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When Congress extended the Bush tax cuts on dividend income and capital gains recently, critics cried foul, blaming these policies for our nation's budget deficit. It's a convenient explanation: Lower tax rates, and watch revenue drop, resulting in huge deficits. The problem is that the explanation isn't true.
The federal government is in the midst of a tax revenue bonanza. Revenue in the first eight months of the fiscal year, October through May, was $1.545 trillion. That's a 12.9 percent increase from the previous year. The budget gap is closing, too. The eight-month deficit was $227 billion, down 16.7 percent from the previous year, which itself was a pretty good year. Federal revenue in fiscal 2005 reached $2.15 trillion – the most ever.
Surging revenue demonstrates the power of tax cuts to stimulate economic growth. That's the reason we can never trust those who tell us how much a tax cut will "cost."
When income taxes are lowered, we tend to work more because less has to be handed over in taxes – and that extra work produces additional tax revenue that makes up for the lower rate. When dividend and capital-gains rates are lowered, investors sell more stocks – or "realize" their capital gains, producing additional tax revenue, which again makes up for the lowered rate. This virtuous cycle leads to more spending and savings, and yet more economic growth, which leads to yet more tax revenue.
The federal government's budget problem isn't the economic activity that tax cuts have stimulated. The real budget problem lies with politicians who can't stop spending. America does not have a revenue problem. Politicians have a spending problem.
In the past five years, nondefense discretionary spending has increased at an unprecedented pace. According to a recent study by the Cato Institute, discretionary spending during President Bush's first term rose an average of 8 percent each year. This is quadruple the rate of discretionary-spending increases under President Reagan and higher than under any president in the past 40 years. Annual federal spending is now approaching $3 trillion.
By contrast, the total size of the recent extension of the Bush tax policies amounts to $70 billion over five years. Of course, this assumes that more money in taxpayer pockets will not generate a single additional dollar of taxable activity. Looking at $3 trillion and $70 billion, we are talking about approximately one-half percent of federal spending.
It's difficult to blame the budget deficit on a measly half-percentage-point in tax cuts when Congress and the president are raising spending by 16 times that amount every year.
Those decrying tax cuts as the cause of the current deficit are clearly addressing the wrong part of the equation. What Congress needs to do is turn off the spending spigot, or at least install a much smaller one. Unfortunately Congress is bent on keeping the Treasury's spigot wide open.
The key to reducing the deficit is spending restraint. That's how the Republican Congresses managed to create budget surpluses in the 1990s.
Until Congress gets serious about kicking its spending habit we will continue to rack up deficits. No amount of debate on tax policy will solve America's problem, which is rooted in government overspending
President, FreedomWorks, a grass-roots organization dedicated smaller government.