Do Tax Cuts Lead to Budget Deficits?
Wednesday February 6, 2008
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.