Interesting New York Times article, A Bit of Doodling About a Tax-Cut Danger, by Daniel Altman:
Early last month, without much fanfare, the Congressional Budget Office released a paper called "Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates" [blogged here]. At a modest seven pages, it didn’t elicit the same sort of interest as the budget office’s budgetary and economic outlooks. Yet it may be one of the most important government publications in years.
As Douglas J. Holtz-Eakin, the budget office’s director, writes in a brief summary at the beginning of the paper, most predictions of the effects of tax-rate changes "do not include the budgetary impact of any possible macroeconomic effects of tax policies." In other words, the predictions don’t take into account how tax cuts could affect the overall size of the economy. It is this omission – one often cited by proponents of tax cuts, especially in the White House – that the paper tries to correct.
The author of the analysis, Ben Page, estimates how an across-the-board cut in income tax rates could generate higher levels of economic activity, potentially replacing lost tax revenue. The theory behind these feedback effects is well worn: putting money back into taxpayers’ pockets will let them spend more and save more, raising demand for goods and services and helping companies to invest for the future….
The recent analysis by Mr. Page at the CBO dismisses the idea that tax cuts may actually improve the government’s fiscal situation. Even in his most generous scenario, only 28% of lost tax revenue is recouped over a 10-year period. The United States, it seems, is firmly planted on the left side of the Laffer Curve….
On the other hand, Mr. Page estimates that gross national product would be an average of about 1% higher, adjusted for prices, as a result of the 10% cut in tax rates. Based on the August forecast by the budget office, that extra income would come to slightly less than $1.5 trillion in today’s dollars. In Mr. Page’s analysis, consumers would also pay about $900 billion less in taxes. Over all, they’d have up to $2.4 trillion more to spend during the decade he analyzed….
For many people, this may sound like a slam dunk, especially if they don’t care what happens after the next decade. But keep going in this direction, and pretty soon the federal government would be collecting no taxes and trying to borrow enough money to cover its entire budget. It’s doubtful that many people would want to lend to a government with no source of revenue for 10 years.
Call it the Altman Curve: the total amount that people will actually lend you rises with the amount you plan to borrow, until you reach a crucial point, after which it falls to zero. The United States is now on the left side of the curve. If Congress keeps cutting taxes by more than it cuts spending, the nation will eventually move to the right side, which, of course, is the wrong side.
