OKPOLICY.ORG
Would an income tax cut foster so much economic growth that tax revenues would actually go up? In other words, can tax cuts pay for themselves? A new poll of 40 of America’s foremost economic experts was unable to find a single one in agreement with the assertion.
The idea that tax cuts pay for themselves, closely associated with economist Arthur Laffer and ‘supply-side economics’, is an article of faith that has been promoted by tax cut proponents for over four decades. It was a central idea in the report prepared by Laffer and his associates for the Oklahoma Council of Public Affairs that formed the basis for tax cut proposals promoted legislators and by Governor Fallin. Laffer’s report selected recent tax collection data to assert that “Oklahoma has demonstrated the dynamic effect of tax cuts” because tax revenues rose following passage of tax cuts in the mid-2000s. The report also stated that the economic growth from eliminating Oklahoma’s income tax “would reduce the static revenue loss of the arithmetic effect, although not completely”.
The idea that tax cut pay for themselves has been widely debunked by economists, including by three leading economic advisers to recent Republican Presidents, Martin Feldstein, Glenn Hubbard and Gregory Mankiw. We explained the fundamental flaws in Laffer’s use of Oklahoma tax data and several Oklahoma economists, along with the Institute on Taxation and Economic Policy, identified methodological problems with their projection of the economic impact of their income tax proposal.
Now comes a survey of a group known as the IGM Economics Experts panel, made up of 40 of the nation’s leading economists from top research universities chosen to represent a range of political and ideological orientations. The economists were asked whether they agreed or disagreed with the following statement: “A cut in federal income tax rates in the US right now would raise taxable income enough so that the annual total tax revenue would be higher within five years than without the tax cut.” Of the 40 members of the panel, 28 ‘disagreed’ or ‘strongly disagreed’ with the statement (71 percent). The remainder were uncertain or had no opinion (5) or did not vote (7). None agreed or strongly agreed.
The comments provided by the panel members were equally revealing. Darrell Duffie of Stanford said: “This calls for a model. A lower tax rate applied to higher earnings could raise or lower tax revenue, depending on the extent of growth.” Bengt Holstrom of MIT said “It seems implausible, but not impossible.” Most others, however, were clear in their assessment of whether tax cuts would produce more tax revenues:
All evidence that I’m aware of suggest that cutting tax rates “marginally” from their current levels would DECREASE revenues, even 5 yrs out (Michael Greenstone, MIT);
Not aware of any evidence in recent history where tax cuts actually raise revenue. Sorry, Laffer (David Autor, MIT);
That did not happen in the past. No reason to think it would happen now (Kenneth Judd, Harvard);
May look plausible on a cocktail napkin (or at a cocktail party), but not true empirically in the US (Anil Kashyup, Chicago)
Not enough time for capital to respond much (physical, human, technology), so it would require implausibly large labor supply elasticities (Pete Klenow, Stanford)
Moon landing was real. Evolution exists. Tax cuts lose revenue. The research has shown this a thousand times. Enough already (Austin Golsbee, Chicago)
That’s a Laffer! (Richard Thaler, Chicago)
Something to keep in mind: The experts rejected the idea that reducing federal taxes, where the top income tax rate is now 35 percent, would increase revenue. Making this argument about Oklahoma’s state taxes, where the top rate is a much smaller 5.25 percent, becomes even more absurd.
I came upon this discussion following one with my wife recently on issues raised by changing tax rates. I find ample justification in economic theory and in empirical observation for the principle illustrated by Laffer’s curve.
The concept of diminishing marginal returns is a basic principle of economic theory, indeed of phenomena far beyond the domain of economic theory. Attempts to ridicule this principle, which is derived from the calculus, by reducing it to scribbles on a napkin or a beer mat are themselves ridiculous. To my knowledge Laffer was only making the elementary point that every percentage increase in tax rates did not yield an equivalent increase or decrease in tax revenues. He may have implied his views on increased taxation but the curve itself does not reflect them.
The principles of economic theory are supported by empirical observation. In many countries, whether industrialised or not, the black economy occupies a significant role in overall economic activity. With few exceptions, in those countries where the burden of taxation is relatively heavy, the black economy tends to grow. In addition, in countries where taxes are relatively high, their administration is often complicated, deterring their fulfillment, especially by small businesses.
Taxation is the price paid for a society made more (or less) civilised by spreading the availability of public goods and services. This is a political choice. Addressing just this choice — or “art” — Jean-Baptiste Colbert, French Minister of Finance in the reign of Louis XIV, said “the art of taxation is so to pluck the goose as to extract the maximum number of feathers with the least possible amount of hissing”. Which is just a delightful characterisation of how we humans, too, react to each percentage change in tax rates. In other words, to diminishing marginal returns; to pain if you’re a goose!