How the Bush-Era Tax Cuts Work

Economic Effects of Bush-Era Tax Cuts

President George W. Bush speaks out in support of his tax cut proposal in Omaha, Neb., in May 2003.
President George W. Bush speaks out in support of his tax cut proposal in Omaha, Neb., in May 2003.
Eric Francis/Getty Images

In theory, tax cuts are supposed to stimulate economic growth by leaving more cash in the pockets of the American taxpayer. Americans will then spend that money on consumer goods or invest it. The 2003 cuts in dividend and capital gains taxes were designed to reward risk and encourage investment in American enterprise, which would, in turn, create more jobs. Bush's Treasury Secretary John Snow said that the 2003 law would "have a profoundly positive effect on job creation" [source: Petruno].

The meteoric rise of the Dow Jones Industrial Average may prove that like the Bush-era tax cuts achieved their desired effect of encouraging investment. In the early months of 2003, the Dow Jones languished at a recession-level 7,524 points. Congress passed the 2003 tax bill in May, and Bush signed it into law immediately, lowering the tax on all investment income to 15 percent. By 2007, the market peaked at 14,164 points [source:]. Many factors fueled the investment craze, including an inflated housing market, but the lowered tax rates were an added boon to investors.

Did those stock market gains translate into explosive job growth over that same period? According to the non-partisan website PolitiFact, employment levels under President Bush grew between 4.5 percent and 7 percent, depending on the employment model you choose from the Bureau of Labor Statistics. When compared with other two-term presidents, that figure represents the slowest job growth since the Eisenhower administration [source: Jacobson].

Unemployment levels were also largely unaffected by the tax cuts. Bush started his presidency with a 4.2 percent unemployment rate in 2001. The recession pushed the rate to 6.1 percent by 2003, but as the stock market doubled in size by 2007, the unemployment rate only fell back to 4.7 percent, higher than when Bush began [source: Bureau of Labor Statistics].

Household income grew modestly from 2002 to 2007, before the economy began its nosedive into a second recession. But it's important to note that over 80 percent of the income gains in those boom years was concentrated in capital gains [source: Congressional Budget Office]. Critics of the Bush-era tax cuts cite this imbalance between investment income and labor income as a sign that the cuts mostly benefitted the wealthy, who earn more of their money from investments.

It is difficult to clearly gauge the success or failure of the economic policies behind the Bush-era tax cuts for a number of reasons. The period following the 2001 cuts was darkened by the shadow of 9/11. And the years after the 2003 cuts were heavily affected by two large wars. On one hand, wars bring an increase in government spending and investment -- which spurs the economy -- but they also drive up national debt. During the housing bubble of the mid-2000s, homeowners saw the equity in their homes rise explosively, spurring many to shift that equity into other investments. In hindsight, the bubble was fueled by questionable banking and lending practices that set the stage for a global financial meltdown.

But of all the issues raised by the Bush-era tax cuts, none is more politically divisive than the effect of the tax cuts on the budget deficit. In the next section, we'll see how the Bush-era tax cuts have become the intractable issue of the budget debates.