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Monday, December 10, 2007

"Do Tax Cuts Ever Raise Revenues?"

Justin Fox, in response to my criticism of his statement that ""Some tax cuts do raise revenues", says:

Do tax cuts ever raise revenues?, by Justin Fox: Mark "Economist's View" Thoma was appalled by my statement in this post that, "Some tax cuts do raise revenues, of course." So much so that he took back a bunch of nice things he'd just said about my column on Arthur Laffer. ...

I'm certainly not going to say that no tax rate cuts have ever raised revenues. Would Mark Thoma say that?

Yes I would, see below. Continuing:

Just two off the top of my head: The 1964 Kennedy reduction of the top marginal income tax rate from 91% to 70% (it was enacted after JFK's assassination, but it was his bill), the 1981 Reagan reduction of the top marginal rate from 70% to 50%. I'm not at all an expert on this, but I don't think it's too controversial among economists to assert that those particular changes (but not the rest of the of Kennedy and Reagan tax legislation) were a break-even or better for the Treasury. (Brad DeLong on the 1980s tax cuts: "As I read the evidence ... reducing the top tax rate from 70% to 50% is probably a revenue gainer and surely not much of a loser. From 50% to 28% is, I think, very different: a big revenue loser.") ...

He's right, it's not controversial, but the lack of controversy is in the other direction, and it's too bad Brad has confused the issue. Let's look at what other economists have said. Quoting Robert J. Gordon's textbook, Macroeconomics, pg. 394:

The fact that the United States entered into an era of persistent deficits after the Reagan tax cuts suggests that it moved from a point like C to B in the 1980s, not from D to C.

He is talking about a graph of the Laffer curve and moving from C to B is a fall in revenues. Likewise, William Baumol and Alan Blinder's text, Macroeconomics, says (pgs. 195-197):

The large Reagan tax cuts in the early 1980s ballooned the budget deficit ... Thus supply-side tax-cuts are bound to raise the government budget deficit. This problem proved to be the Achilles heel of supply-side economics in the United States in the 1980s. It left behind a legacy of budget deficits that took 15 years to overcome.

So, the Reagan tax cuts do not provide us with an example of tax cuts paying for themselves, not at all. There's no controversy about whether deficits increased after the Reagan tax cuts - they did - so the Reagan tax cuts were not self-financing. It's disappointing to see that some people think they were after all the debunking of this myth that has occurred.

It was mainly the suggestion about the Reagan tax cuts that brought the response, but let's deal with the Kennedy tax cuts as well. Did they pay for themselves? Unlikely. Rather than running down a bunch of references, here's the explanation for the confusion. It's important to remember that the debt from the Vietnam war was, to a large extent, monetized (so the debt that was created was hidden by monetary policy). Thus, throughout this period there was stimulus to the economy from debt monetization, and when evaluating the tax cuts it's important to take this effect out (i.e. the effect that monetary policy had on stimulating output as well as the reduction in debt from the  debt monetization). When you do, the evidence that the tax cut paid for itself just isn't there.

So, to answer Justin's question once again, yes, I would and do say that there's no evidence that tax cuts have ever paid for themselves. [I realize that there is an attempt by Brad and Justin to isolate particular features of the tax changes, e.g. to just look at the change for the top group in isolation and analyze those changes by themselves, and I suppose with a narrow enough focus we could find somebody who paid more taxes after the change, perhaps even a group who did, but to me that just confuses the issue - overall these tax cuts did not pay for themselves, and even the statement that they did for small subgroups at the very top is debatable and subject to interpretation].

Update: Here's Bruce Bartlett:

As the staff economist for Representative Jack Kemp, a Republican of New York, I helped devise the tax plan he co-sponsored with Senator William Roth, a Delaware Republican. Kemp-Roth was intended to bring down the top statutory federal income tax rate to 50 percent from 70 percent and the bottom rate to 10 percent from 14 percent. We modeled this proposal on the Kennedy-Johnson tax cut of 1964, which lowered the top rate to 70 percent from 91 percent and the bottom rate to 14 percent from 20 percent.

We believed that our tax plan would stimulate the economy to such a degree that the federal government would not lose $1 of revenue for every $1 of tax cut. Studies of the 1964 tax cut showed that about a third of it was recouped, and we expected similar results. Thus, contrary to common belief, neither Jack Kemp nor William Roth nor Ronald Reagan ever said that there would be no revenue loss associated with an across-the-board cut in tax rates. We just thought it wouldn’t lose as much revenue as predicted by the standard revenue forecasting models...

I think that's overly optimistic (recovering a third), but even that is a far cry from self-financing.

Update: More from David Beckworth.

    Posted by on Monday, December 10, 2007 at 11:07 AM in Budget Deficit, Economics, Taxes | Permalink  TrackBack (0)  Comments (67)


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