The US government believes that tax cuts will be self-funding. The evidence does not support thisby George Magnus / May 1, 2017 / Leave a comment
In the National Museum of American History, there is an exhibit of a white cloth napkin taken from a Washington DC restaurant in 1974. The reason it is there because it is adorned with a graph and some scribbling that came to have a profound effect on economic thinking. The diners were Dick Cheney, Donald Rumsfeld, Jude Wanniski, and a 34-year-old economist called Art Laffer who gave his name to the curve on the graph, the Laffer curve. It was the core thinking behind the economic policies of Ronald Reagan, both George Bushes, and now President Donald Trump. The Laffer Curve basically says that significant cuts in taxation are self-financing because of the galvanising effect on economic growth and jobs. Discuss.
Let us just remember that Laffer’s reasoning was used to justify Reagan’s tax cuts in the early 1980s. In the event, Reagan tripled the Federal deficit from 2 to 6 per cent instead of balancing the budget in four years as he had promised, and added more to the stock of Federal debt than all the Presidents from George Washington to Jimmy Carter combined. He tripled debt outstanding from $900bn to $2.7trn. The debt to GDP ratio had tumbled from 117.5 per cent in 1945 to 32.5 per cent when Reagan took office. By the time George H Bush left office in 1993, it had doubled to 66 per cent. Under Bill Clinton, it dropped back to 56.4 per cent, but George W Bush, pursuing similar fiscal policies to his father and to Reagan, pushed the ratio back up to 73 per cent. It is true that President Barack Obama left office with debt to GDP at around 100 per cent but remember this includes a pile of debt owned by the Federal Reserve not the public, and is attributable mainly to the financial crisis and what followed, not a belief in self-financing tax cuts.
In any event, these empirical observations seem not to be enough for modern day Laffer fans.
Last Wednesday, the Trump Administration released one sheet of paper, rather than a full document that calls for a dramatic overhaul of the US tax code. The government wants, amongst other things, to replace seven income tax rates with three (10, 25…