What Every Republican Needs to Know About the Realities of 21st Century Tax Reform

 

The great economic lesson of the 1980s supply-side revolution is that taxes matter. But what are the nuances of that lesson, and how should that lesson by applied to the modern American economy? Politicians and pundits typically offer extreme versions of how tax reform would affect growth, either that it is a magic bullet or a complete irrelevancy. A new study by William Gale and Andrew Samwick offers a good summary of consensus thinking of the matter:

Tax rate cuts may encourage individuals to work, save, and invest, but if the tax cuts are not financed by immediate spending cuts they will likely also result in an increased federal budget deficit, which in the long-term will reduce national saving and raise interest rates.

Further:

The net impact on growth is uncertain, but many estimates suggest it is either small or negative. Base-broadening measures can eliminate the effect of tax rate cuts on budget deficits, but at the same time they also reduce the impact on labor supply, saving, and investment and thus reduce the direct impact on growth.

However, they also reallocate resources across sectors toward their highest-value economic use, resulting in increased efficiency and potentially raising the overall size of the economy. The results suggest that not all tax changes will have the same impact on growth. Reforms that improve incentives, reduce existing subsidies, avoid windfall gains, and avoid deficit financing will have more auspicious effects on the long-term size of the economy, but may also create trade-offs between equity and efficiency.

For instance, most economists are skeptical that the 1986 Tax Reform Act, the model for many current efforts at tax reform, had much more than a modest positive effect on the long-term economic growth. Maybe the economy ended up 1% bigger than otherwise. I asked AEI economist Alan Viard for his take on the Gale-Samwick study:

I might have written the study with a different tone and might have covered some additional policies (the ones more likely to promote growth), but I think its conclusion are generally right, as far as they goRevenue-neutral individual income tax reform has little impact on work and saving incentives, but can benefit the economy by reducing distortions between different sectors. Deficit-financed individual income tax cuts typically reduce economic growth. Individual income tax cuts financed by reducing government consumption typically increase growth.

The study expressly does not discuss corporate income tax cuts and movements toward consumption taxation. In my view, those are the policies most likely to promote growth. The study appears to overlook individual income tax cuts financed by cutting entitlements, which would also tend to promote growth.

As it happens, Viard has developed a comprehensive tax reform plan that would replace the income tax with a progressive consumption tax, or “X tax,” that would potentially create some fairly impressive pro-growth effects.

 

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  1. Tuck Inactive
    Tuck
    @Tuck

    James Pethokoukis: …but may also create trade-offs between equity and efficiency.

    Equity?

    • #1
  2. BuckeyeSam Inactive
    BuckeyeSam
    @BuckeyeSam

    “if the tax cuts are not financed by immediate spending cuts”

    I have no problem with the notion of spending cuts, especially when all I hear coming out of DC is one IG report or another or some other report or another informing us that the feds are essentially flushing money down the toilet. Beyond that, I want to criticize the language used by these authors. The notion that tax cuts need to be “financed” by spending cuts seems to assume that tax money is the government’s money in the first instance rather than the taxpayers’ money.

    • #2
  3. Spin Inactive
    Spin
    @Spin

    BuckeyeSam:“if the tax cuts are not financed by immediate spending cuts”

    I have no problem with the notion of spending cuts, especially when all I hear coming out of DC is one IG report or another or some other report or another informing us that the feds are essentially flushing money down the toilet. Beyond that, I want to criticize the language used by these authors. The notion that tax cuts need to be “financed” by spending cuts seems to assume that tax money is the government’s money in the first instance rather than the taxpayers’ money.

    The language is unfortunate, but the point remains.  You can’t just cut taxes.  You also need to cut spending.

    • #3
  4. Misthiocracy Member
    Misthiocracy
    @Misthiocracy

    <img src=”https://en.wikipedia.org/wiki/Income_tax_in_the_United_States#mediaviewer/File:Historical_Mariginal_Tax_Rate_for_Highest_and_Lowest_Income_Earners.jpg”>

    Current rates don’t seem that much higher than their pre-1990 low, and they’re still a heck of a lot lower than their pre-1980 high. As such, the rates don’t seem like the biggest problem at the moment.

    Tackling tax complexity (coupled with tackling runaway entitlements spending) seems like it would reap greater dividends, from my very non-expert reading.

    • #4
  5. Misthiocracy Member
    Misthiocracy
    @Misthiocracy

    Here’s that graph, since the link didn’t work and the edit button still doesn’t work:

    US Income Tax Rates

    • #5
  6. RushBabe49 Thatcher
    RushBabe49
    @RushBabe49

    You CAN “just cut taxes”.  Every additional dollar that people take home in their paychecks gets recycled into savings, investment, and spending.  Cut corporate taxes, and companies can hire employees who pay taxes, thus increasing the amount of tax revenue flowing to the government.  That’s what happened with the Reagan tax rate reductions.  As proof that Democrat administrations don’t want just more government revenue is the fact that they mention “fairness” so often.  Their goal is not government funding, but punishment of their political enemies, high-earning individuals and successful companies.

    • #6
  7. Larry3435 Inactive
    Larry3435
    @Larry3435

    May I be so bold as to ask why the only economist who regularly posts on Ricochet also regularly trots out this Keynesian tripe?  The 1986 tax reform had a “small or negative effect” on growth?  Trade-offs between “equity and efficiency”?  Really?

    And the post calls the Keynesian view a “consensus.”  It is a consensus only in the sense that catastrophic global warming is a “consensus.”  You just ignore everyone who disagrees with you, and what’s left is a “consensus.”

    Since I need not worry about offending James (because it is apparent that he never reads the comments to his own posts), let me ask the editors:  Is there no conservative economist who would be willing to be a Ricochet regular?  Russ Roberts maybe?  Anyone to present the other side of the argument?

    • #7
  8. The Party of Hell No! Inactive
    The Party of Hell No!
    @ThePartyofHellNo

    “Modern American economy?” What’s that? Do we not still use dollars? Do not people still work for corporations, themselves, small businesses and receive paychecks – with all the appropriate government fees stolen before they even get a chance to convert those checks to grubby dollar bills – then go pay bills and buy what they want? Or are we talking about huge corporations which manufacture nothing are valued in the billions if not hundred of billions – in potential (What I like to call fake money.) which send the “new investor” into a tizzy to buy when the others in a tizzy say,” buy?” Come on, there is no modern American economy, there is the economy of dollars and when you give people incentive to earn more with the same amount of work, they earn more, go back to work and throw money at the government. Increase in deficits? DEFICITS, DEFICITS, your worried about stinkin DEFICITS? When haven’t we had deficits? Oh, yeah under Billy Clinton; yeah this is the high light of your argument. The highlight of my argument – you have millions of citizens not working, not paying taxes and receiving money from a the same government not receiving taxes. Better to get people working and paying something, than just draining the treasury. Or we can do nothing, because you know, deficits might cause a problem.

    Also went to the link about the “progressive consumption tax” I whole hardly agree with this concept but, “sheesh” don’t have those guys sell it. Gobbly-de-gook about something having to do with savers pay more later than those…blah, blah, blah. No! The reason we want the consumption tax – 1) everyone has to participate – no more 47% not paying their unfair share, and 2) it will kill, destroy, decimate the Nazi institute known as the IRS once and for all! No more social security number attached to your money and no puny sleazeball scum bureaucrat knowing anything about the most private – after sexual behavior, that is – of American behaviors – how much they earn, how they invest, and save and how they throw  their money away. Oh and no political party (Democrats) running the government from the White House using the Nazi power of the IRS to subvert politics in their favor. That’s how you sell the repeal of the Sixteenth Amendment and the passage of the Twenty-eighth Amendment for a National Sales Tax.

    • #8
  9. BuckeyeSam Inactive
    BuckeyeSam
    @BuckeyeSam

    Spin:

    BuckeyeSam:“if the tax cuts are not financed by immediate spending cuts”

    I have no problem with the notion of spending cuts, especially when all I hear coming out of DC is one IG report or another or some other report or another informing us that the feds are essentially flushing money down the toilet. Beyond that, I want to criticize the language used by these authors. The notion that tax cuts need to be “financed” by spending cuts seems to assume that tax money is the government’s money in the first instance rather than the taxpayers’ money.

    The language is unfortunate, but the point remains. You can’t just cut taxes. You also need to cut spending.

    I don’t agree. Buck up $5 and learn something from Thomas Sowell–someone Ricochet ought to have posting on its site.

    http://www.hooverpress.org/productdetails.cfm?PC=1582

    • #9
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