An unexpected increase in revenues, as documented by both the Administration in its Mid-Session Review and the Congressional Budget Office (CBO) in its August update has led to a renewed discussion of the effect of the 2001-2004 tax cuts on the economy and the possible feedback effects on revenue. The OMB Mid-Session Review also summarizes results from two Treasury studies indicating that tax cuts moved the economy out of the recession more quickly than would otherwise have been the case, and will encourage greater long-run economic growth. Some proponents of the tax cuts suggest that induced economic growth was large enough that taxes on the additional income more than offset the cost of the tax cuts, causing an increase rather than a decrease in revenues. Other observers doubt that economic growth was related to the tax cuts, or that it was large enough to significantly offset the cost of the cuts. After reviewing the data on the revenue increase, this report examines available economic studies, theory, and empirical data to assess the possible revenue feedback from the 2001-2004 tax cuts. Three major pieces of legislation constitute the bulk of these tax cuts. P.L. 107-16 , The Economic Growth and Tax Relief Reconciliation Act (referred to as EGTRRA) passed in 2001: its most important provisions were phased-in rate reductions, expansion of child credits, expansion of brackets and standard deductions for joint returns, and phaseout and eventual repeal of the estate tax. Most provisions were set to expire in 2010 (and some earlier), but some or all of them may be extended or made permanent. The main provision of The Job Creation and Worker Assistance Act of 2002 ( P.L. 107-47 ) was the adoption of bonus depreciation, which allowed a share of investment to be deducted immediately. P.L. 108-27 , The Jobs and Growth Tax Relief Reconciliation Act (JGTRRA), passed in 2003, accelerated the 2001 rate reductions, allowed lower tax rates for dividends and capital gains, and expanded and extended bonus depreciation. Bonus depreciation expired at the end of 2004, but there have been extensions of some other expiring provisions. The first section of this paper examines the data on revenues and growth that have given rise to these arguments. The next three sections discuss the three basic types of behavioral effects that might lead to increased (or decreased) revenues: short-run stimulus effects and the subsequent effects on the debt, "supply-side" effects that alter the amount of labor and capital in the economy, and shifts between taxable and tax-favored activities. The final section presents findings. The OMB Mid-Session Review projected revenues to be $115 billion higher than forecast in February, while CBO projected revenues $99 billion higher than its March forecast. According to CBO projections, the deficit will fall from 2.6% of GDP in FY2005 to 2.0% of GDP in FY2006. This revenue increase arose from increases in both individual and corporate income and followed an increase in 2005. In 2005, GDP grew by 6.5%, but revenues grew by 14.5%; in 2006 GDP is projected to grow by 6.6% and revenues by 11.6%. In 2005, revenues from social insurance taxes grew by 8.3%, revenues from individual income taxes by 14.6%, and revenues from corporate taxes by 47%. In 2006, CBO estimates revenues from social insurance taxes will grow by 5%, revenues from individual income taxes will grow by 14.3%, and revenues from corporate income taxes will grow by 22.2%. This growth in revenues is not due to any extraordinary growth of output, as the economy has been growing at rates typical of those following recoveries from previous recessions. Moreover, according to CBO, the economy has essentially reached its full employment level. Rather, the growth in revenues is due largely to an increase in taxes as a percentage of output. Most of the increase in taxes as a percentage of output is due to income taxes, with about 60% of the effect coming from the individual income tax and the remainder from the corporate tax. Table 1 reports, since 1990, the growth rate of real output and revenue from the corporate and individual income taxes as a percent of GDP as reported by CBO. Before discussing the data in this table, it is important to correct the data for a major effect from tax legislation, the introduction of bonus depreciation in 2002, its expansion in 2003, and its termination at the end of 2004. This provision is having effects on corporate tax revenue outside of economic performance. Bonus depreciation allowed depreciation deductions to occur earlier than they would have otherwise, thereby shifting revenue from the present to the future. Using the revenue estimates made at the time for bonus depreciation and another small tax issue having to do with losses, and assigning a share to corporations equal to the share of accelerated depreciation on equipment reported in the Joint Committee on Taxation's (JCT) tax expenditure estimates (79%), we correct the corporate tax ratio to see what it would have been without this legislative change. This number is reported in the last column. Using these figures, there no longer appears to be a significant growth in corporate tax revenues from 2005 to 2006. The effect of the depreciation change accounted for 84% of the faster growth in corporate tax revenues, and without it, corporate taxes would have grown by less than 9% rather than by 22%. (It accounts for slightly over half the 47% growth from 2004 to 2005.) This adjustment probably applies too much weight to bonus depreciation, however, because preliminary evidence through 2003 suggests the usage of bonus depreciation has not been as great as might have been predicted. Thus, the pattern adjusted for this legislative change probably falls between the two last columns of Table 1 . Nevertheless, adjusting even in part for this effect smooths out the general pattern of corporate taxes during the recession and recovery, with the shares during the recession and slow growth years similar to those in the early 1990s, and the shares now similar to the period prior to the recession in 2000/2001. Because at least part of the growth in corporate revenues can be explained by legislative changes, and because revenue from the individual income tax was a greater contributor to growth in general, the more important issue to focus on seems to be the growth in the individual income tax share. Some small part of the growth from 2005 to 2006 is also attributable to depreciation for unincorporated businesses, but in this case it accounts for only 14% of the faster growth in revenues based on the original revenue estimates. Policymakers are interested in the question of what, if any, part of the increasing individual income tax share is a result of economic stimulus brought about by the 2001-2004 tax cuts? The following discussion looks at this issue from a macroeconomic viewpoint. First, the fact that income taxes as a percentage of output rose does not necessarily mean that effect is due to growth effects arising from the tax cuts. If that were the case, one could also conclude that the rate increase in 1993 led to a growth in effective tax rates independent from the direct effects. The share of output collected in individual taxes continued to grow in the late 1990s after the tax rate increases were in place. This growth in the late 1990s generally reflected both an increase in the average effective tax rate on taxable income (which could arise from increasing inequality in incomes and real bracket creep), and increases in taxable income relative to GDP, which could reflect items such as faster growth in capital gains. Second, were there no similar growth effects following the 1993 tax cut, one could not empirically attribute the recent growth to a specific event because it is not possible to know what would have happened to the economy in the absence of the tax cut. To attribute the growth to the tax cut would be to presume that because one event occurs before another, the first event causes the second. When estimating the effect of tax changes, observing the aftermath really does not change our knowledge derived from observing economy wide changes except in a very marginal way. At best, it is one more observation, and in order to project economic changes we need enough observations to form an adequate statistical sample. Finally, CBO suggests (based on comparing withholding and other receipts) that the recent growth in revenue is not due to growth in wage income, which is the basic conduit through which most economic growth occurs in the short run, but through other routes. Any change in saving and investment induced by the tax cut (and it is not clear there is such a change) would have a negligible effect on the capital stock and output: this effect is a long-run phenomenon, not a short-run one. To think about the potential revenue offsets due to economic or behavioral change induced by a tax change, it is necessary to turn to a more general analysis of these effects. They can be separated into three types of effects: demand-side stimulus effects including the eventual consequences of increased debt, "supply-side" effects on labor and capital, and changes in the allocation of consumption and other forms of taxpayer avoidance. When the economy is in a recession, the demand-side effects of a tax cut can increase output. But do these demand-side effects suggest that a tax cut can pay for itself, or even partially pay for itself? Any effects on output from demand-side stimulus (or contraction) are transitory and the long-run effects are generally negative as the increased government borrowing from the tax cut is likely to crowd out private capital. Demand-side stimulus can have little effect on real output if enacted when the economy is at full employment; however, the 2001-2004 tax cuts took place when the economy was not at full employment. Since the tax cuts began in 2001, much of the demand-side effect has likely faded and will continue to fade, and any offsets would have been temporary and are now on the decline.