Myth: Growth from Tax Cuts Makes Up Lost Revenue

We Set Out to Discover if Tax Cuts Pay for Themselves. Here’s what we found: It’s a common myth that reducing marginal tax rates would spur economic growth. The idea is that lower tax rates will give people more after-tax income that they will spend on goods and services.

Julianna Truesdale

We Set Out to Discover if Tax Cuts Pay for Themselves. Here’s what we found:

It’s a common myth that reducing marginal tax rates would spur economic growth. The idea is that lower tax rates will give people more after-tax income that they will spend on goods and services.

Advocates of tax cuts argue that reducing taxes improves the economy by boosting spending. Those who oppose them say that tax cuts not only do not stimulate the economy, but the tax cuts can actually hurt lower-earning individuals by reducing government services which they may also rely on. Let’s look at the two distinct sides to this economic balancing scale.

A Taxing Situation

Cutting taxes reduces government revenues and creates a budget deficit, which occurs when government expenses exceed revenue. The natural countermeasure would be to cut spending, but the services that would likely get cut are beneficial to the poor, so those who are against tax cuts ask, are tax cuts hurting more than they are helping? Proponents of the tax cuts argue that by putting money back in consumer’s pockets spending will increase. They believe the economy will grow and wages will rise, but the federal minimum wage had not been raised since 2009, until just recently. As an example, despite several tax cuts, Wyoming went without a minimum wage increase for almost 20 years when their minimum wage went from $1.60/hour to $5.15/hour.

Let’s Dig Deeper

In the largest tax overhaul since the Tax Reform Act of 1986, the Tax Cuts and Jobs Act (TCJA) of 2017 made substantial changes to the rates and bases of both the individual and corporate income taxes. The biggest change under the proposal was reducing the business tax rate from 35 to 15 percent for both big and small corporations alike, personal income tax brackets go from seven brackets to three (10, 25, and 35 percent), and the so-called standard deduction — the amount of personal income not subject to federal income tax — will be doubled, while some other deductions are removed.

With the TCJA there are substantial changes to the rates and bases of both the individual and corporate income taxes, most prominently cutting the maximum corporate income tax rate to 21 percent, redesigning international tax rules, and providing a deduction for pass-through income. Other major changes include expensing of equipment investment; elimination of personal and dependent exemptions, the tax on people who do not obtain adequate health insurance coverage, and the corporate alternative minimum tax; and increases in the standard deduction, the estate tax exemption, and the individual alternative minimum tax exemption. Almost all the individual income tax and estate tax provisions expire after 2025, while most of the corporate provisions are permanent. TCJA will stimulate the economy in the near term. But most models indicate that the long-term impact on gross domestic product (GDP) will be small.

TCJA will reduce federal revenues by significant amounts, even after allowing for the impact on economic growth. It will make the distribution of after-tax income more unequal. If it is not financed with concurrent spending cuts or other tax increases, TCJA will raise federal debt and impose burdens on future generations. If it is financed with spending cuts or other tax increases, TCJA will, under the most plausible scenarios, end up making most households worse off than if it had not been enacted.

The new law simplifies taxes in some ways but creates new complexity and compliance issues in others. It will raise health care premiums and reduce health insurance coverage. It will affect activities in many sectors, including state and local public spending, charitable organizations, and housing.

What Do Economists Say?

Edward Kleinbard, University of Southern California professor of law and business, said smart corporate tax reform could stimulate the economy somewhat, but at a net loss.

“A really well-designed corporate tax reform package, including a rate cut, would be accretive to growth,” he said, “but not enough to pay for any resulting large-scale deficits.”

So tax cuts could, in theory, create some growth, according to the experts. But are there any historical cases of tax cuts producing so much growth they pay for themselves?

“I am not aware of any credible evidence (in the U.S.) over the last several decades of a broad-based tax cut paying for itself,” said Alan Auerbach, an economist at the University of California, Berkeley. “I don’t think this is at all controversial among actual economists.”

Kleinbard was similarly emphatic: “There is no time in modern history where tax cuts could be said to pay for themselves.”
According to Kleinbard, the 1981 tax cuts triggered massive federal deficits and were largely reversed within three years. The Tax Reform Act of 1986 was basically revenue neutral, he said, meaning tax cuts were virtually offset by spending cuts. He added that President Bill Clinton’s tax hike was followed by robust growth, while the George W. Bush tax cuts led to anemic growth. None of the experts interviewed cited evidence that tax cuts under President Barack Obama produced sufficient growth to pay for themselves either.

On the contrary, there’s some evidence that tax cuts can be a drag on the economy in this report from the Congressional Budget Office (CBO). When the CBO studied the effects of a hypothetical 10 percent income tax cut for Americans, they projected that tax cuts would lead to a 3 percent increase in lost revenue over 10 years.

Indeed, tax cuts can have a number of adverse effects that may actually impede growth, according to Kleinbard.
One example is a phenomenon known as the “crowding out” effect. This disastrous potential tax cut side effect could happen because the tax cuts create deficits that cause the government to borrow more money and therefore enter deeper debt, which can make private sector borrowing more expensive.

Our Conclusion: BUSTED!

We found no economic experts who could point to evidence of tax cuts fully paying for themselves. Neither the modern historical record nor government analyses supported the claim that tax cuts create enough growth to eventually offset lost revenue. On the contrary, there’s evidence that tax cuts may actually hinder economic growth.

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