Commentary | Budget, Taxes, and Public Investment

The boom that wasn’t: Bush’s tax cuts jeopardize tomorrow’s living standards


Politicians of both parties often exaggerate the role that taxes play in economic decisions. As a result, they tend to believe that small tax cuts can have huge positive effects on the economy and that tax increases run the risk of dire negative effects. Contrary to those widely held beliefs, the experience of the last five years has shown disappointing benefits from tax cuts and remarkable resilience in the face of reductions in specific tax breaks.

In early 2001, when the economy reached a business cycle peak, Congress passed the first of a series of major tax cuts. The tax cuts passed between 2001 and 2004 had the combined effect of lowering revenues by $860 billion through September 2005. Together, they reduced revenues by $225 billion (or 1.9% of gross domestic product) in the last fiscal year alone. The tax cuts have created excessive permanent deficits largely financed by foreign lenders. Servicing those debts will lower Americans’ future standard of living.

In the annual debates over taxes from 2001 to 2004, controversy has swirled over how deeply to cut taxes, for whom, and for how long, but not over whether taxes should be cut at all. Each year, the president proposed relatively deep tax cuts and the Congress cut even deeper. Each year, the benefits flowed disproportionately to those with greater income and wealth. And, with one notable exception (discussed later), the tax cuts have not been allowed to expire. Proponents justified the permanent, regressive structure of the tax cuts with the promise that it would lead to greater investment and labor supply.

Because the tax cuts began early in a recession, it is only fair to compare the last four-and-a-half years with similar periods of past business cycles. We have had five previous business cycles that lasted at least four-and-a-half years from one business cycle peak to another. The performance of major indicators, such as GDP, jobs, personal income, consumption, and non-residential investment, has been notably worse over the last four-and-a-half years than the average of the previous five business cycles (see chart below).

The current cycle lags past averages by key measures

GDP has grown at an average rate of 2.6% since early 2001, more than a percentage point slower than the average 3.7% rate of the prior cycles. For three other important measures—payroll jobs, personal income, and non-residential investment (equipment and software)—growth over this cycle has fallen about two percentage points below the average of the past. Unlike past cycles, consumption has grown much faster than personal income because of rapid growth in debt. Because the tax cuts failed to stimulate either investment or employment, it seems difficult to attribute the strong performance of productivity to the tax cuts.

There is one clear instance in which the Bush Administration explicitly projected a concrete benefit that would result from his tax cuts. With jobs still declining for almost two years, the Council of Economic Advisers projected that 4.1 million jobs would be created between mid-2003 and the end of 2004 without the 2003 tax cuts, and that 5.5 million jobs would be created with the tax cuts (see JobWatch below). In fact, Congress enacted even deeper tax cuts than those on which the Bush Administration’s estimates were based. Even so, only 2.6 million jobs were created over that 18-month period. Thus, by the Bush Administration’s own analysis, the 2003 tax cuts failed to create more jobs than would have been expected without the tax cuts.

Contrary to proponents of lower tax rates, another measure of employment has also had disappointing results. By 56 months after a business cycle peak, the share of the population employed rose by an average 0.6 percentage points in past cycles, but it has fallen by 1.5 percentage points in this cycle.

Not only have $860 billion in tax cuts not led to faster than normal growth, but reductions in specific tax breaks— housing and business investment—have not impeded economic gains. Changes in tax law since 2001 have worked against the housing sector because lower income tax rates reduce the effective value of deductions for mortgage interest and real estate taxes. For a person with a marginal tax rate of 35%, taking on a mortgage with $10,000 in interest lowers taxes by $3,500. Reducing that person’s marginal rate to 30% lowers the subsidy for that mortgage to $3,000. Despite reduced incentives to spend on homes, residential investment has risen from 6.2% to a record 8.5% of personal consumption expenditures. In fact, as the chart shows, residential investment stands out for expanding 2.1 percentage points faster a year than the average of prior cycles—7.4% versus 5.3%. Obviously the reductions in tax breaks have been more than counterbalanced by other factors since 2001.

The same holds true for the expiration of “bonus depreciation” at the end of 2004. “Bonus depreciation” for business investment was passed in 2002, expanded in 2003, and expired at the end of 2004. It reduced business tax payments by $62 billion in FY2004. Expiration of the “bonus depreciation” tax break has contributed to higher revenues since then, but had virtually no effect on continued growth of investment. Essentially, businesses got a nice short-term tax break with little evidence of benefit to the economy.

As the Congress debates whether to enact new or extend expiring tax cuts, it should carefully weigh their substantial effects on the already excessive deficit against their insubstantial effects on economic performance. We would enhance the standard of living of most Americans in the future if the tax cuts for those with high income and wealth were allowed to expire.

EPI did a monthly analysis on its JobWatch Web site of the failure of the 2003 tax cuts to deliver the promised benefits. To see the above-mentioned projections by the Council of Economic Advisers, read its “ Strengthening America’s Economy: The President’s Jobs and Growth Proposals ,” at

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