Economists agree: Tax cuts don’t create revenue

Editor’s note: This is the first of two columns on the economics of tax cuts. The second column is Look at the record: Tax cuts did not boost revenue.

Self-paying tax cuts are a popular delusion, except among economists.

University of Michigan economist Joel Slemrod is adamant on one of the key economic issues of our day: ‘Tax cuts don’t pay for themselves! Period!’

Hardly any economist would disagree. This is true for Republicans as well as Democrats. It is also true regardless of whether they describe themselves as NeoClassical, New Classical, Rational Expectations, Monetarist, Keynesian, Austrian or New Institutional economists.

Yet, for a substantial portion of the general public, the idea that cutting tax rates will increase tax revenues has become an article of faith. The following anonymous comment to an online Associated Press story is typical: “The only way our government can create jobs is to cut taxes. It’s been proven over and over again. Cutting taxes also increases government revenue.”

The phenomenon of economists sharing a broad consensus on some issue that is at odds with the beliefs of many in the general public is not rare. Since 1776, most economists have believed free international trade can benefit all countries involved. But many in the general public don’t buy that. For 90 years, virtually all have agreed that the way to deal with external costs like pollution is to tax whatever causes it. This is still scoffed at by noneconomists from both ends of the political spectrum.

Right now, however, those issues are secondary. And the idea that a tax cut would increase tax revenue is particularly dangerous. Since the federal budget was last near balance a decade ago, we have been running persistent deficits that increased the national debt, adjusted for inflation, by 57 percent from 2001 to 2009.

Reduced tax revenues due to the recession, emergency financial rescue programs like TARP and new spending initiated by the Obama administration will make the debt grow even larger. The lack of credibility of the government’s fiscal position threatens global willingness to buy U.S. Treasury bonds.

Many in the general public and many Republican elected officials believe lowering tax rates would help reduce the deficit. Virtually all economists disagree, including the most respected ones who identify themselves as Republicans and who have served in Republican administrations. The stakes are high. If we double down and cut tax rates as many want, the deficit will balloon, not shrink. That will compound our economic problems.

I know this assertion will spur a flood of angry emails telling me I don’t know anything about economics. But I prefer the company of the respected economists, especially the Republicans who oppose the idea of self-paying tax cuts, to the “cranks and charlatans” who sold this delusion to the American people in the first place.

Andrew Samwick, a Dartmouth economist who was chief economist at the Council of Economic Advisers early in the George W. Bush administration, expressed a view most economists endorse: “You know that the tax cuts have not fueled record revenues. You know that the first effect of cutting taxes is to lower tax revenues. The ultimate reduction in tax revenues can be less than this first effect, because lower tax rates encourage greater economic activity. No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts. Not a single one.”

As noted at the top of this column, Joel Slemrod, who served as a tax specialist on the staff of Ronald Reagan’s Council of Economic Advisers in the 1980s, strongly agrees.

So does Martin Feldstein, a Harvard economist who headed the CEA in Reagan’s first administration. Feldstein led the respected National Bureau of Economic Research for 30 years and is a past president of the American Economics Association.

And there’s Greg Mankiw, who headed the CEA for George W. Bush and made the “cranks and charlatans” remark about advocates of self-paying tax cuts.

These are just four highly respected economists who served in Republican administrations. One could go on and on listing others. And it is exceedingly difficult to find any prominent ones who disagree with them

This does not mean these scholars advocate high taxes or big government. They simply reject the gimmicky idea that cutting tax rates will raise revenues.

It is hard to find a more articulate critic of government playing a large role in the economy or a stronger advocate of lower taxes than V.V. Chari, one of the most respected contemporary “neoclassical” economists. Chari has served as a Federal Reserve economist and headed the econ department at the University of Minnesota. But as he noted on a Minnesota Public Radio show last year, smaller government and lower taxes require actual cuts in government spending.

Believers in self-financing tax cuts may respond that all of these distinguished economists are pointy-headed academics who ignore the fact that Reagan administration tax cuts increased tax revenues. They are wrong.

The Reagan administration did cut corporate and personal income tax rates and closed loopholes, thus broadening the base of income subject to taxation. And government revenues at the end of the administration were higher than at the beginning. However, they would have risen even more without the tax cuts. Explaining why that is true requires another column. So save any angry emails until after next week!

© 2010 Edward Lotterman
Chanarambie Consulting, Inc.