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Return of the Tooth Fairies

Summary:
(as referenced by Larry Summers, quoted in this post). As I watched Secretary Mnuchin on Meet the Press (before discussing his taxpayer funded trip to view the recent eclipse) state : …the president is not going to sign something that he believes is going to increase the deficit. I was struck by an overwhelming sense of déjà vu. Of course, the caveat “he believes” is important. Mnuchin mentions “dynamic scoring”, but most economists agree that it is not plausible that the tax cuts as currently sketched out would lead to a revenue neutral outcome. This sheer implausibility is laid out by Bruce Bartlett in his illuminating retrospective, informed from his vantage point at the inception of supply side economics: Extravagant claims are made for any proposed tax cut. Wednesday, President

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(as referenced by Larry Summers, quoted in this post).

As I watched Secretary Mnuchin on Meet the Press (before discussing his taxpayer funded trip to view the recent eclipse) state :

…the president is not going to sign something that he believes is going to increase the deficit.

I was struck by an overwhelming sense of déjà vu. Of course, the caveat “he believes” is important. Mnuchin mentions “dynamic scoring”, but most economists agree that it is not plausible that the tax cuts as currently sketched out would lead to a revenue neutral outcome.

This sheer implausibility is laid out by Bruce Bartlett in his illuminating retrospective, informed from his vantage point at the inception of supply side economics:

Extravagant claims are made for any proposed tax cut. Wednesday, President Trump argued that “our country and our economy cannot take off” without the kind of tax reform he proposes. Last week, Republican economist Arthur Laffer said, “If you cut that [corporate] tax rate to 15 percent, it will pay for itself many times over. … This will bring in probably $1.5 trillion net by itself.”

That’s wishful thinking. So is most Republican rhetoric around tax cutting. In reality, there’s no evidence that a tax cut now would spur growth.

The Reagan tax cut did have a positive effect on the economy, but the prosperity of the ’80s is overrated in the Republican mind. In fact, aggregate real gross domestic product growth was higher in the ’70s — 37.2 percent vs. 35.9 percent.

Moreover, GOP tax mythology usually leaves out other factors that also contributed to growth in the 1980s: First was the sharp reduction in interest rates by the Federal Reserve. The fed funds rate fell by more than half, from about 19 percent in July 1981 to about 9 percent in November 1982. Second, Reagan’s defense buildup and highway construction programs greatly increased the federal government’s purchases of goods and services. This is textbook Keynesian economics.

Here is a summary of assessments by two organizations (CFRB, TPC) and Deutsche Bank:

Return of the Tooth Fairies

Source: Luzzetti, et al., “Trump Tax Plan: Tough Sledding Ahead,” US Economic Perspectives, Deutsche Bank, September 29, 2017.

Incorporating dynamic scoring is unlikely to lead to big changes in these overall numbers.

As former CBO head Douglas Holtz-Eakin noted:

“If it is a well-designed tax policy, it will partially offset the cost,” said Douglas Holtz-Eakin, a conservative economist who served in the George W. Bush administration and advised John McCain’s 2008 presidential campaign. But, he added, “there’s no evidence anywhere that a tax cut of that magnitude, regardless of composition, will offset” the entire $1.5 trillion.

I think the likely output impact is even more limited given that by many measures (and most importantly, the Fed’s), the output gap is essentially zero, so fiscal stimulus is likely to be met by offsetting monetary policy. That, too, is textbook.

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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