This election year, there is a vast amount of misunderstanding and disinformation regarding taxes rates, tax revenues, spending and deficits. One of the most common is that Clinton left a burgeoning surplus, and the Bush “tax cuts for the rich” have caused huge deficits. This is false.

One of the hardest things for most people to understand is that deficits are caused by spending, not tax revenues. This can be hard to understand because unlike the private sector, there is no relationship in government between revenue and expenses. As an example, if a company builds a new factory or offers a new service, increasing expenses, it expects the products created at that factory will increase revenues. If the company gets no return on its investment, it stops the activity.

Government does not work this way. There is no causal relationship between government services and government revenues. The government confiscates the tax dollars it wants for revenue regardless of the programs offered. If the government cancelled all defense spending in Iraq tomorrow, it would have no effect on the taxes you pay.

Because there is no causal relationship between tax revenues and government expenses, deficits do not result simply because tax rates are cut. Deficits are caused when the government spends more than the incoming revenues. Since 1965, the government has operated at a deficit for almost the entire 33 year period. The only exception was the period immediately following the 1994 Republican Revolution in Congress. It was during this period that Bill Clinton famously declared “the era of big government is over.”

1994 was the first time the Republicans held a majority in Congress since 1972 (roughly the last time government spending came close to matching revenues). The Gingrich Congress was able to control the rate of spending relative to revenues, and a surplus resulted.

Unfortunately, three things happened starting in 2000 that caused the surpluses to disappear:

1. The dot-bomb recession started in April of 2000, causing a drop in GDP and government revenues. Bush responded appropriately by pushing his first tax cut in 2001 to fix the economy. Before these tax cuts could take hold in 2001, 9/11 happened.
2. The attacks on 9/11 cratered the economy, further reducing government revenues. The US responded appropriately in kind around the world. As in all times of war, military spending increased, but in this case there was no corresponding drop in domestic spending to offset the costs.
3. George Bush and the Republicans in Congress forgot they were supposed to be the party of small government. The budget in 2001 included spending increases of 42%. The Republicans spent like drunken sailors on programs such as Medicare Drug Benefits and No Child Left Behind. These massive new spending and entitlement programs bloated government spending.

After 2001, spending spiked up and revenues fell. The results of these three things caused federal deficits starting in 2002. By the time the tax cuts of 2003 went into effect, we already had deficit spending. Even so, 3 years later, tax revenues were back to their pre-recession pre-9/11 year 2000 levels. Four years after the Bush tax cuts, federal revenues had risen from their 2000 levels by $144 billion dollars. That’s right, revenues went up AFTER the tax cuts. Unfortunately over the same period, spending increased by $589 billion PER YEAR. Welcome to the deficit.

The second myth about deficits are that tax cuts reduce revenues at all. As John Laffer illustrated in the 1980s with his Laffer Curve, the effects of tax cuts depend on the current level of taxation and the type of taxes being cut. For example, when Ronald Reagan took office, the marginal tax rate was 70%. But cutting the top marginal rate to 35%, Reagan was able to increase federal revenues due to increase economic activity. Tax cuts will almost always reduce revenues in the first year they are enacted because it takes time for people to change their behaviors. However, once the new rates have been absorbed, the increased economic activity can more than make up for the short term loss in revenue. The 2003 capital gains tax cuts caused capital gains tax revenues to double by 2006.

The third myth about our current deficits are that they have been caused by the war in Iraq. According to zfacts.com, Iraq spending is currently costing us $133 billion, but our deficit is $589 billion. Where did the other $456 billion go? Some of it went to wasteful new programs like the Medicare Prescription Drug Benefit. This new entitlement which was completely unnecessary costs us $36 billion this year. Some of it went to the massive expansion of federal education spending on the No Child Left Behind program, which costs us $54 billion this year. Some of it went to earmarks like Obama’s $1 million per day he’s been in the Senate, or the fruit fly research in France program that Palin has been criticizing.

Most of it went to the across the board spending increases on every aspect of the federal government. Pick your department and you’ll see massive increases in federal spending. Did we really need to increase spending on community development 29% this year? Transportation by 8.1%? State Department by 15.4%? Like pigs at the trough, every bureaucracy expands every year, and no program ever solves the program it was created to solve.

Now we have a massive $700 billion federal bailout of the banking system. This is another cost of social programs run amuck. The roots of our current financial system mess are contained in the 1977 Community Reinvestment Act created by Jimmy Carter and a Democrat Congress, made worse in 1992 by the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 passed by the Democrat Congress and signed by Bush I, and further driven into the crapper by Clinton’s changes to the CRA in 1995 and the 1999 Gramm-Leach-Bliley Act.

All of these laws FORCED banks to lend money to individuals who could not afford to pay back the loans. The liberals in both parties loved these programs because they allowed the government to force a redistribution of wealth without spending federal dollars. Until now. Now, we need to spend our tax dollars on the worst act of socialism we have ever seen in the country, to save the global financial system from an experiment in big government liberalism. If we are lucky, we may get some of this money back, but the damage of this crises will be with us for many decades.

Jimmy Carter and Bill Clinton are to blame for this. George Bush I and II are to blame for this. So are the Republicans who controlled Congress from 1994 – 2006. So are the Democrats who control Congress now. When the Republicans controlled Congress, they spent and spent. When the Democrats gained control, they spent even more. If Obama wins the White House and the Democrats gain a super majority, we can expect out of control spending and larger deficits. Obama has promised higher taxes, which will reduce revenues as economic activites decline, and over $1 trillion in new spending. His deficits will make all previous administrations look like amateurs.

If McCain wins, we can expect less spending, but probably will still see deficits. The reason is the far-left liberals in the Democrat party like Obama and the “moderate” Republicans like McCain have completely lost the concept of limited government. The solution to this problem is less government, fewer programs, reduced spending, and lower tax rates. McCain’s idea of a spending freeze is a good start, but we need to cut spending and cut unnecessary federal programs to truly fix this problem.