Some readers disagreed with my assertion in that tax cuts will lead to budget deficits, if the lost revenue isn't balanced by a decrease in spending. (See Compare the 2008 Presidential Candidates on the Economic Issues)
These readers are referring to supply-side economics which states that tax cuts will stimulate the economy enough to eventually recoup the lost tax revenue.
However, economists do not agree that supply-side economics really works. In fact, after doing a lot of digging, I have not found one indisputable research report to back this up.
The research does show, however, that tax cuts can lead to economic growth if spending is also decreased. Other research shows that the tax cuts can recoup some of the lost revenue.
For a more detailed discussion of what I found, and my conclusions, see Supply-side Economics - What Is It and Does It Work?
Comments
I got a chuckle from your article.
You say “I have not found one indisputable research report to back this up.”
I’m not surprised.
When this idea was first raised by Ronald Reagan, George Bush Sr. referred to it as Voodoo Economics.
It was voodoo then and it’s voodoo now.
Using a term over and over doesn’t make it more true, but as propagandists have shown it does bring acceptability. The same process has occurred with claims that Iraq was a haven for terrorists before the U.S. invaded. Interestingly both ideas come from the same source.
Hi Jim,
Thanks for the confirmation. One of my core values on this site is to back up my assertions with fact.
I also provide links to my research, so you can review it.I am open-minded about ideas, but need to see the facts before I will adopt them.
Kimberly
I am so glad that economics has gotten that simple. Here I was thinking that there were a number of effects on budgets. That a tax cut would have the effect of raising tax collection on one side because of the economic stimulus and lower them on the other side because taxes are reduced. Here I was thinking that you needed to carefully study the potential effects on different sectors of the economy in order to make an informed jugement. Thank God you found the silver bullet. After all, if you have not found any “indisputable research report” to back up supply side economics, that can mean only one thing. Tax cuts will ALWAYS ONLY increase the budget deficit. There is ABSOLUTLY NO NEED to study the different effects of the tax cut.
You are correct in that tax cuts do lead to a number of effects. I did, in fact, state that they cuts lead to growth IF spending is also decreased.
However, it is also true that there has not yet been proof that tax cuts lower the budget deficit. If you have found research to support it, please let me know and I will be happy to review it with an eye to revising my statement.
Kimberly
I didn’t say that supply side economics works. But your assertion is not backed up at all. There is actually no “indisputable research” that shows that supply side economics does not work. Tax cuts may or may not lead to growth depending on a wide variety of factors including the state of the budget, the nature of the taxes being cut, the nature of spending that may or may not be cut… Let’s look at the following situation: you have a very large budget surplus and a tax whereby all income above $100 000 is taxed at 95%. Let’s say now you remove that tax (which accounted for half of the budget surplus) and you increase spending on infrastructural development (using what remained of the budget surplus). I am ready to bet the farm you will get an increase in growth. Yet, you have NOT cut spending (you in fact increased spending) and you have cut taxes. Fiscal policy is a very complicated topic and all theories within that field of economics need to be qualified with endless assumptions and conditions of operation. You cannot in all honesty say that supply side economics was proven correct or wrong. The truth is, we don’t know… Only a handful of economists would say that supply-side economics has no merit nor use. People make endless fun of the Laffer curve being drawn on a napkin, but those displaying intellectual honesty to agree that there has to be some sort of a relationship similar to the one described by the curve. If you tax people too much, they have little incentive to work and therefore, there will be less taxes to collect. If you don’t tax people enough, you won’t collect enough taxes. ceterus paribus being the key here. But the relationship exists in some form or another implying that there is a point at which if you decrease taxes ceterus paribus you will increase tax revenue. To deny supply-side economics like that is like saying that because bowling balls fall faster on earth than apples fall on the moon, Newton was wrong.
PrometheeFeu, there is nothing complicated about fiscal policy that politicians haven’t made complicated simply to try and save their own necks. Here’s a scenario. A family brings in $20,000 in one year. Their expenses that year equal $15,000. They have no deficit. The next year, one income falls. The expenses are still $15,000, but they only bring in $14,000. They now have deficit. The next year, still only one person is still working in the family, but hours are cut and he only makes $12,000. Expenses are still $15,000. Now, they have a deficit budget of $4,000, coming from the $1,000 the first year, and another $3,000 the second year. They are in debt. The amount of money they take in decreases, and they end up in more debt.
That family then decides they can get rid of $2,000 in expenses. They still only make $12,000 this year, so expenses are still $13,000. The next year the family gets rid of $1,500 in expenses. So, expenses are $11,500. The family brings in $12,000. The deficit is now down $500. However the total is 1000+3000+1000-500= $4,500.
Before someone notes it, yes, this is a very simplistic, underestimated, and somewhat unrealistic view of the average family. However, it does illustrate that in any check book, if spending is more than income, debt is the result. It is the same way with government. The rules of sound finance do not stop in the White House, though admittedly it seems that people believe they do. Saying that fiscal policy is complex is merely a cop out, an excuse fed to the general public to redirect blame for where it truly lies on the shoulders of irresponsible spenders.
Conclusion: Fiscal policy is in reality no more complex than family finances. There are bills. Someone has to pay them. If there is not enough money, the result is deficit, debt, and financial collapse. Welcome to reality.
TP, you are right for the most part. There is only one difference between a government and a family’s debt. When a parent dies or goes bankrupt, the children cannot be held responsible for the debt. However, government debt will be paid by our children and grandchildren as either increased taxes or lower standard of living.
Kimberly
T P:
Yes. If your income goes down and your spending does not, then you get a larger deficit or a smaller surplus. That is true by definition and very few people would argue with that. However, you are forgetting that fiscal policy is not just a decision to get x dollars of income. If that was it, it would be easy: “We want to spend y more dollars, so let’s just increase the governement’s income by y dollars…”
Taxes can have an important effect on the allocation of the means of production and ultimately on the amount of money that ends up being taxed. If you tax more heavily something, it becomes less profitable and so it might drive people to do something else that you are taxing less which may end up driving the tax receipts down. How you spend is the same thing: Build infrastructure, and it may cause economic growth which may result in a growth in tax receipts.
Notice how I am using the word “may” instead of “will.” That’s because it’s very difficult to know what the final effect of many policies will be. The truth is, we’re not sure both because there are way too many factors at work (raising taxes on milk would be likely to increase the price of milk but may also drive some farmers to produce beef instead of milk which will drive down the price of meat for a net result on consumers, employees of both industries and tax receipts of? Nobody knows…) and because, there are serious disagreements between economic theories.
And yes, politicians have not proved themselves to be the best stewards of public funds. But the complication is not entirely their doing.