Deficit-Financed Tax Cuts Can Harm Economic Growth

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A recent Brookings paper says deficit-financed tax cuts generally do little to boost economic growth, and can even harm it.

The authors, William Gale and Andrew Samwick, reviewed historical evidence, simulation models and the experiences of other countries. They found that whether economic growth follows from changes in the tax code depends largely on their structure — including whether the changes add to the deficit or are “paid for” by cuts in spending or increases in other taxes.

Reforms that broaden the tax base and lower rates can foster economic growth. But according to the paper, this does not happen through boosts in the labor supply, saving or investing, as most people assume.

Instead, the economic growth potential is found by creating a more open flow of resources across the economy as the result of eliminating targeted subsidies.

Bipartisan deficit-reduction plans such as Simpson-Bowles and Domenici-Rivlin include comprehensive tax-reform plans that would lower rates, broaden the tax base, and reduce deficits — the sorts of reforms the paper suggests might increase economic growth.

Senior tax-law writers in both parties and President Obama say they support broadening the tax base. Many lawmakers in both chambers,  however, want to renew a long list of deficit-financed tax breaks for some businesses and special interests — the kind of cuts that the Brookings paper says will likely hurt the economy.

External links:
Effects of Income Tax Changes on Economic Growth (Brookings)
Deficit-Financed Tax Cuts May Be Counter-Productive (CRFB)

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