Economy / Fiscal policy / Politics / Tax

What Are the Bush Tax Cuts?

The period between March 1991 and March 2001 was the longest continuous expansion in U.S. economic history, according to the National Bureau of Economic Research.  But the sunset of this period, with the bursting of the Dot Com bubble and the attacks on 9/11, marked the beginning of a two-year recession.  In response, the Bush Administration passed what it believed to be the solution: tax cuts.

The Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 instituted a broad range of tax reforms.  The top tax rates were reduced by 3%; the lowest rate was reduced by 5%; rates were reduced for capital gains and dividends; the Child Tax Credit was expanded and the “marriage penalty” was all but eliminated; and the Dependent Care Credit was expanded.

The Bush Administration sought to address two inefficiencies in the tax system which they felt were hindering economic growth.  The first is a foundational principle of conservatism: capital is better allocated by families and individuals than by government.  Lower individual income tax rates allow the people to spend their own money as they please and, in doing so, stimulate the economy as consumers; thus the income rate reduction.

The second inefficiency was the double-taxation of dividends, which are earnings distributed by corporations to shareholders.  Prior to the Bush Tax Cuts, dividends for high-income earners were taxed at 35% after the corporate profits had already been taxed at the same rate; thus the double-taxation.  As Bush Treasury Secretary John Snowe explains here, this distortion of the tax code “favors debt financing over equity capital formation, because interest is deducted as a cost of doing business and lowers taxable income, while dividends are taxed twice.”

Congress didn’t eliminate the double taxation, but they substantially reduced it; dividend and capital gains tax rates were reduced to 15%.  It is hard to judge the success of an individual policy over a decade as there are various influencing factors (wars, losses in manufacturing, financial crisis) and the Bush Tax Cuts are no different.

As a Pew report entitled “States of the Union Before and After Bush” explains, real median household income dropped slightly, the unemployment rate increased, and the national debt doubled.  At the same time, Gross Domestic Product (GDP) increased by almost $2 trillion, GDP per capita increased by almost $4,000, and inflation was essentially zero.  While the tax cuts contained a sunset provision so that they would expire in 2010 (this was meant to avoid the Byrd Rule which is another story altogether), they were extended in the 2010 lame duck session for two years.

While the focus of the last six months has been on the November election, the ramifications of the coming fiscal cliff (the expiration of the Bush Tax Cuts, sequestration going into effect, and the debt limit reached) may be more consequential.  Economists and financial analysts alike have warned about the potential impact of failure to act.  After the election, it will be the issue dominating the political minefield that is a lame-duck session of Congress.

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