Unpredictable Tax Revenues

On July 16th 2006, The New York Times published an article by Edmund L. Andrews entitled 'Those Wild Budget Swings'. Here is the article:

It was enough to make a supply-side, tax-cutting Republican beam with pride. Striding into the East Room on Tuesday morning, President Bush announced that tax revenues had been pouring in so fast this year that the federal deficit was likely to shrink for the second year in a row — even though spending continued to balloon. Tax revenue hasn’t climbed this quickly since President Bill Clinton was in office. After plunging throughout Mr. Bush’s first term, tax receipts are running 27 percent higher this year than in 2004 — an added $500 billion. The White House now predicts that the budget deficit this year will be $296 billion, down from $318 billion in 2005 and $412 billion two years ago.

But the real news is not that tax revenues are particularly high; they are not. The big change is that tax revenues have become more of a crapshoot — more volatile, more unpredictable and more buffeted by swings in the stock market than they were 10 years ago.

Why? Because tax revenues are increasingly dependent on the fortunes of the very rich. And it turns out that the rich are different from most other taxpayers. Much more of their income is tied, not to wages and salaries, but to the stock market and to executive bonuses, which can swing widely from year to year. Relying on these gyrating tax revenues makes it harder to gauge the government’s true fiscal health. Mistakes are easier to make, and long-term problems can be glossed over.

At first blush, the recent jump in tax revenue would seem to validate Mr. Bush and those who believe that tax cuts ultimately generate higher tax revenues because they prompt people to work harder, invest more and take more entrepreneurial risk. The White House, in a news release last week, boasted that tax revenues have climbed 34 percent since Congress passed Mr. Bush’s second big tax cut — which included a major reduction in taxes on stock dividends and capital gains.

But revenues are only up in comparison with how low they had plunged in recent years. Individual income taxes, the biggest component of federal revenue, are barely back to the level that was reached in 2000, $1 trillion. Adjusting for inflation, income tax revenue is still lower than six years ago. “The idea that tax cuts have led to higher revenues is pernicious,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan research group that lobbies for fiscal discipline. “Tax revenues may be higher, but they are not higher than they would have been if the tax cuts hadn’t occurred.”

But beyond the perennial debate about whether “fiscal discipline” means raising taxes or cutting spending, there is also an issue about the increasingly erratic pattern of the tax revenue itself. The top 1 percent of taxpayers — those who earn more than $300,000 a year — provide about 30 percent of the federal government’s individual income tax revenues. The top 10 percent of taxpayers — those with incomes above $100,000 — provide about two-thirds of income tax revenue. The lopsided burden is partly a result of progressive taxation, and partly a result of widening income disparities between people at the top and bottom of the economic ladder.

It’s hard to imagine what the federal government could do to reduce instability. Because about 40 million people do not owe any federal income taxes, almost any attempt to broaden the tax base would shift more of the tax burden from the wealthy to middle-income households. Yet the more the rich bear the burden, the more they will seek to escape it.

The unpredictable tax revenues first surfaced almost 10 years ago, as booming economic growth and the dot-com frenzy propelled the stock market to spectacular highs. The result was a tidal wave of tax revenue that far eclipsed projections by both the White House and the Congressional Budget Office. As if by magic, budget deficits disappeared and turned into surpluses. For the most part, the Congressional forecasts missed the mark by less than 4 percent from 1982 until 1995. But starting in 1996, when the dot-com frenzy erupted in earnest, the agency began undershooting by as much as 9.5 percent. In 1996, tax revenues came in $93 billion higher than expected; in 1997, they were $163 billion higher; in 1999, they were $152 billion higher. When the dot-com bubble popped in 2001, and the economy slid into a brief recession, tax revenues plunged $308 billion below what the Congressional Budget Office had predicted and remained depressed for the next three years.

NOW the pendulum is swinging once again. Corporate tax payments, which plunged more than $70 billion from 2000 to 2003, could hit a new record of $332 billion this year. Capital gains taxes could climb back from a low of $50 billion in 2003 to $75 billion this year. Few budget analysts would say the jump in revenues is bad news. But if the last decade is any indication, it would be foolish to count on more of the same.

The Bush administration has quietly acknowledged the point. Its latest estimate anticipates that tax revenues will be almost flat in 2007 and that the deficit will widen to $339 billion. But only if things turn out as expected.