Lowering Taxes Does Not Raise Revenue

Posted on November 26, 2011. Filed under politics

I try to give all political opinions a fair shake, but there is one conservative assertion that just makes me hang my head with embarrassment. This is the assertion that cutting taxes actually increases government revenues.

No, it doesn’t. Not at the present rate of taxation, anyway. And now I have some evidence to back that up, beyond my hunch (keep reading).

The argument goes that by leaving the public with more money, that stimulates the economy, which results in more taxable income, which results in more tax revenue. Wouldn’t this be awesome?

I absolutely do believe that less taxes stimulates the economy. But not to the level required to offset the cut in revenue. I made this exact argument over a year ago:

For the record – and before I get jumped on by someone on the Right – I do absolutely believe that tax cuts stimulate the economy. But they can’t “just” stimulate the economy – they have to do so to such a degree that they generate enough new taxable revenue to offset themselves, and this is trickier.

Example: if you have a 25% tax rate, cutting $1 in taxes means that $1 cut has to generate $4 in taxable revenue in order to replace the $1 you just cut from actual tax revenue (25% of the $4 in newly-generated taxable revenue replaces the $1 we just cut from actual tax revenue). With a 90% tax rate, your $1 tax cut would have to generate just $1.10 in new revenue.

No, Simon Johnson of the New York Times has given us a handy reading guide for proving this ridiculous assertion false.

Can tax cuts “pay for themselves,” inducing so much additional economic growth that government revenue actually increases, rather than decreases? The evidence clearly says no.

Johnson cites a study done in 2006 by one of George Bush’s own advisors:

Specifically, Professors. Mankiw and Weinzierl calculated that 32.4 percent of the “static” or direct revenue loss of a capital-gains tax cut and 14.7 percent of the static revenue loss of a labor tax cut could be offset in present-value terms by additional growth, ignoring short-term Keynesian effects (i.e., any immediate stimulus provided to the economy).

Those numbers again: 32.4 and 14.7 percent. Remember, the claim is that the tax cut is offset by 100 percent. We’re quite a bit short there.

Another study (PDF), this time by the then-Republican-controlled CBO:

More broadly, in 2005, the Congressional Budget Office, then headed by a Republican appointee, Douglas Holtz-Eakin, estimated that the economic effects of a 10 percent cut in income taxes would offset from 1 to 22 percent of the revenue loss in the first five years; in the following five years, the economic effects might offset up to 32 percent of the revenue loss, but might also add 5 percent to the revenue loss.

The numbers there: 1 or 22 percent, or maybe 32 percent, but perhaps –5 percent. Again, none of those numbers are 100 percent.

Five years ago, Andrew Samwick, who was once the Chief Economist on Bush’s Council of Economic Advisors, wrote this on his personal blog:

You are smart people. You know that the tax cuts have not fueled record revenues. You know what it takes to establish causality. You know that the first order effect of cutting taxes is to lower tax revenues. We all agree that the ultimate reduction in tax revenues can be less than this first order effect, because lower tax rates encourage greater economic activity and thus expand the tax base. No thoughtful person believes that this possible offset more than compensated for the first effect for these tax cuts. Not a single one.

Now, look – I’m all for tax cuts. I believe that affordable tax cuts are a great thing – it’s our money, and we should keep more of it. So my antipathy to this argument is certainly not a moral or philosophical one.

Rather, I find myself insulted by it. I’m insulted when someone stares me in the face (or into a TV camera) and tries to get me (or the public) to believe something as patently stupid as this. Do I really look this dumb?

Sadly, this argument still resonates with a lot of public. Why? Because it’s awesome. it’s like trickle-down economics – it’s a neat, palatable theory that makes us all happy because we get both of the things we want: less taxes and more growth. This is the ultimate dream, so we sit around and nod our heads and don’t look critically at it lest we realize it’s a massive load of bullsh*t.

If you want to cut taxes, couch it in terms of government waste, or the immorality of higher taxes, or...something. But please don’t tell me that cutting taxes will actual raise government revenue. I’m just not that stupid.

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