The promise that can’t be fulfilled

Boy, wouldn’t I like (another) tax cut. Who wouldn’t? Well, if you are thinking about the future, about the wellbeing of your children and grandchildren, you might not want a tax cut either.

Politicians are not only reluctant to raise taxes when needed – think Social Security and Medicare – but they like to make irresponsible promises of lower taxes.

Consider these analyses

• There is no theoretical basis to suggest tax cuts could be self-financing. To do that, the economy would need to grow by $5 to $6 for every $1 of tax cuts.
• There is broad consensus among economic models that future tax cuts won’t pay for themselves. Some models find tax cuts would be partially self-financing, while others find the economic feedback would actually increase the deficit effect of tax cuts.
• Past tax cuts in 1981 and the early 2000s have led to widening budget deficits and lower revenue, not the reverse as some claim.

No Reasonable Economic Model Shows Tax Cuts Paying for Themselves

Theory aside, there is no evidence that large tax cuts could pay for themselves. At best, they would offset a relatively small fraction of the initial revenue loss. At worst, they may lose more revenue.

As referred to above, CBO evaluated the potential impact of a 10 percent cut in individual marginal tax rates using a number of different models in 2005. They found that, at best, the added economic growth would offset one-quarter of the ten-year cost of the initial tax cut, and this scenario assumed that future tax increases would be enacted to offset the cost. At worst, CBO concluded the tax cut would slow economic growth and increase the cost slightly (by 3 percent).

Past Tax Cuts Have Led to Lower Revenue

When the theory and analysis show tax cuts will not pay for themselves, some advocates look to historic examples – especially arguing that the 1981 and 2001/2003 tax cuts paid for themselves. In reality, virtually all tax cuts in U.S. history have lowered revenue.

William Gale and Andrew Samwick in 2016 surveyed studies of actual individual income tax cuts – as well as simulations of possible tax cuts – and their effects on economic growth. They summarized that most studies found either only a very small positive effect or a negative effect on growth due to the deficit-financed nature of the tax cut. According to the studies and simulations, it is not clear whether individual tax cuts increase growth at all, let alone by enough to pay for their initial cost.

Looking specifically at the performance of revenue after the 1981 and 2001/2003 tax cuts confirms this. Advocates point to the fact that nominal or inflation-adjusted revenue levels rose after these tax cuts. However, this is the wrong measure – revenue almost always rises as a result of growing real wages and income (as well as inflation in the case of nominal revenue).

Looking at revenue as a share of potential GDP, which uses cyclical adjustments to account for recessions, one can see very clearly the effects of these tax cuts on revenue.

Prior to the 1981 tax cuts, cyclically-adjusted revenue totaled 19.3 percent of potential GDP. After 1981, it fell precipitously to a low of 16.9 percent of GDP in 1986 before rising to 17.8 percent – still well below the pre-cut levels by 1989. Similarly, revenue prior to the 2001/2003 tax cuts totaled 19.8 percent of GDP. After the tax cuts, it fell to a low of 15.7 percent in 2004 before rising to 17.9 percent by 2007 – again remaining well below the pre-tax cut levels.

Source: Committee for a Responsible Federal Budget

Promises

Now, people don’t realize, I brought taxes way down, way, way down. And yet we took in more revenues the following year than we did when the tax rate was much higher. Most people said, how did you do that? Because it was incentive. Everybody was coming to the country, they were bringing back billions and billions of dollars into our country. The companies made it impossible to bring it back.

The tax rate was too high and the legal complications were far too great. I changed both of them, and hundreds of billions of dollars by Apple and so many other companies would work back into our nation, and we had an economy the likes of which nobody, no nation had ever seen. China, we were beating them at levels that were incredible. And they know it. They know it. We’ll do it again, but we’ll do it even better.

Source: D Trump convention speech

What the facts on tax cuts, especially the 2017 tax cuts? Here is a good analysis based on the numbers.