Just How Much Economic Growth Will Tax Reform Give Us?

by Robert VerBruggen

Response To...

A Word on the Joint ...

My late-night deficit-hawking has provoked some friendly pushback, so I wanted to briefly explain my thinking on the question of tax cuts and economic growth. I spelled out my approach more completely in a piece last month, in the context of the House’s tax bill.

Basically, the challenge of using “dynamic scoring” on a deficit-financed tax cut is twofold. First, how does the tax cut affect the economy? And second, how does the increased deficit affect the economy? The answers to these questions determine how much revenue the tax loses (or in rare circumstances gains).

Expert opinion tends to break down on the expected ideological lines. The right-leaning Tax Foundation believes that tax cuts can boost GDP, and it rejects the notion that increased government borrowing will harm the economy by “crowding out” investment. The folks behind the Penn Wharton Budget Model, who often collaborate with the left-leaning Tax Policy Center, believe the crowd-out effect is very real and can cancel out the growth inspired by tax cuts.

Their rivalry is quite respectful; I often find myself referring back to this explanation from the Tax Foundation of why it disagrees with Penn Wharton’s assumptions, and then rereading Penn Wharton’s own explanation of why it does things the way it does. And of course it’s hardly un-conservative to worry about the effect that deficits have on the economy.

Where did the JCT come down? Roughly in between them, though probably a bit closer to Penn Wharton. Its revenue-from-growth estimate was about half the Tax Foundation’s, while falling in line with the more optimistic of Penn Wharton’s two assumptions (“high return to capital” rather than “low return to capital”). Under Penn Wharton’s more pessimistic assumption, though, the bill could lose $1.2 trillion in revenue instead of $1 trillion (as the JCT and Penn Wharton’s sunnier guess have it) and could boost GDP by a measly 0.3 percent instead of 0.8 percent, a drop of more than half.

[Update: The Tax Policy Center released its own dynamic analysis today as well. They project 0.7 percent higher GDP in 2018, “little effect” on GDP by 2027, and just $179 billion in revenue from increased growth over ten years.]

Which is right? We can’t say for sure, because this is such a live issue among economists. It’s difficult to tease out the effects that past tax cuts had (as subsequent economic performance could be caused by other things as well); we’re facing different economic conditions today from those we faced in the 1960s or 1980s or early 2000s; as shown above, different models produce very different estimates.

What does seem clear is that a $1.5 trillion cut will be unlikely to fully pay for itself anytime soon — especially when the bill includes obvious gimmicks such as making all the individual tax cuts expire after 2025. But that doesn’t get us very far. Today, with the idea of an automatic revenue trigger off the table, Republicans need to decide just how much growth they’re willing to count on and how much of a deficit increase they’re willing to risk. The JCT’s estimate isn’t unimpeachable — no one’s is — but it’s hardly an outlier, either, and deserves serious consideration.

 

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