I went to work for the Federal Reserve in 1992 and the United States entered its greatest economic expansion in the 20th century. I left the Fed in 1999. Little more than a year later, the economy was spiraling into recession. Therefore, I caused the 1990s economic boom.
Obviously, this argument is bogus. That is why I use it in economics classes to explain the logical fallacies that plague discussions of economics. It exemplifies the “post-hoc fallacy.” The term comes from a Latin phrase that means “after this, therefore because of this.”
Even though millions of students learn that post-hoc arguments are fallacious, such assertions continue to dominate public discourse. In an election year, the vast majority of candidates’ economic assertions contain some variation of post-hoc reasoning.
A flurry of post-hoc arguments followed the announcement two weeks ago that the federal deficit would be lower than projected. Supporters of the Bush administration argued that higher-than-projected revenue was proof that lower tax rates cause higher tax revenue and that the deficit will fix itself.
The facts are clear. President George W. Bush sent a bill to lower individual-income tax rates to Congress early in his administration and Congress promptly passed it. In February, the administration forecast that the 2006 budget deficit would be $423 billion. Personal and corporate income tax revenue was higher than expected. The projected deficit dropped to $296 billion.
Are these facts proof that lower tax rates caused higher tax revenue? Would higher taxes lower revenue? Will lower taxes stimulate the economy so much that the deficit disappears by itself?
Examples to the contrary can be found. In 1994, the Clinton administration initiated slightly higher income tax rates. Republicans argued these increases would torpedo the economy. Our gross domestic product expanded. Revenue from individual income taxes increased 15 percent in two years and corporate tax revenue increased 21 percent. The federal budget deficit fell by 47 percent in those two years. By 1998 the budget showed a surplus for the first time in three decades.
Lyndon. Johnson raised taxes at the end of his administration in the early 1970s. Revenue jumped by a third in two years, and output grew more than 12 percent. Under Franklin Roosevelt, taxes rose sharply in 1942. Revenue jumped 300 percent by 1944. National output grew nearly 50 percent.
Do these counter-examples prove that tax rate increases always raise revenue and output? No, but they offer up times in our history that refute the Bush administration’s argument that higher taxes always hurt the economy.
Our nation’s economy is complex. Many factors affect output and government revenue. Tax rates are just one such factor, and the effects of rate changes are complex in themselves. Anyone who ignores such complexity and asserts simplistic post-hoc links from rates to revenue is either incompetent or dishonest. Citizens have to decide which is the case.
© 2006 Edward Lotterman
Chanarambie Consulting, Inc.