Tax Cuts Mostly Explain Low Revenue

The usual story about the recent historical low in revenue we have seen over the past three years is due to the recession. After all, revenue was at 19 percent of GDP before the recession and is projected to rise back above its 40-year historical average later this decade (even with the 2001/2003 tax cuts extended). But an interesting "Tax Notes" post at Tax Policy Center shows that the down economy is not fully to blame for the low revenues.

Samuel Brown of TPC calculated separately what revenue as a percent of potential GDP would be in the absence of cyclical effects, then what it would be without the tax cuts that passed last December. For this year, revenue is projected to be 14.4 percent of potential GDP. Using CBO's April report on automatic stabilizers, Brown found revenue to equal 16.1 percent when removing the cyclical effects of the down economy, a difference of 1.7 percentage points. On top of that, when removing the 2010 tax cut, revenue climbs to 19.3 percent of potential GDP, a difference of 3.2 percentage points.

By Brown's calculation the effect of the tax cuts is almost twice as large as the cyclical effects.

Based on these numbers, the conclusion is somewhat surprising: the 2010 tax cut actually had much more of an effect on revenues this year than the poor state of the economy. This does not change the fact that revenues will recover back to historical averages when the economy reaches full capacity again. But, it is interesting to see the breakdown of the reasons for our current revenue levels.