The Economics of a 10-Percent Tax Cut

December 2, 2005

The Congressional Budget Office released a new study yesterday (PDF) exploring the economic impact of a straightforward 10-percent cut in federal income tax rates.

The paper tackles various assumptions about how far into the future people plan, and then explores how that foresight affects how people react to tax cuts as demanders and suppliers in markets. The bottom line shouldn’t surprise anyone: tax cuts have the biggest economic bang for the buck when people have longer planning horizons.

Under the different assumptions about foresight and the openness of the country to capital flows, the tax cuts are projected to increase output from 0.5 percent to 0.8 percent on average over the first five years and from 0.2 percent to 1.1 percent over the second five years (see Table 2). The estimates are most positive when … people form their plans with maximum foresight … and thus increase saving and work effort accordingly.

Read the full paper here (PDF).


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