Are Tax Cuts Good for Economic Growth?

November 1, 2008

Today's Los Angeles Times had a story about how Obama and McCain differ on taxes, with Obama focusing on questions of vertical equity and McCain focusing on efficiency. In the article, there was a quote from Jared Bernstein of EPI:

"You can't find evidence that low tax rates foster high economic growth," said Jared Bernstein, director of a research program at the liberal Economic Policy Institute. "In my view, Medicare, education, child care and preschool services that the government provides are going to be more necessary in the future."

I'm not sure what Bernstein's definition of "high economic growth" would be, but if he's implying that there is no evidence that lower tax rates help promote economic growth, he's way off the mark. Of course, it's not always the case that a tax rate cut will promote economic growth given that there must be some spending offset, but I could come up with a pretty good list of tax rate cuts financed by spending cuts that would increase economic growth.

It is true that better education pre-K through grade 12 would promote economic growth, maybe even more than tax rate cut. But I can guarantee that if you cut farm subsidies out of the budget and lowered tax rates accordingly, economic growth would be fostered. (As for Medicare promoting economic growth, I'd say that's a stretch…maybe universal coverage for those under 25, but not for those 65+.)

Ask any left-of-center economist who opposed the Iraq war whether or not economic growth would have been higher under lower taxes instead of spending that money in Iraq. They would be unanimous in telling you that lower taxes would have been preferential (holding the deficit constant).

If Bernstein's standard for "high" economic growth is that a tax cut pay for itself, I would agree that no major tax rate cut at today's tax levels is going to promote that much economic growth. (I'm referring to major federal taxes, as I'm sure there is some state out there with a situation where lower tax rates would pay for themselves…say on a cigarette tax or something where there is a large amount of border activity. Also if you consider certain prohibitions to be implicit taxes, repealing them and in effect cutting tax rates would pay for themselves.)

But Bernstein's position seems to be like that of many on the left, which is a lexicographic preference for government always getting bigger, and he's trying to act as if it's a free lunch. It's very similar to the view of those on the right who say that government is a waste and should be starved of all revenue. The fact of the matter is that the optimal size of government > 0, but its optimal size is not 100 percent of the economy (and there would be substantially lower economic growth if that were the case).

There are some government spending items currently in existence that are not worth their costs to taxpayers. Then again, there are some hypothetical government spending items that do not exists right now that would be worth additional tax dollars. The secret is finding which spending items are worth their costs and only funding those, and raising the necessary revenue in the best possible way that meets various criteria (such as equity and efficiency).

It is one of the paradoxes for those who seek to rally support for starving the beast (even if it worked, say, at the state level under a balanced budget rule). You are starving a beast because you view the beast as too wasteful and not looking out for the best interest of the taxpayer. But who's to say that when you starve it, it's going to devote its now more limited resources to the best interest of the taxpayers? It may starve you in return of the services you and those whom you seek to garner support from value most (since you already believe that it doesn't look out for your own interests), thereby not getting rid of the programs at the margin that aren't worth their costs to taxpayers but instead getting rid of the programs that are worth their costs.


Related Articles