Tax reform won't happen — but tax cuts that hurt future generations will
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The House Ways and Means Committee will hold hearings Thursday on how tax reform can grow the economy and create jobs. The members shouldn’t get their hopes up — and neither should the American people. We’ll be lucky to get any net long-term economic growth out of a tax package.

What we can expect from the Congress is tax cuts, not tax reform. Reform involves changing the tax structure, which will cause some individuals or firms to pay more. In a bipartisan deal, both sides share blame for tax increases, which limits the scope for partisan attacks after the fact. But a single party that controls both chambers of Congress and the White House has a target on its back.

When financial burdens are raised on important constituencies, there’s nowhere to pass the blame. Tax cuts, by contrast, raise the debt and burden members of future generations, who don’t have lobbyists and can’t vote in the members’ next re-election campaigns.

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In principle, tax cuts could raise growth, since lower marginal tax rates boost people’s incentive to work and save and firms’ incentives to invest and hire. But lower rates also give people more after-tax income — discouraging productive activity — and require higher government borrowing, which will reduce future economic growth. Both the House GOP “Better Way” plan and the president’s proposal would boost government borrowing by trillions of dollars to finance the resulting increased federal budget deficits.

 

In practice, the record shows tax cuts have small or negative effects on long-term growth. Since tax cuts advocates routinely invoke Ronald Reagan, whose 1981 plan reduced top individual income tax rates by 20 points, let’s start there. The economy did, in fact, grow robustly in the years following the 1981 tax cut. But the vast majority of this growth, according to Martin Feldstein, President Reagan’s former chief economist, was due to expansive monetary policy that slashed interest rates massively.

In addition, a defense buildup boosted spending and an influx of baby boomers — who were between 17 and 35 years old in 1981 — and women expanded the labor force. In a separate study, Feldstein and former Congressional Budget Office Director Doug Elmendorf, then a graduate student, found no evidence that the 1981 tax cuts got people to work more. And alarm about deficits convinced Reagan and Congress to roll back a big share of the tax cuts — though not to increase the tax rates themselves.

The Bush tax cuts in 2001 and 2003 paint a similar picture. Between 2001 and 2007, the economy grew at a lackluster pace — real per-capita income rose by 1.5 percent annually, compared to 2.3 percent from 1950 to 2001 — with gains concentrated in housing and finance, two sectors that were not favored by the 2001 and 2003 tax cuts. In 2006, prime-age males worked the same amount and women worked less, compared to 2000, inconsistent with the view that lower tax rates raise labor supply. Bill ClintonWilliam (Bill) Jefferson ClintonMueller’s probe doesn't end with a bang, but with a whimper Mark Mellman: History’s judgment Congress should massively ramp up funding for the NIH MORE’s tax increase in 1993 didn’t cause the economic boom that followed in the 1990s, but at the very least it shows that higher levies on high-income households need not interfere with faster economic growth.

More recently, several states experimented with tax cuts with little obvious success. The most notorious case is Kansas, where Gov. Sam Brownback said in 2012 that a tax cut would be “like a shot of adrenaline into the heart of the Kansas economy.” Since the tax cut, however, Kansas’s economy has lagged behind neighboring states’ and the state’s budget has been in tatters.

The international evidence is equally discouraging. Research shows little correlation between how countries change their top income tax rate and how much their economies grow. Despite the evidence, the administration continues to vastly overstate the prospects for growth from their package of tax cuts. Treasury Secretary Steven Mnuchin says that the president’s proposed tax cuts would raise growth by so much that they would be self-financing.

Virtually everyone outside the administration not named Laffer disagrees, including all of the 37 leading economists in a recent University of Chicago survey. So why does the pursuit of tax cuts in the name of growth persist? The most obvious answer is wishful thinking. Self-financing tax cuts would be so much easier to enact than the hard choices that face policymakers who are budget realists.

For the cost of the president’s tax cut proposals, we could boost infrastructure spending by 1 percent of gross domestic product (GDP), and safety net and education spending by another 1 percent of GDP. These programs wouldn’t pay for themselves, but research strongly suggests they would be more effective and inclusive ways to boost both short- and long-term economic growth than tax cuts.

 

William G. Gale is the Arjay and Frances Miller Chair in Federal Economic Policy and a senior fellow at the Brookings Institution. He is co-director of the Tax Policy Center, a joint venture between the Urban Institute and Brookings. He served as a senior economist for the Council of Economic Advisers under President George H.W. Bush.


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