 percent in 1998, even after adjusting for inflation. The economy continued to grow at a quick pace. As a percentage of GDP, combined individual and corporate income tax revenue rose by 4.4 percent in 1997 and 4.8 percent in 1998.
In 1996, the CBO projected that individual income tax revenues would be 8.4 percent of GDP in 1997 and 1998. Even though the top 1 percent paid lower tax rates in 1997 and 1998 compared to 1996, revenue exceeded the CBO’s projections, coming in at 8.7 percent of GDP in 1997 and 9.3 percent of GDP in 1998.
In 1987, the Tax Reform Act of 1986 took effect, cutting corporate income tax rates. Among other changes, income above $1.4 million was taxed at 40 percent instead of 46 percent. In 1988, it was cut even further to 34 percent. Except for one, every quarter from 1987 to 1989 experienced annualized economic growth above five percent. Inflation-adjusted corporate income tax revenue rose every year over the same time period: 28.3 percent in 1987, 8.2 percent in 1988, and 4.3 percent in 1989. As a percent of GDP, corporate income tax revenue rose from 1.4 percent to 1.8 percent in 1987, and then increased slightly again in 1988 and 1989.
In January 1987, the CBO released its economic and budget outlook for the following five years. In 2014 dollars, it projected total revenues would be $1.7 trillion in 1987, $1.8 trillion in 1988, and $1.8 trillion in 1989. Actual revenues exceeded projections by 2.4 percent in 1987, 1 percent in 1988, and 3 percent in 1989.
In 1985, the total average federal tax rate paid by the top one percent of income earners fell to 26.1 percent from 27 percent. It fell again in 1986 to 24.6 percent. Even though the top one percent of earners were paying less in taxes, total income tax revenue grew by an inflation-adjusted 8.3 percent in 1985 and 2.3 percent in 1986. Actual income tax revenue in 1985 slightly exceeded CBO’s revenue projections from January of that year, by about $3 billion inflation-adjusted dollars.
Of course, it would be oversimplifying to suggest that tax rates and economic growth are the only determinants of tax revenue. Not every tax cut will increase revenue, nor will every tax increase. Most tax cuts partially pay for themselves with increased revenue from higher economic growth, but not all.