Did the 2001 and 2003 Tax Cuts Work? Defining ‘Boom’ Down
March 2006 Luncheon
Speaker: L. Josh Bivens
Affiliation: Economic Policy Institute
Rapporteur: Ben Wright
In his presentation, Dr. L. Josh Bivens discussed how the U.S. economy has performed during the recent recovery and whether the federal tax cuts of 2001 through 2003 can explain this performance. The tax cuts, which have had a direct cost of $860 billion, have added $930 billion to the deficit after accounting for interest costs.
The rebate checks of 2001 were aimed at boosting the economy in the short term through Keynesian stimulus. The remainder of that year's cuts, which were spread out over a number of years in the future, the 2002 cuts, which allowed businesses to write-off 30 percent of their depreciation costs, and the 2003 cuts, which reduced taxes on dividends and capital gains, were intended to generate growth over the long term through supply-side incentives. Sufficient time has passed that the effectiveness of these latter cuts can now be evaluated.
The fact that the economy is stronger now than it was in the summer of 2001 does not necessarily mean that the tax cuts have been effective. Because the US economy has shown that it will always recover from periods of recession, the recent recovery, which is now 19 quarters removed from the last business cycle peak, should be evaluated against past recoveries of the same duration. There have been four previous business cycles that lasted 19 quarters. After a peak-to-peak comparison of the recent recovery to these previous recoveries, Dr. Bivens concluded that, on average, the recent recovery has under-performed the other recoveries. This is evidence that the tax cuts have not been effective.
Two broad indicators of economic health, gross domestic product and gross domestic income, increased more slowly during the recent recovery than during the average 19 quarter recovery of the past. GDP during the recent recovery increased at an annual rate of 2.8 percent, well below the 3.4 percent average of the previous four. GDI increased at an annual rate of 2.3 percent, which is much slower than the 3.6 percent average, and the slowest of the five recoveries under consideration.
Payroll jobs, income, and the employment rate also increased more slowly during the recent recovery than during the previous four. Total payroll jobs increased at an average annual rate of two percent during the previous recoveries, but increased only 0.3 percent per year during the recent one, the slowest of the five recoveries under consideration. In addition, payroll jobs did not return to the March, 2001, level for 48 months. By contrast, the average time frame for returning to peak-level payroll employment among the previous four recoveries was 27 months, and the slowest time frame was 32 months.
Private sector payroll jobs, which were supposed to benefit from 2001-2003 tax breaks, also increased very slowly compared to previous recoveries. They did not return to the March, 2001, level for 53 months, compared to an historical average of 27 months and a low of 35 months in the past. Wage and salary income, which returned to the peak level after an average of seven quarters in past recoveries, didn’t return to the March, 2001, level for 11 quarters during the recent recovery, matching the previous low. Personal income also lagged all of the previous recoveries. In addition, the employment rate of the recent recovery lagged the rates of all of the four previous recoveries, and after 58 months was still 2.2 percentage points below the March, 2001 level.
Despite the tax cuts of 2002 and 2003, which were meant to provide investment incentives, investment during the recent recovery lagged all of the previous four. Non-residential investment and equipment and software investment increased far more slowly in the recent recovery than in the past, including the recovery of 1990 to 1994 that included two tax increases.
When temporary investment tax cuts are enacted, it is expected that firms will front load investment in order to receive the tax break, and then decrease investment after the break expires. Such was the case in 1986 and 1987, when an increase investment took place in the quarter before an investment tax cut expired, and decreased the following quarter.
When the recent tax breaks expired on December 31, 2004, the annualized rate of change of investment not related to information technology decreased, fitting the expected pattern. But the annualized rate of change of investment in information technology actually increased, suggesting that the tax incentives did not help in the first place. The only form of investment that outperformed the past recoveries was residential investment. It increased at a faster rate than the average of the past recoveries, despite tax incentives that decreased as the interest rate rose. In fact, in the fourth quarter of 2005, residential investment as a percentage of after-tax income stood at 8.5 percent, which is 2.3 percentage points higher than during the first quarter of 2001, before the recession.
After considering all of these points, Dr. Bivens concluded than the tax cuts have not been effective in stimulating the economy because the current recovery lags all past recoveries of the same duration in almost every measure.
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