Do tax cuts grow the economy?

Contents
The Claim
  • Reducing taxes grows the economy
    • That is, reducing federal tax rates increases GDP
  • Corollary
    • Raising federal tax rates reduces GDP
Assessment
  • The historical record provides little or no evidence that tax cuts grow the economy.  
  • The record provides solid evidence that tax cuts are almost certain to increase the national debt.
Historical Tax Cuts and Increases
  • Reagan’s supply-side tax cuts of 1981 and 1986
    • Personal income tax rate top rate 70 > 50 > 28
    • Corporate tax rate 50 > 35
    • Reduced estate tax
  • Clinton tax increase of 1993
    • Previous top personal income tax rate
      • 31% on income over $51,900.
    • New income brackets added
      • 36% on income over $115,000
      • 39.6% on income over $250,000
    • Raised corporate tax, gasoline tax, and removed cap on Medicare payroll tax
  • Bush’s tax cuts of 2001 and 2003
    • Lowered personal income rates for all brackets, with top rate 39.6 > 35
    • Reduced tax rate on capital gains and dividends
    • Reduced estate tax
  • Trump Tax Cuts of 2018
    • Reduced top bracket for individual income from 39.6% to 37%
    • Reduced corporate tax rate from 35% to 21%
    • Increased the threshold for paying estate tax
    • Reduced tax rates for pass-through entities, such as partnerships and S-corporations
Historical Tax Cuts and GDP
  • If tax cuts grow the economy, then
    • Reagan GDP should be higher than Carter GDP
    • Clinton GDP should be lower than Bush-I GDP
    • Bush-II GDP should be higher than Clinton GDP

Image Credit: princeton.edu/~mwatson/papers/DemRep_BlinderWatson_July2015.pdf
Red = Tax Cuts, Blue = Tax Increase
Historical Tax Cuts and the National Debt
Red = Tax Cuts, Blue = Tax Increase
Kansas Experiment
  • In a “real live experiment” led by Governor Brownback, Kansas cut taxes in January, 2013 with the specific objective of growing the Kansas economy.  The legislation was drafted with the help of former Ronald Reagan adviser Arthur Laffer (The Father of Supply-side Economics) and Heritage Foundation economist Stephen Moore.
    • State income tax
      • Highest income tax rate was reduced from 6.45% to 4.9%
      • Lowest tax rate was reduced from 3.5% to 3%
    • Taxes on “pass-through” business income were eliminated
      • That is, income from businesses such as partnerships, S corporations, and sole proprietorships
      • For example, if you’re an engineer working for a company, you’d pay individual income tax on your salary. But if you’re a self-employed freelance engineer — a one-person business — who contracted with the company instead, you’d pay no income tax.
  • In June 2017, the Kansas legislature, overriding the governor’s veto, repealed the tax cuts and ended the five-year experiment
  • Over the five-year period of the experiment the Kansas economy performed worse than neighboring states and the nation as a whole regarding:
    • Economic growth (GDP)
    • Job growth
    • Population growth
    • Disposable income growth
    • Small business formation
  • Over the five-year period tax revenues plunged, causing:
    • Huge budget shortfalls
    • Cuts to services
    • Two downgrades to Kansas bond rating
    • A ruling by the Kansas Supreme Court that the state’s spending on public
Image Credit: cpbb.org
IGM Economic Experts Panel

Question: A cut in federal income tax rates in the US right now would lead to higher GDP within five years than without the tax cut.

Conclusion
  • Will the next federal tax cuts grow the economy?  Maybe, maybe not. There are too many independent variables to make a reliable prediction.
  • The historical record provides little or no evidence that tax cuts grow the economy.
  • But the record provides solid evidence that tax cuts are almost certain to increase the national debt.
    • Reagan tax cuts, Clinton tax increase, Bush tax cuts, Kansas Experiment 
    • Jared Bernstein and Ben Spielberg
      • [The failure of the Kansas Experiment] doesn’t mean economies can’t grow after tax cuts. But what you can be sure of, regardless of which way growth bounces, is revenue losses.
Addenda
Addendum: Do Tax Cuts Pay for Themselves?
  • Claim
    • Reducing federal tax rates increases GDP so much that the resulting increased tax base, taxed at the new, lower tax rate, generates at least as much tax revenue as the previous, higher rate on the previous, smaller tax base.
      • Tax Base is the total amount of assets or revenue that a government can tax.
  • Analogy: This is like a retailer who cuts the price on a product with the idea that the lower price will produce enough profit in new sales to offset the lower profit per unit.  That is, higher sales volume will make up for lower profit per unit.
  • Will the next federal tax cuts pay for themselves?  Almost certainly not.
  • The historical record provides solid evidence that tax cuts are almost certain to increase government debt and thus will not pay for themselves.
    • Reagan tax cuts, Bush tax cuts, Kansas Experiment 
  • CBO 2005 Analysis
    • In the most generous estimated growth scenario, only 28% of the projected lost revenue from the lower tax rate would be recouped over a 10-year period after a 10% across-the-board reduction in all individual income tax rates.
  • IGM Economic Experts Panel
    • Question: A cut in federal income tax rates in the US right now would raise taxable income enough so that the annual total tax revenue would be higher within five years than without the tax cut.
Addendum: Sources for Kansas Experiment