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Tax Cuts Caused Economic
Growth
Tax Policy Wire
April 25, 2006
By Diana Furchtgott-Roth
According to Raghuram Rajan, Chief Economist
of the International Monetary Fund, the United States should
adopt "revenue-enhancing measures," such as tax
increases, to reduce its deficit.
However, the tax cuts that Congress adopted were instrumental
in stimulating the economy after the recession and increasing
tax receipts. At a time when global growth was practically
stagnant, the U.S. economy was the world's engine of growth.
After the tax cuts were put in place, real GDP growth expanded
from 0.8% in 2001, to 2.7% in 2003, to 4.2% in 2004. In 2005
GDP growth was 3.5%, and it is forecast to remain in this
range in 2006. And the average annual growth rate of productivity
since the business cycle peak in March 2001, at 3.4%, has
been one of the best rates in over 30 years. Retail sales
are almost 8% higher than a year ago, and construction spending
is at a record high, 7.4% higher than this time last year.
Particularly impressive are the labor market data. In 2003
the media was full of "jobless recovery" stories,
with the theme that corporate profits were expanding but the
hiring of workers was left behind. Yet over the past year
employment has increased by over 2 million jobs, of which
1.9 million have been in the private sector. The unemployment
rate is at 4.7%, and the four-week moving average of initial
jobless claims, a widely-watched indicator of the strength
of our labor market, is 9% lower than a year ago.
Tax revenues have far exceeded projections. Earlier this
month the Congressional Budget Office announced that tax receipts
for the first half of the fiscal year were $100 billion higher
(11%) than in the same period last year. And in July 2005
tax receipts were almost $100 billion higher than forecast.
The tax revenues come from rising incomes and gains on investments
and business earnings. Tax cuts have improved economic growth,
and economic growth results in more tax receipts.
Some say that the tax cuts have nothing to do with the strong
performance of the economy. But the economy is only following
the path described by leading academic economists, such as
Professor Harvey Rosen of Princeton and Professors William
Gentry and Glenn Hubbard of Columbia University. In numerous
articles in peer-reviewed journals, they have made the theoretical
and empirical case that tax cuts result in additional incentives
for people to work and for businesses to expand.
Both International Monetary Fund and European Union officials
have been successful at persuading countries around the world
to raise taxes to eliminate their deficits, with the result
that growth in many countries abroad is far slower than in
the United States. Rather than recommending U.S. tax increases,
Dr. Rajan should suggest that Congress make the tax cuts permanent.
Diana Furchtgott-Roth is Senior Fellow and Director of
the Center for Employment Policy at the Hudson Institute.
From 2003 to 2005 she was Chief Economist at the U.S. Department
of Labor.
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