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GOP Shouldn’t Expect Tax Cuts to Pay for Themselves
There are various economic models used to estimate how changes in tax policy will affect economic growth and budget deficits. They contain lots of variables and lots of assumptions. (Of course, don’t mistake the map for the territory and all that.)
But it’s pretty tough to find a legit model that suggests tax cuts pay for themselves. That usually doesn’t happen. The Reagan tax cuts didn’t pay for themselves. The Bush tax cuts didn’t pay for themselves. And the Trump tax cuts almost surely won’t pay for themselves. In other words, they are overall revenue reducing even if they boost economic growth somewhat. Doesn’t necessarily mean tax cuts are bad, just that they need to be judged in the broader fiscal context. The Reagan tax cuts, for instance, took place when the debt-GDP ratio was 25%. Now it’s three times that.
We can argue, of course, over the best way to model the impact of a tax cut. But this, from a column by economist Thomas Sowell, is about the worst way of judging a tax cut:
The hardest of these hard facts is that the revenues collected from federal income taxes during every year of the Reagan administration were higher than the revenues collected from federal income taxes during any year of any previous administration. How can that be? Because tax RATES and tax REVENUES are two different things. Tax rates and tax revenues can move in either the same direction or in opposite directions, depending on how the economy responds. But why should you take my word for it that federal income tax revenues were higher than before during the Reagan administration? Check it out. . . .
Each annual “Economic Report of the President” has the history of federal revenues and expenditures, going back for decades. And that is just one of the places where you can get this data. The truth is readily available, if you want it. But, if you are satisfied with political rhetoric, so be it. . . . That should have put an end to the talk about how lower tax rates reduce government revenues and therefore tax cuts need to be “paid for” or else there will be rising deficits. There were in fact rising deficits in the 1980s, but that was due to spending that outran even the rising tax revenues.
That column, by the way, is from last May but is making its away again around the internet.
Anyway, here’s the thing: Generally when an economy grows, revenue goes up. Usually, revenue only falls during recessions. Revenue even rises despite supposedly economy-killing tax hikes. So pointing out increasing revenue is sort of beside the point. It doesn’t tell us whether the tax cut generated enough growth to offset the decline in tax rates. (It probably didn’t.)
Oh, and one more thing about the Reagan tax cuts since they continue to influence GOP economic thinking:
Published in Domestic Policy, EconomicsFor starters, the Reagan tax cuts didn’t pay for themselves, despite what Paul subtly suggests. Income tax revenue fell from 9 percent of GDP in 1981 to 8 percent in 1989. A 2006 Bush administration study found Reagan’s 1981 tax cuts lost an average of $200 billion a year, in today’s dollars, over their first four years. A 2004 study by two Bush economists estimated that in the long run, “about 17 percent of a cut in labor taxes is recouped through higher economic growth. The comparable figure for a cut in capital taxes is about 50 percent.” . . . What’s more, the Reagan tax cuts didn’t spur some crazy period of light-speed growth. From 1981 through 1990 — a period including both the 1981 and 1986 tax cuts and ending just before the Bush I tax hikes — real GDP grew by 3.3 percent a year, versus 3.2 percent during the previous decade. Indeed, the Reagan boom occurred in the middle of the “great stagnation” in U.S. productivity that has lasted from the early 1970s until today (other than a period from the mid-1990s through mid-2000s).
“If you believe in free will, you can’t truly believe in social science and economic projection.”
— Nassim Taleb in The Bed of Procrustes
With friends like these, who needs enemies? Cut expenditures.
The very idea we have to “pay” for tax cuts instead of making our spending stay within our revenue belies the entire argument.
Yeah, this phrasing makes my blood boil every time I hear it. The fact that even conservatives talk about “paying for tax cuts” is a huge victory for the Left. We’ve adopted their terminology and their way of thinking.
You don’t pay for tax cuts. Taxes pay for other things.
If taxes need to be cut for the health of the economy, cut them. Then use that revenue, whatever it happens to be, to pay for whatever is most important. When you run out of money, stop spending it. If there’s other stuff you wanted to do, then you need to revisit your priorities.
If we have a deficit, it’s because we spend too much. Not because we tax too little.
Good quote. Econometric models are interesting and can be used to gain a deeper understanding of economic theory, and for teaching. But there exist no scientifically valid models for predicting the future evolution of economic aggregates. It is pure superstition to think otherwise. Writing down equations, supplying constants drawn from statistics, and solving the equations impresses some people. It seems so sophisticated and mathy, and they even use computers! which are really smart, as everyone knows.
But to have a scientific reason, rather than a superstitious one, to believe that a model can predict the behavior of a system requires that one not just make up some equations, but that one have scientifically valid equations. Economic science doesn’t provide these equations, so no-one can create a predictive model. The pseudo-economists don’t even attempt to show that their equations have any scientific, rational basis. They simply wave their hands and state that they have a new model, and demonstrate that it has successfully predicted the past (after they have arbitrarily assigned and re-assigned the coefficients and re-run the model until it reproduced the historic data). When it fails to predict the future, they rinse and repeat.
This is not economics. It is magic.
Substitute “theft” for “revenue” in the OP. I fail to see why government theft (“revenue”) should be positively correlated with GDP, even if one believes in such aggregate fairy tales.
Fiddling with the revenue side misses the biggest driver of debt – the spending. If spending outpaces revenues – and it always does – then tax cuts, however desirable a goal, just exacerbate the problem. Then the left suddenly turns into deficit hawks, and you get to the current state.
Which is just a rehash of the old state.
It can be better argued that lower tax rates will pick up M2 velocity, but I still think there’s a lack of demand, in general, because cash is cheap and there’s a lot of it.
Ultimately, the “pays for itself” argument is a bad one, because they sort of never do. But more importantly, they should discard that trope altogether. Why a tax cut? If you need help answering that question, you’re not a Republican.
Part of the evidence for this in the cited article is
Ah, the importance, and potential for deception, of choosing the base year. The first tax cut was indeed signed in August of 1981 but the cuts were phased in over three years, with the final provisions taking effect in 1985. Surely, it is misleading to include 1981 as part of the GDP growth data. Simply changing the base year to 1982 changes the annual real GDP growth rate from 1982 to 1990 results in 3.6%,* using data from the BEA. What a difference a year makes! The decade was also contaminated by the beginnings of a recession in the Bush administration. The chart illustrates both points:
* (61.776/44.907)^(1/9)=3.6% per annum. A nine-year period in the 1970s (72–80 inclusive) yields 3.0%.
N.B.: Beware the fencepost error in making such calculations.
The author’s language begins with the essential concession to statist dogma: increases in government spending are inherent and that revenue MUST always keep pace. If this is conservative economic commentary, we are really beyond hope.
In 1982 revenue was a 1.3 trillion by 1989 it was nearly 1.7 trillion. Yes 1983/84 had a slight dip . Me thinks 1.7 is bigger than 1.3 remember you don’t spend a% you spend a $
PHCheese gets it right.
You can talk all you want James about percentage of GDP returned in revenue to the government, but the bottom line is that total revenue grew much more than it otherwise would have under Reagan, and thus did pay for itself.
Compare that to Obama. Obama’s take of the GDP in taxes was the lowest since the early 50’s – far lower than any other President during those decades including Reagan – by about 15%, but on top of that, GDP growth and job growth were terrible under Obama adding up to about one trillion dollars less in tax revenue a year if the economy had performed as it did under Reagan. That’s right – ONE TRILLION DOLLARS A YEAR.
George W. Bush was not much better. He allowed far too much regulation as well – as did Buraq Hussein. As a result there has been literally no growth in permanent full time jobs since the year 2000. An abysmal record.
That said, I am no fan of the Republican tax plan, as I don’t think it will either do that much for the economy or will it pay for itself because it does very little to improve the Small Business sector which historically produces the vast majority of full time jobs.
Moreover , Deep State Establishment Washington clearly does not want cut the bureaucracy, regulation, or taxes as would be necessary to put the economy on a solid growth footing and instead are choosing to allow the economy year after year to slowly falter under the heavy weight of a out of control government that probably will lead someday soon to a gut wrenching collapse.
So I get to keep more of my money and that’s a bad thing. Got it.
Exactly. I have a more terse way of putting it: Macroeconomics is all bunk.
@phcheese. Spot on.
From the Heritage Foundation…
In 1980, the last year before the tax cuts, tax revenues were $956 billion (in constant 1996 dollars).
Revenues exceeded that 1980 level in eight of the next 10 years. Annual revenues over the next decade averaged $102 billion above their 1980 level (in constant 1996 dollars).
James’ % of GDP argument is disingenuous at best. It’s like getting a $10,000 dollar raise every year yet concluding that, because the $10,000 represents a declining percent of your total income, you are losing money!
This debate is getting old. It’s simple, with a 100% tax there is no revenue. With a zero tax there is no revenue. So some where in between there is a optimum tax if the goal is revenue. But it isn’t. The goal is human flourishing, security and these do better when there is growth and freedom. The Federal government, like state governments spend too much, regulate too much and do not foster human flourishing and ultimately not even security. Moreover, what we tax is as important as the rate. We spend too much and save too little both privately and publicly, so it makes no sense to tax work, savings and investment and to encourage spending. That’s the debate we need not silly predictions by linear models that all turn on non linear interactions. We can’t model this stuff but we can understand it.
Amen. Your last line should be a Quote of the Day.
I’m typically a fan of Pethokoukis’ writing, but this article seems way off base to me.
It sounds like cutting taxes within reason will lead to them being “paid for” (which, as mentioned in other comments, is a liberal premise to begin with). The real issue here is the debt-GDP ratio, but that is driven by over-spending, not by an ever-increasing amount of tax revenue.