Claim That Tax Cuts "Pay For Themselves" Is Too Good To Be True
Data Show No "Free Lunch" Here
End Notes
N. Gregory Mankiw, former chairman of President Bush’s Council of Economic Advisors and a Harvard economics professor, wrote in his well-known 1998 textbook that there is “no credible evidence” that “tax revenues … rise in the face of lower tax rates.” He went on to compare an economist who says that tax cuts can pay for themselves to a “snake oil salesman trying to sell a miracle cure.”[13]
Commenting on President Bush’s claim that tax cuts pay for themselves, the Economist magazine recently wrote, “Even by the standards of political boosterism, this is extraordinary. No serious economist believes Mr. Bush’s tax cuts will pay for themselves.”[14]
The President’s own Council of Economic Advisors concluded in its Economic Report of the President, 2003, that, “although the economy grows in response to tax reductions (because of the higher consumption in the short run and improved incentives in the long run) it is unlikely to grow so much that lost revenue is completely recovered by the higher level of economic activity.”[15] The CEA chair at the time was conservative economist Glenn Hubbard.
Deficit-Financed Tax Cuts May Cost Even More than Official Estimates
A recent CBO study of the economic effects of tax cuts found that how tax cuts are financed significantly impacts how they affect the economy. In the short run, deficit-financed tax cuts may help stimulate an economy in recession and thus temporarily improve growth (although the 2001 and 2003 tax cuts were poorly structured as stimulus). But in the long run, the deficits that result from unpaid-for tax cuts constitute a drag on the economy because they lower national savings.[16]
For this reason, deficit-financed tax cuts may actually weaken long-run economic growth. A study and literature review by Brookings Institution economists William Gale and Peter Orszag, for instance, concluded that the 2001 and 2003 tax cuts were “likely to reduce, not increase, national income in the long term” because of their effect in swelling the deficit.[17] Studies by economists at the Congressional Budget Office and the Joint Committee on Taxation have found that, even in models that predict that deficit-financed tax cuts can have a positive economic impact over the ten-year budget window, their longer-run impact is negative.[18]
If deficit-financed tax cuts weaken economic growth, their long-run cost could be greater than conventional revenue estimates suggest, because they will reduce revenues not only directly (by lowering people’s tax bills) but also indirectly (by slowing the economy). A recent CBO study of the economic effects of a hypothetical 10 percent across-the-board cut in income tax rates found that under certain assumptions, the increased deficits resulting from the tax cut would be enough of a drag on the economy that the tax cut actually would lose more revenue than if one assumed it had no effect on the economy. In other words, deficit-financed tax cuts could be even more expensive than officially “scored,” rather than less expensive or costless.
In the final analysis, the idea that tax cuts can spur sufficient economic growth to pay for themselves sounds too good to be true because it is too good to be true. In tax policy, as in other aspects of policymaking, there is no “free lunch.”
[1] “Remarks by the President on the Mid-Session Review,” July 11, 2006.
[2] “President Discusses 2007 Budget and Deficit Reduction in New Hampshire,” February 8, 2006.
[3] “Remarks by the Vice President on the 2006 Agenda,” Washington D.C., February 9, 2006.
[4] Bill Frist, “Tax Cuts Make Money,” USA Today, February 21, 2006.
[5] We consider here the revenue growth that the Administration projects through the end of fiscal year 2006. The fiscal year will end on September 30, 2006, which will be 5 ½ years after the business cycle began in March 2001. Hence, the equivalent period of earlier business cycles is the first 5 ½ years of those cycles.
[6] Aviva Aron-Dine, Joel Friedman, Richard Kogan, and Isaac Shapiro,
“The Recent Upturn in Revenues and OMB’s Mid-Session Review,” Center on Budget and Policy Priorities, revised July 11, 2006.
[7] For more detailed comparisons, see Isaac Shapiro, Richard Kogan, and Aviva Aron-Dine, “How Good Is the Current Economic Recovery?” Center on Budget and Policy Priorities, revised July 10, 2006.
[8] Wesley Elmore, “Snow Touts Dynamic Analysis before Ways and Means Committee,” Tax Notes, February 16, 2006.
[9] Growth rates are adjusted for inflation and population growth.
[10] Growth rates are measured from business cycle peak to business cycle peak (fiscal years 1979 to 1990 and fiscal years 1990 to 2000). By measuring growth over complete business cycles, we avoid the distortions that could result from, for example, comparing an expansion to a recession.
[11] James Horney, “A Smoking Gun: Claim that Tax Cuts Pay for Themselves Refuted by Administration’s Own Analysis,” Center on Budget and Policy Priorities, revised July 27, 2006.
[12] Edward Lazere, Testimony before the Joint Economic Committee, June 27, 2006.
[13] N. Gregory Mankiw, Principles of Economics, Dryden Press, Fort Worth, TX, 1998, pp. 29-30.
[14] The Economist, “Tripe Is Back on the Menu,” January 14, 2006.
[15] Council of Economic Advisors, Economic Report of the President, February 2003, pp. 57-58.
[16] Congressional Budget Office, “Analyzing the Economic and budgetary Effects of a 10 Percent Cut in Income Tax Rates,” December 1, 2005. See also Isaac Shapiro and Joel Friedman, “Tax Returns: A Comprehensive Assessment of the Bush Administration’s Record on Cutting Taxes,” Center on Budget and Policy Priorities, revised April 23, 2004, chapter 4,
[17] Williams Gale and Peter Orszag, “Bush Administration Tax Policy: Effects on Long-Term Growth,” Tax Notes, October 18, 2004.
[18] Douglas Hamilton, “Dynamic Analysis of a 10 Percent Cut in Federal Income Tax Rates,” June 16, 2006, Joint Committee on Taxation, “Exploring Issues in the Development of Macroeconomic Models for Use in Tax Policy Analysis,” June 16, 2006.