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Thursday, October 1, 2015

Can tax cuts pay for themselves?

The assorted Republican hopefuls are now trotting out pieces of policy platforms. Most of them aren't very good working with media. Then there's Trump. If you have to watch a would-be politician speaking nonsense, then he's the clear winner, so untroubled by consistency and logic as to be fun. So while Jim Bresnahan, the host of my radio show on WREL Lexington VA (at 1450 AM), asked me to comment on Trump. Well, I'm not willing to read much into any of the Republican policy pronouncements at this point. Those will flip: we know that what appeals to Republican primary voters does not work with the general electorate. Trump will do well if he reaches that point, as no one expects him to be consistent.

...the mantra that tax cuts ... pay for themselves ... but repetition doesn't mean it's true

That said, the biggest dollar component of Trump's proposals – as with those of Jeb Bush – consists of tax cuts for the rich. Yes, there's Trump's headline proposal of zero taxes below a certain income level, but those people already pay little or no income tax. Yes, certain deductions for the wealthy will be removed. At the same time, he's put forward a lot of arcane-sounding items that in fact represent very large tax cuts for the wealthy. That shouldn't be a surprise: he makes no bones about being a billionaire, and when it comes to taxes he knows how to butter his own bread. In any case, he's not shy about chanting the one mantra all Republicans share: cut taxes. Remember: presidential candidates can propose, but it's the actual elected Congress that legislates.

So let me turn to the other mantra our candidates are chanting: tax cuts are not only good for growth, there's so good for growth they'll pay for themselves. (There's jargon for that: dynamic scoring.) Constant repetition may be soothing for the stress of the campaign trail, but doesn't make it any more true or false. Art Laffer's conceptual case is merely that: with very high tax rates, a cut can lead to an increase in revenue. But we no longer have 90% (marginal) income tax rates, or even 40% rates. We can't presume that the conceptual case is relevant to US circumstances. That is, we need to do a reality check.

First, there's basic arithmetic of what it takes for a tax cut to be revenue neutral: if you cut taxes by 10%, then the economy has to grow by more than 10%, because you've shrunk the tax base. Furthermore, it has to do that immediately, because you lose revenues up front. That a decade from now the economy is larger is not sufficient to do the trick.

Second, there's diminishing returns. If tax cuts work, then most of the bang comes from the initial round of cuts. The second time around they won't work as well. By the third round they lose virtually all of their power. So if there is a big effect, that would have been with those of Reagan's first-term in the early 1980s. Now many listeners won't remember that era, after all the youngest of those who voted for him are now 53 years old. But while growth wasn't bad, most of that can be attributed to recovery from the Volcker recession and the second oil crisis, which included a drop in interest rates by over 10 percentage points from peak. (Three-year bond rates fell from a peak of over 16.5% to a bit under 6.5%.) Our second big round of cuts was under Bush Jr, with little visible impact. The third round under Obama had even less impact. (While that fact has disappeared from political rhetoric, Obama sided with Republicans, with half of the ARRA "stimulus" package in the form of tax cuts.) A fourth round will get us nothing.

Furthermore, the empirical evidence is that the biggest part of tax cuts in fact take the form of losses in revenue. The Federal deficit ballooned from 1.5% of GDP during the Reagan's first election campaign to 4.9% in 1986, well into his second term. Whatever gains those cuts brought through growth were far short of what was needed to offset them. A quick example: tax cuts for regular workers were up to 25%. So you'd need 25% more labor income to offset them. But while they were sold as "supply side" cuts, we didn't see the average work week go from 40 hours to 50 hours, or a huge jump in wages. But we did see consumption boom: these tax cuts did have a clear demand-side effect.

So neither logic nor empirical evidence provides a direct case that cuts pay for themselves.

Let's examine this from another angle: labor and capital. If the economy is to grow, then inputs have to grow. Is there evidence that employers can't find enough workers, and that is what is holding back growth? Likewise, do businesses find it hard to come up with the cash for investment?

On the first point, it's very clear that the problem is that workers lack of jobs, not that jobs lack workers. The number of long-term unemployed remains high by the standards of the past 70 years. Ditto the number of workers on involuntary short hours, the number of discouraged workers, and the number of workers with jobs that pay low wages.

On the second, firms are sitting on record amounts of cash, and they earn very little on it. Similarly, if a modest cut in tax rates would boost investment, then a modest cut in interest rates should likewise boost investment. Well, we've tried the latter to little effect: investment isn't low, but it's not enough to drive growth higher. The bottom line is that when it comes to investment businesses see a lack of opportunity, not a lack of ability.

To sum up, there's no evidence that yet one more round of tax cuts will be effective, much less serve as a panacea to America's slow recovery from the Great Recession. The evidence is however clear that cuts would boost our deficit.

[Aside: As an economist analyzing the impact of tax cuts provides empirical challenges. The underlying dynamics of population growth and ongoing investment and new technologies mean that there's a strong base of growth. This is the "cake," the substance of the economy. If tax cuts matter, then it's because they add icing to the cake. Since many other factors add icing, the bottom line is inevitably that tax cuts are at best a part. However, there is one major offsetting effect that does allow us to "bracket" the empirical impact: unfortunately the US cake isn't top-heavy with icing, the share of growth that can't be tied to extraneous factors such as taxes has shrunk over the past 25 years. So if taxes matter, they don't matter much.]
Addendum: see the blog post of Oct 8th, 2015 for graphs that present the arithmetic of "dynamic scoring." The bottom line is that tax cuts don't pay for themselves.


A quick news item was the failure of the latest effort to legislate by temper tantrum. Funding for the government isn't guaranteed, the bill that passed merely kicks the can down the road to December. Now those who voted for a shutdown surely could count votes, and knew it wouldn't go through, so it's hard to know whether they were serious. In any case, I personally dislike grandstanding of this sort.

United Way of Rockbridge:

We've now launched our 2015-16 fundraising campaign, with a goal of $250,000. It's too early to have any results. In any case, we've always had far more demand than resources: whatever we succeed in raising, we realistically have non-profits who could do much more for our community if we could help them with additional funding. So what I want to focus on during the next three months are these community-oriented non-profits.

One is the Rockbridge Area Occupation Center (RAOC), headquartered on Sycamore Street in Buena Vista. Their mission is to employ disabled members of our community. That helps these individuals to maintain a measure of independence, it improves their lives by giving them purpose, it lets them contribute directly to their community, and it provides for regular interaction with others. Towards this end RAOC defines its mission as to "Create a safe workplace where people with disabilities can provide high quality products & services in a timely manner." (http://raoc.org) They are very good at their mission: about 10% of their workers are ultimately able to find private-sector jobs.

To turn mission into practice requires three components. First, they need to locate work that aligns with the capabilities of their workforce of about 30-35 individuals. Second, they need to provide training and supervision. Third, they need to provide transportation, as most of their workers are unable to drive.

The Great Recession has made their operation more challenging, as numbers of businesses that employed their workers went out of business or cut back. So they are now undertaking jobs as far away as Lynchburg, with the attendant costs in transportation.

Keep them in mind this fall: they can assist with yardwork, some of their workers can use a chainsaw and help clear out woods, and of course there are other tasks that they can undertake. If you run a small business, consider using them to clean your workplace once a month. Willy Funkhouser, the Executive Director, can help you sort out what their workers can realistically do. Contact him through their website, or call 261-6159. Of course they welcome cash contributions, too, and have a click-to-donate function on their website.

Contributing to the United Way of Rockbridge is a way to help an array of such non-profits that serve our community. We currently fund 22 organizations and projects; for each, we review their funding proposal, check their financial statements, and have reviewers from our community meet with their leadership to gather information first-hand. We do say "no" when groups cannot make a compelling case that they will use our – your! – money well. And unfortunately we also turn down projects – and fund them at levels below what they request – because we don't have enough money to fund them all.

You can go to our website to contribute via a secure click-to-donate button at uwrockbridge.org, or contact us at our offices at 218 South Main Street (P. O. Box 1094) in Lexington, VA 24450. We do answer our phone, too, at 463-4414.