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Friday, July 28, 2006

Dynamic Scoring Undermines the Arguments of Tax-Cut Advocates

It's getting repetitious repeating the same thing again and again, that tax cuts do not pay for themselves, etc., but Paul Krugman's column today makes me realize that we need to keep rebutting the claims of tax-cut advocates for as long as the "propaganda machine" is up and running, and it doesn't run out of gas easily.

In this article from the Center on Budget and Policy Priorities, Jason Furman makes the same point in the box below that I made here about changes in the level of output versus changes in economic growth (see David Altig also). If anyone tries to tell you that tax cuts change the long-run growth of output per capita, call them on it. They don't.

The CBPP report is followed by an article from American Prospect on inconsistencies in the "starve the beast" and "tax cuts pay for themselves" dogma espoused by tax-cut advocates:

Treasury Department Dynamic Scoring Analysis Refutes Claims by Supporters of Tax Cuts, by Jason Furman: On July 25, the Treasury Department released a study entitled “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief.” This study refutes many of the exaggerated claims about the tax cuts that have been made by the President and other senior Administration officials, the Wall Street Journal editorial page, and various other tax-cut advocates. Contrary to the claim that the tax cuts will have huge impacts on the economy, the Treasury study finds that even under favorable assumptions, making the tax cuts permanent would have a barely perceptible impact on the economy. Under more realistic assumptions, the Treasury study finds that the tax cuts could even hurt the economy.

In addition, the study casts doubt on claims that the tax cuts are responsible for much of the recent growth in investment and jobs. It finds that making the tax cuts permanent would lead initially to lower levels of investment, and would result over the longer term in lower levels of employment (i.e., in fewer jobs).

Misunderstanding of the Treasury Study Mars Some News Accounts

Some of the reporting on the Treasury analysis has made a basic mistake. The Treasury study found that making the tax cuts permanent would increase the size of the economy over the long run — i.e., after many years — by 0.7 percent, if the tax cuts are paid for by unspecified cuts in government programs. This is a very small effect. If it took 20 years for the 0.7 percent increase to fully manifest itself (Treasury officials have indicated it would take significantly more than ten years but have not been more specific than that), this would mean an increase in the average annual growth rate for 20 years of four-one-hundredths of one percent — such as 3.04 percent instead of 3.0 percent — an effect so small as to be barely noticeable. Moreover, after the 20 years or whatever length of time it would take for the 0.7 percent increase to show up, annual growth rates would return to their normal level — that is, they would be no higher than if the tax cuts were allowed to expire.

Several news reports, however, mistakenly said that the Treasury found that making the tax cuts permanent would lead to a 0.7 percentage point increase in the annual growth rate. If true, that would be an enormous economic benefit; it would increase the size of the economy by 40 percent after fifty years. It would be more than fifty times larger than the 0.7 percent increase in the size of the economy over several decades that the Treasury study actually found.

The Treasury also study decisively refutes the President’s claim that “The economic growth fueled by tax relief has helped send our tax revenues soaring,” — in essence, that the tax cuts have more than paid for themselves. Instead, under the study’s more favorable scenario, the modest economic impact of the tax cuts would offset less than 10 percent of the cost of making the tax cuts permanent.

Finally, the conclusions in the Treasury study are based on the assumption that the tax cuts will be paid for by deep and unspecified cuts in government programs starting in 2017. The Treasury study is consistent with other research on dynamic scoring in finding that in the absence of such budget cuts — i.e., if the tax cuts continue to be deficit financed indefinitely — the tax cuts would end up weakening the economy over the long run.

The following are four key findings from the report.

Finding #1: At best, making the tax cuts permanent would have a barely perceptible effect on the economy. ...Moreover, the Treasury study acknowledges that the long-run growth rate would not rise at all... 

Finding #2: The tax cuts would pay for less than 10 percent of themselves in the long run. ...This finding shreds claims that the tax cuts are paying for themselves or even offsetting a sizable fraction of their costs...

Finding #3: Tax cuts will benefit the economy modestly only if they are paid for by large and unspecified cuts in government programs. The featured results in the Treasury study are based on the assumption that government programs are cut sharply starting in 2017 in order to pay for the tax cuts. ... That would be equivalent to cutting domestic discretionary spending in half...

Finding #4: The Treasury study confirms that it is more prudent to raise taxes by a small amount today than to raise them by a larger amount in the future. ... The Treasury study ... finds that cutting taxes today and raising them by even more in the future to make up for the lost revenue and the larger deficits would ultimately reduce the size of the economy (real GNP) by 0.9 percent. ...

Here's another piece along the same lines from The American Prospect. This is Robert S. McIntyre, director of Citizens for Tax Justice:

Report Retort, by Robert S. McIntyre, American Prospect: For decades, most Republican politicians have treated as an article of faith that tax cuts, especially tax cuts for the rich, will “pay for themselves” through improved economic growth and resulting higher revenues. Critics deride this implausible belief as “voodoo economics” or “the free-lunch theory.” Its adherents prefer to call it “supply-side economics.”

Oddly, the same GOP politicians who think tax cuts augment revenues also fervently hold exactly the opposite position, which they call “starve the beast.” They insist that big tax cuts will so sharply reduce revenues that they will force steep cuts in government programs.

The apostle of these conflicting dogmas was President Ronald Reagan, back in the 1980s. On the one hand, Reagan claimed that the way to stop Congress from providing what he saw as excessive public services was to “cut off their allowance.” On the other hand, he also promised that he would pay for his huge increase in defense spending “with the revenues generated by the [even huger] tax cuts” he pushed through Congress in 1981. As it happened, of course, neither theory panned out.

Despite the sorry historical record, our current president, George W. Bush, and most of his fellow Republicans in Congress are ardent disciples of Reagan’s contradictory belief system. In their ongoing and increasingly desperate search for proof of their faith -- at least the part that holds that tax cuts are a blessing for the economy and the federal budget -- Bush and Congress recently asked the Treasury Department to undertake a “dynamic analysis” of the economic and budgetary effects of making the Bush tax cuts permanent...

On July 25, the Treasury Department released its report. Despite the fact that Treasury is managed by Bush appointees who profess a deep affection for Bush’s tax-cutting policies, the results offer no comfort to supply-side true believers.

Instead, Treasury’s study found that extending Bush’s tax cuts would have essentially no beneficial effect on the U.S. economy at all. But, the report casually implies, it could have grave consequences for the ability of our government to deliver the public services that Americans depend on. ...

I think it's also worth recall in Menzie Chinn's excellent point that this is not a welfare analysis. For example, in the analysis no benefit is derived from what the government does with the taxes it collects. If the government builds schools, water systems, roads, keeps the elderly healthy and out of poverty, and so on, the study does not include any benefit from such spending.

Update: David Altig clarifies in comments:

Mark -- I think the statment "If anyone tries to tell you that tax cuts change the long-run growth of output per capita, call them on it. They don't." is too strong.  It is true that they don't in the class of exogenous growth models that the Treasury group seems to employ.  However, such effects are clearly possible in some variants of endogenous growth models. Cheers -- da

Thanks David. I should have made it clear, as I hope it was in the original discussion when I quoted from the report, that I was talking in the context of the model used by Treasury that had generated all the buzz. Better wording would have been, "If anyone tries to tell you ... using the evidence in the report ..."

    Posted by on Friday, July 28, 2006 at 12:21 PM in Budget Deficit, Economics, Policy, Politics, Taxes | Permalink  TrackBack (0)  Comments (6)


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