Would Another Tax Cut Help?

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One of the biggest disagreements between the presidential candidates is over tax policy. It’s really another episode in the ongoing debate over how best to create jobs and maintain a strong economy. “Supply-siders” recommend low taxes to encourage savings and investment, while Keynesians recommend government spending to boost aggregate demand for goods and services. The government can’t do too much of both at once without running large deficits. Keynesians are explicitly willing to allow deficit spending when combating recessions. Supply-siders more often claim to be deficit “hawks,” but they often run up debt anyway because of their eagerness to cut taxes.

President Obama’s position on taxes is familiar by now. He would keep tax rates the same as they are now, except that he would allow the Bush tax cuts on incomes over $250,000 to expire. He would use part of the additional revenue to support spending intended to create jobs, and part to reduce the deficit. Republicans characterize Obama’s policy as a “job-killing” tax increase. Democrats defend it as just bringing tax rates on the wealthy back up to where they were in the Clinton years, when job growth was actually much stronger than it has been since then.

Governor Romney joins most Republicans in opposing any expiration of the Bush tax cuts. He would also preserve tax breaks that specifically encourage investment, such as low rates on capital gains and municipal bonds. In addition, he proposes another large cut in income tax rates, as well as the complete elimination of estate taxes. He maintains that he can cut taxes without increasing the deficit, for two reasons. First, for incomes over $250,000, the reductions in tax rates would be balanced by the elimination of “loopholes,” so the revenue collected from the wealthy would remain the same. Second, the rate reductions would encourage saving, investment and job-creation, and that would broaden the tax base and generate new revenue. So the idea is to help the economy without aggravating the deficit.

Critics of the Romney plan usually make one or more of these points:

  1. Offsetting rate cuts for the wealthy by closing loopholes is very difficult, perhaps mathematically impossible. Romney refuses to say what deductions he would eliminate, but the independent Tax Policy Center concluded that the eliminations would have to hit less wealthy taxpayers as well in order for the numbers to add up. Political resistance to some of the changes would be strong; for example, the deduction for mortgage interest is important to housing sales and the deduction for charitable contributions is vital to non-profits. This is one reason why the tax cuts are likely to increase the deficit, just as the Bush tax cuts did.
  2. Although the assumption that tax cuts generate economic growth is an article of faith for supply-siders, the evidence for it is weak. Testing it properly would require cutting taxes while holding other factors constant–especially spending–but that’s not what governments in recent memory have done. Ronald Reagan and George W. Bush both cut taxes, but they also increased military spending and ran big deficits; job growth was good for Reagan but poor for Bush. Job growth was even better during the 1950s and 60s when taxes were higher, as well as during the Clinton administration, as mentioned earlier. Overall, researchers have found little correlation between rates of taxation and rates of economic growth. If the Romney tax cuts turned out to be no more successful than the Bush tax cuts in expanding the economy, then that’s another reason why they might just aggravate the deficit.
  3. Even if we assume that another tax cut could pay for itself by creating jobs and broadening the tax base, the existing deficit would remain an issue. If the Romney tax cut turned out to be revenue neutral at best, and the Republicans continued their refusal to reduce military spending, then the entire burden of reducing the deficit would fall on domestic spending. That is essentially the Ryan budget plan. The trouble with that is that cuts in domestic spending destroy jobs, both the jobs of government employees and those of private workers whose work (such as road construction) doesn’t get funded. Economists such as Mark Zandi of Moody Analytics calculate that each dollar spent by the government has a larger multiplier effect on economic activity than each dollar reduction in taxes. For that reason, the Economic Policy Institute estimates that job creation would be much weaker under Romney’s plan than under President Obama’s plan (considering both his tax increase on the wealthy and his American Jobs Act).

A positive effect of another tax cut on the economy is not out of the question. But the benefits seem dubious, and the risks of higher deficits or more jobs destroyed seem very high.

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