How to Evaluate Proposed Tax Cuts

Blog Post
Tuesday, July 12, 2011

Although elected officials often talk about tax cuts helping the economy, whether such reductions live up to the high expectations for them depends on the circumstances. Three key factors to consider: the state of the economy, how a proposed cut would be structured, and how the government would pay for it.

“Tax cuts aren’t the ‘be-all and end-all’ of economic policy that they’re often claimed to be, no matter how attractive they might be politically,” Diane Lim Rogers, chief economist for The Concord Coalition, cautioned in a blog post Monday.

In a downturn with closed factories and unemployed workers, it takes greater demand for goods and services to boost the economy. So tax cuts aimed at households and businesses that are most likely to spend extra cash will be most effective.

With full employment and little excess capacity, on the other hand, growth requires tax policies that increase the work force, savings and investment in productive capacity.

Deficit financing is problematic if a tax cut is supposed to encourage supply-side, longer-term growth. A better approach: Pay for the tax cuts with spending reductions or revenue increases. In a recession, however, there is a risk that this will place excessive drag on the economy.