I’ve been working on a paper about America’s looming fiscal crisis. Earlier today I drafted a short (and as-yet-unfinished) section about tax policy that goes as follows:
Three decades ago, supply-side economists first argued that high marginal tax rates would discourage work, saving, and investment, and that well-crafted reductions in those tax rates could help boost long-run economic growth. Those observations have since become part of the fabric of mainstream economics. Meanwhile supply-side economics transformed into a doctrine that endorsed any tax cut at any time and that peddled the idea that tax cuts would inevitably pay for themselves.
Both of those notions are nonsense. Tax cuts rarely, if ever, pay for themselves, and they can do more damage than good.
As policymakers begin to confront our budget challenges and the conversation shifts from tax cuts to tax increases, it is essential that they understand the now-mainstream insight that taxes are not created equal. Taxes on income, for example, are usually worse for the economy than taxes on consumption. That’s why there’s a rising chorus of economists recommending the introduction of a value-added tax, rather than higher income taxes, if our nation decides it wants to support substantially higher government spending. High tax rates similarly tend to be worse for the economy than low rates. That’s why economists usually favor broad tax bases and low rates, rather than narrow tax bases and high rates. Finally, it’s preferable to levy taxes on bads rather than goods. Where appropriate, taxes on pollution (e.g., emissions of greenhouse gases) should thus be preferred over taxes on working, saving, or investing.
Everything that was true about [supply-side economics has] been fully incorporated into mainstream economic thinking and all that was left was a caricature.
All economists now accept the importance of marginal tax rates to economic decisionmaking, and organizations like the National Bureau of Economic Research publish vast numbers of papers on this topic.
During the George W. Bush years, however, I think [supply-side economics] became distorted into something that is, frankly, nuts–the ideas that there is no economic problem that cannot be cured with more and bigger tax cuts, that all tax cuts are equally beneficial, and that all tax cuts raise revenue.