Tax Cuts Widen Budget Gaps

Here’s another claim that falls into the “myths that never die” category: “Cut taxes and revenues will increase!” Sound too good to be true? It is.

A new CBP report, No Free Lunch: Tax Cuts Widen Budget Gaps, turns this longstanding myth about taxes on its head by reviewing economics research showing that tax cuts result in lower revenue collections. In fact, California learned this sobering reality more than a decade ago when it enacted legislation requiring the Department of Finance (DOF) to conduct “dynamic” revenue analyses to evaluate proposed tax policy changes. “Dynamic” analyses are sometimes argued to be superior to traditional “static” analyses because they attempt to account for the effects of tax policy changes on the broader economy – a critical factor to consider, according to those who believe that tax cuts could generate enough economic growth to boost state revenues and fully “pay for themselves.”

What did the DOF’s “dynamic” analyses find? “No evidence … that tax rate reductions … can in general ‘pay for themselves,’ as some parties in the past have claimed,” according to a summary of the results by the Legislative Analyst’s Office. For example, a $1 billion “static” cut in corporate income taxes – a very large tax cut, equivalent to a 20 percent reduction at the time of the analysis – would result in an $816 million “dynamic” revenue loss. In other words, the state would lose 82 cents for each dollar of “static” reduction in corporate income taxes, even after factoring in any economic gains that the tax cut might produce. So much for hopes of a free lunch.

And the evidence doesn’t stop there. “Dynamic” revenue analyses by the Congressional Budget Office, as well as by other states, have consistently found that tax cuts reduce revenue collections. And the historical record confirms this: Tax cuts, both at the state and national level, have failed to generate net gains in revenues. Even several economists who served as chair of the Council of Economic Advisors during the George W. Bush administration have disputed the notion that tax cuts pay for themselves.

While it’s certainly appealing to hope for a magic bullet, the notion that tax cuts can pay for themselves is simply too good to be true.

— Alissa Anderson 

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