From the Archives: Tax cuts will stunt your revenue growth

This blog post originally ran on April 24, 2012 and is reprinted verbatim. The claim that prior tax cuts led to higher tax revenues continues to be advanced by tax cut proponents in Oklahoma. For the findings of a survey of leading economists on the idea that tax cuts pay for themselves, click here.

Despite frequent claims by proponents of cutting or eliminating Oklahoma’s personal income tax, it is a myth that tax revenues grew because Oklahoma cut income tax rates in the mid-2000s.  Their claims are based on highly selective use of data and flawed methodology that is contradicted by more careful analysis.

We can trace the myth that tax cuts sparked revenue growth to last year’s study by Arthur Laffer and his colleagues for the Oklahoma Council of Public Affairs. This study has served as the basis for the Governor’s tax cut proposal and various bills introduced this session. In the report, Laffer contends:

Oklahoma has demonstrated the dynamic effects of tax cuts. For example, prior to personal income tax cuts beginning in FY-2005, the annual state sales tax growth rate was 2.7 percent for the preceding four years. Once the personal income tax cuts began in FY-2005, annual sales tax growth for the following five years was 6.6 percent.

The growth in sales tax revenue means people were buying more things, a sure sign of an improvement in the state’s economy. But it is a huge methodological flaw to simply compare growth rates in two period and attribute the difference to a single, specific policy change. To do so is to claim causation when there is only correlation, and these are two very different things.

What’s missing in the Laffer analysis is a crucial and obvious detail: the four years prior to FY 2005 included the national recession of 2001-2002, while the four years following the tax cut were ones of robust economic growth nationwide. During this period of growth, Oklahoma’s economy was further lifted by high oil and gas prices: natural gas during this period averaged $6.92 per MCF, oil averaged $69 per barrel, and gross production taxes rose by at an annual average rate of 16.0 percent.

Laffer also uses faulty logic in at attempt to tie growth in income tax collections to the tax cut . He states in the report:

It is important to note that, according to the 2005 Oklahoma Senate session summary, 2005 session tax cuts were estimated to have a static loss of $150.8 million in FY-2007. Despite this estimate, individual income tax collections grew by more than $305 million, and state sales tax collections grew by more than $243 million.

Here again, this limited data cannot support Laffer’s conclusions about the effect of tax cuts. Yes, it is true that income tax revenue grew following the tax cuts, at least initially. But the question that needs to be asked is, if state revenue collections hadn’t been cut, how much more might tax collections have grown?

In the two years prior to the onset of the recession in 2009, Oklahoma’s economy enjoyed vigorous growth, with state personal income increasing at an average annual rate of 8.1 percent. Yet during those two years, as tax cuts phased in, income tax revenue growth came to a virtual halt, growing by a mere 0.6 percent annually in 2007-08, before plummeting with the recession’s onset in 2009. We have calculated that income tax revenues were $400 – $600 million less in 2008 than they would have been without the income tax cuts. Nor did income tax cuts spark any exceptional growth in sales tax revenues. While sales tax collections remained strong in the years preceding the economic downturn, they still grew at a slightly slower rate than state personal income, which is consistent with the historical pattern prior to the income tax cuts.

As with Laffer’s already-debunked assertions that states with no income tax enjoy stronger growth than high-income tax states, he makes selective use of partial data  to draw the false conclusion that the tax cuts of the mid-2000′s led to increased tax revenue. State policymakers considering vital decisions about future tax policy should not rely on such shoddy and misleading work.