FISCAL POLICY II A.K.A., “How useful is our preferred method of fiscal policy: Cutting taxes?”

What did the Bush Tax Cuts do? The Bush tax cuts that were passed in 2001 an 2003 cut taxes in many different ways. The most important of these cuts came in the form of lowering the tax rates for all Americans. The Bush tax cuts lowered the income tax rates in the following manner:The Bush tax cuts lowered the income tax rates in the following manner - A new 10% tax bracket was created. This effectively lowered taxes of people who previously found themselves in the “bottom” 15% tax bracket. In 2010 the first $8,375 of a single individual’s income will be taxed at 10%. Income earned between $8,375 and $34,000 will be taxed at 15%. - The 28% tax bracket was lowered to 25%. In 2010 income earned between $34,000 and $82,400 will be taxed at this 25% rate. - The 31% tax bracket was lowered to 28%. In 2010 income earned between $82,400 and $171,850 will taxed at this new 28% rate. - The 36% tax bracket was lowered to 33%. In 2010 income earned between $171,850 and $373,650 will be taxed at this 33% tax rate. - Finally, the top tax rate was lowered from 39.6% to 35%. In 2010 all income earned over $373,650 will be taxed at this 35% rate. In addition to these changes, the Bush tax cuts also greatly reduced the estates tax (a tax on inheritances over $1,000,000), the capital gains tax (tax on profits from selling stocks), and reduced the Alternative Minimum Tax (the AMT is designed to make sure the rich pay a certain “minimum” tax since many could escape tax liability through exemptions and deductions).

Marginal U.S. Income Tax Rates (2010) Marginal Tax Rate [4] [4] Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household 10%$0 – $8,375$0 – $16,750$0 – $8,375$0 – $11,950 15%$8,376 – $34,000$16,751 – $68,000$8,376 – $34,000$11,951 – $45,550 25%$34,001 – $82,400$68,001 – $137,300$34,001 – $68,650$45,551 – $117,650 28%$82,401 – $171,850$137,301 – $209,250$68,651 – $104,625$117,651 – $190,550 33%$171,851 – $373,650$209,251 – $373,650$104,626 – $186,825$190,551 - $373,650 35%$373,651+ $186,826+$373,651+

Tax Disparity In 2007, Warren Buffett, the 3 rd richest man in the world, gave a speech in which he criticized our tax code for taxing his secretary’s $60,000/yr. income at 30%, while his $46 million/yr. income was taxed at 17.7%--WITHOUT using a tax shelter to get further reductions This was due to a provision in the tax code that lets take- home pay for managers of private-equity firms and hedge funds be taxed at the capital gains rate of 15% rather than the income tax rate of 35%

Why does this matter now? The Bush tax cuts have a ten-year expiration date, so this means that in 2011, if Congress does nothing, the “old” rate will return. There is broad bi-partisan agreement in Washington to extend the lower tax rates for 98% of Americans, but a battle in Congress over extending them for the wealthiest 2% of Americans—individuals making over $200,000/yr. or families making over $250,000. The CBO and Joint Committee on Tax project that extending the Bush tax cuts for the top 2% will reduce revenues by $690 billion over 10 years; the cost of borrowing that amount (in interest) will add another $140 billion, for a total of $830 billion

SO HOW EFFECTIVE WERE THE BUSH TAX CUTS AS FISCAL STIMULUS? DO THEY WARRANT BEING EXTENDED AT A COST OF $830 BILLION OVER TEN YEARS? Let’s look at some data…

1.Explain why the economic indicators on the chart are useful indicators of a healthy economy. 2.Based on the economic indicators in the chart you feel are the most important, identify the best economic expansions since WWII 3.Using the top marginal tax rate chart on the next slide, compare the tax rates to the expansions. What can you infer from this comparison?

Top Marginal Tax Rate (U.S.)

Comparing Fiscal Policies’ Effects These comments by Mark Zandi, chief economist of Moody’s Economy.com, are edited excerpts of testimony he gave before the U.S. House Committee on Small Business on July 24, One-year $ change in real GDP per $ reduction in federal tax revenue or increase in spending Tax Cuts Nonrefundable Lump-Sum Tax Rebate 1.02 Refundable Lump-Sum Tax Rebate 1.26 Temporary Tax Cuts Payroll Tax Holiday 1.29 Across the Board Tax Cut 1.03 Accelerated Depreciation 0.27 Permanent Tax Cuts Extend Alternative Minimum Tax Patch 0.48 Make Bush Income Tax Cuts Permanent 0.29 Make Dividend and Capital Gains Tax Cuts Permanent 0.37 Cut Corporate Tax Rate 0.30 Spending Increases Extend Unemployment Insurance Benefits 1.64 Temporarily Increase Food Stamps 1.73 Issue General Aid to State Governments 1.36 Increase Infrastructure Spending 1.59

Concluding Questions: 1. Why do you think that high marginal tax rates in the U.S. have not resulted in poorer economic growth than average or low rates of taxes? 2. If high marginal tax rates do not notably retard economic growth, what effect do you think they do have?

The previous graph shows the income of the given percentiles from 1947 to 2010 in 2010 dollars. The 2 columns of numbers in the right margin are the cumulative growth and the annual growth rate over that period. The vertical scale is logarithmic, which makes constant percentage growth appear as a straight line. From 1947 to 1970, all percentiles grew at essentially the same rate; the light, straight lines for the different percentiles for those years all have the same slope. Since then, there has been substantial divergence, with different percentiles of the income distribution growing at different rates. For the median American family, this gap is $39,000 per year (just over $100 per day): If the economic growth during this period had been broadly shared as it was from 1947 to 1970, the median household income would have been $39,000 per year higher than it was in This plot was created by combining data from the US Census Bureau [46] and the US Internal Revenue Service. [47] There are systematic differences between these two sources, but the differences are small relative to the scale of this plot. [48] [46] [47] [48]

According to CBO, [55] the major reason for observed rise in unequal distribution of after-tax income was an increase in market income, that is household income before taxes and transfers. Market income for a household is a combination of labor income (such as cash wages, employer-paid benefits, employer-paid payroll taxes), business income (such as income from businesses and farms operated solely by their owners), capital gains (profits realized from the sale of assets, stock options), capital income (such as interest from deposits, dividends, rental income), and other income. Of these, capital gains accounted for 80% of the increase in market income for the households in top 20%, in the period. Even over period, according to CBO, capital gains accounted for 45% of the market income for the top 20% households. [55] A 2006 analysis of IRS income data by Emmanuel Saez and Thomas Piketty at the Paris School of Economics showed that the share of income held by the top 1 percent was as large in 2005 as in The data revealed that reported income increased by 9% in 2005, with the mean for the top 1 percent increasing by 14% and that for the bottom 90 percent dropping slightly by 0.6%. [5] Other sources that have noted the increased inequality included economist Janet Yellen who stated, "the growth [in real income] was heavily concentrated at the very tip of the top, that is, the top 1 percent." [56]Emmanuel SaezThomas PikettyParis School of Economics [5]Janet Yellen [56]