April 26, 2017
Yes, it’s Groundhog Day. Republicans are once again claiming that tax cuts will spur enough economic growth to pay for themselves. Well, old-timers like myself remember Round I and Round II when we tried this grand experiment. It didn’t work.
Round I was under President Reagan when he put in big tax cuts at the start of the presidency. These tax cuts were supposed to lead to a growth surge which would cover the costs of the tax cuts. Not quite, the deficit soared and the debt-to-GDP ratio went from 25.5 percent of GDP at the end of 1980 to 39.8 percent of GDP at the end of 1988. (It rose further to 46.6 percent of GDP by the end of the first President Bush’s term.)
Round II were the tax cuts put in place by George W. Bush. At the start of the Bush II administration the ratio of debt to GDP was 33.6 percent. It rose to 39.3 percent by the end of 2008.
In addition to these two big lab experiments with the national economy, we also have a large body of economic research on the issue. This research is well summarized in a study done by the Congressional Budget Office (CBO) back in 2005 when it was headed by Douglas Holtz-Eakin, a Republican economist who had served as the head of George W. Bush’s Council of Economic Advisers.
I commented on this study a few years back:
“In a model that examined the effects of a 10% reduction in all federal individual income tax rates, the economy was slightly larger in the first five years after the tax cut and slightly smaller in the five years that followed. In this case, using dynamic scoring showed the tax cut costing more revenue than in the methodology the CBO currently uses.
“The CBO did find that dynamic scoring of the tax cut could have some positive effects if coupled with other policies. In one set of models, policymakers assumed that taxes were raised after 10 years. This led the government to raise more tax revenue in the first 10 years because people knew that they would be taxed more later, so they worked more.”
In short, Holtz-Eakin considered the extent to which tax cuts could plausibly be said to boost growth and found that they had very limited impact on the deficit. The one partial exception, in which growth offset around 30 percent of the revenue lost, was in a story where people expected taxes to rise in the future. In this case, people worked and saved more in the low-tax period with the idea that they would work and save less in the higher tax period in the future.
That is not a story of increasing growth, but rather moving it forward. I doubt that any of the Republicans pushing tax cuts want to tell people that they better work more now because we will tax you more in the future. But that is the logic of the scenario where growth recaptures at least some of the lost revenue.
Having said all this, let me add my usual point. The debt-to-GDP ratio tells us almost nothing. We should be far more interested the ratio of debt service to GDP (now near a post war low of 0.8 percent).
Also, if we are concerned about future obligations we are creating for our children we must look at patent and copyright monopolies. These are in effect privately imposed taxes that the government allows private companies to charge as incentive for innovation and creative work. The size of these patent rents in pharmaceuticals alone is approaching $400 billion. This is more than 2 percent of GDP and more than 10 percent of all federal revenue. In other words, it is a huge burden that honest people cannot ignore.
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