With leading members of both parties placing tax reform high on the agenda for next year, a new paper by William B. Gale, Co-Director of the Urban-Brookings Tax Policy Center (TPC), and Andrew Samwick, a Dartmouth College professor and former Chief Economist for President George W. Bush’s Council of Economic Advisers, is a must read. They review the evidence about how income taxes affect economic growth and explain:
The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel. However, theory, evidence, and simulation studies tell a different and more complicated story.
Gale and Samwick highlight some often-overlooked factors about how tax changes affect growth, including:
Tax changes affect the budget. As Gale and Samwick note, research shows that large, unfinanced tax cuts can hurt growth because the increase in deficits creates a drag on national savings and investment that outweighs any positive incentive effects. Conversely, in the face of increasing long-run deficits, revenue increases could boost growth.
Scaling back inefficient tax subsidies can promote growth. Howard Gleckman, a TPC fellow and moderator of a discussion at the TPC event releasing Gale and Samwick’s paper in which I participated, noted that our panel:
[G]enerally agreed that the real benefit [of tax reform] likely comes from scaling back or even eliminating inefficient tax preferences, rather than reducing rates. Those changes make it more likely that people will allocate resources to maximize their economic benefit, rather than to maximize their tax savings. If that shift is big enough, it could increase the overall size of the economy.
We could use the revenues generated by such base broadening to reduce long-run deficits, which would boost growth over the long run. (As we repeatedly emphasize, however, getting the economy back to full employment should be a greater priority than deficit reduction.)