What is the biggest economic and political lie in our country’s history?

It’s probably the tale that tax cuts pay for themselves by increasing GDP growth. Like most lies told by politicians, there is a touch of truth to it. When hundreds of billions of dollars are pumped into consumers’ pockets with a tax cut, consumer spending, business activity, employment and business profits increase, increasing tax receipts. However, the taxes collected won’t increase enough in the long run to even come close to recovering the tax revenue lost in the first place. 

The Republicans justify cutting taxes by pointing to the short-term increase in tax revenue and implying the tax cuts pay for themselves. But if tax cuts paid for themselves, our National Debt should not have increased anywhere near as much as it did under Reagan, Bush, and G. W. Bush. In fact, our National Debt should have decreased and we ought to be rolling in money if “stimulating” our economy with tax cuts significantly increased our GDP growth rate.

A study by the Center on Budget and Policy Priorities in 2003 concluded that tax cuts don’t even come close to paying for themselves. A follow-on study in 2006 validate the 2003 study and concluded the idea that tax cuts can pay for themselves sounds too good to be true because it is to good to be true¹.  Some key findings of the 2006 study are the following.

• Despite recent statements by the President, Vice President, and certain Congressional leaders that tax cuts pay for themselves, economists from across the political spectrum — including the Administration’s current and former chief economists — reject this notion. Further, the Treasury Department’s own analysis of the President’s tax cuts confirms common sense and conventional wisdom; it concludes that, even under favorable assumptions, the tax cuts would generate added [GDP] growth that would offset no more than 10 percent of their long-term costs.
• Overall, this economic recovery [after 2001] has been slightly weaker than the average post-World War II recovery. In particular, GDP growth and investment growth have been below the historical average, despite recent tax cuts specifically targeted at increasing investment.
• Studies by the Congressional Budget Office, the Joint Committee on Taxation [a non-partisan House and Senate committee], and the Administration itself show that tax cuts do not come anywhere close to paying for themselves over the long term. CBO and Joint Tax Committee studies find that, if financed by government borrowing, tax cuts are more likely to harm than to help the economy over the long run, and consequently would cost more than conventional estimates indicate, rather than less. Moreover, in its recent “dynamic analysis” of the impact of making the President’s tax cuts permanent, the Treasury Department reported that even under favorable assumptions, extending the tax cuts would have only a small effect on economic output. That small positive economic impact would offset no more than 10 percent of the tax cuts’ cost. [Some other studies estimated a maximum payback of 30-40%. Is a loss of 60-70% a good investment?]
• When the 1981 tax cuts were being debated, some supporters contended the tax cuts would more than pay for themselves. Similarly, opponents of the 1990 and 1993 tax increases claimed they would damage the economy and cause tax receipts to grow more slowly in the 1990s than in the 1980s. In fact, the economy grew at about the same rate in the 1990s as in the 1980s, while tax revenues grew about twice as fast in the 1990s [when tax rates were increased] as in the 1980s.
• The Treasury Department’s own recent “dynamic analysis” of the effects of making the President’s tax cuts permanent shows that the tax cuts would not come anywhere close to paying for themselves.
• The Administration itself does not project in its budget forecast that the tax cuts will pay for themselves.
• There is no evidence capital gains tax cuts pay for themselves or increase tax revenue.
• N. Gregory Mankiw, former chairman of President Bush’s Council of Economic Advisors and a Harvard economics professor, wrote in his well-known 1998 textbook that there is “no credible evidence” that “tax revenues … rise in the face of lower tax rates.” He went on to compare an economist who says that tax cuts can pay for themselves to a “snake oil salesman trying to sell a miracle cure.”²
• Commenting on President Bush’s claim that tax cuts pay for themselves, the Economist magazine recently wrote, “Even by the standards of political boosterism, this is extraordinary. No serious economist believes Mr. Bush’s tax cuts will pay for themselves.”³

Reducing taxes is great, but if spending isn’t cut, the result is a budget deficit and debt that future taxpayers will have to pay. Reducing taxes, spending borrowed money, calling it prosperity, and ignoring the increased debt has convinced many Americans there is a tax fairy that brings free lunches to those in need.

Promoting this lie may have been smart (but dishonorable) politics, but has led to bad spending, tax, and policy decisions that have covered up many of our economy’s problems, weakened our competitiveness in international markets, made us financially more dependent on foreigners, cheapened our dollar, and weakened our economy. We are seeing some of those effects today.

Contrary to what many Americans believe, most of what ails our sick economy cannot be fixed simply by reducing taxes and fiddling with interest rates. The problems are much deeper than that. All of the propping up of our economy with budget deficits and tax cuts after 1981 has done little to cure the fundamental causes of our failing economy.

If we had invested the money we borrowed in our national infrastructure, education, energy, and other programs that could have yielded a net return, the tax cuts might have paid for themselves and strengthened our economy. But that’s not what we did. The money was put into taxpayers’ pockets and spent on consumer goods and services, making everyone think all was well when it wasn’t.

Government financial data clearly show that the tax cuts made after 1981 have not paid for themselves by a wide margin. Anyone making statements to the contrary is very poorly informed, lying or in a state of denial. Repeating policies that didn’t work in the past isn’t going to make them work in the future.

Does anyone out there still believe in the tax fairy? What should our government’s policy be regarding budget deficits?

Footnotes:

¹Kogan, Richard and Aron-Dine, Aviva, “Claim That Tax Cuts ‘Pay For Themselves’ is Too Good to be True: Data Show No ‘Free Lunch’ Here”, Center on Budget and Policy Priorities, July 27, 2006, http://www.cbpp.org/3-8-06tax.htm.
²N. Gregory Mankiw, Principles of Economics, Dryden Press, Fort Worth, TX, 1998, pp. 29-30.
³The Economist, “Tripe Is Back on the Menu,” January 14, 2006.