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Scot Lehigh

Straight shooter, wacky tax idea

Email|Print|Single Page| Text size + By Scot Lehigh
December 7, 2007

JOHN MCCAIN has a reputation as a straight shooter, and on some issues, deservedly so.

But when he came to the Globe Wednesday, McCain took refuge in a supply-side myth: the notion that President Bush's tax cuts have created a compelling revenue surge.

Queried about funding programs like expanded healthcare for children by letting some of the Bush tax cuts expire, McCain replied, "I would suggest that most economists agree that there was an increase in revenues . . . associated with the tax cuts." Letting those tax cuts expire might actually have the opposite effect on revenues, the Republican presidential candidate warned.

Asked specifically about the idea that tax cuts pay for themselves, McCain said that "a lot of economists" believe the Bush tax cuts had stimulated the economy and that without them, "the economy would not have boomed, and therefore you would not have seen these increases in revenues."

His campaign later insisted McCain didn't mean that tax cuts pay for themselves. But the notion that tax cuts somehow leave the federal government with as much revenue - or nearly as much - as it would have had without them is a popular one in the Republican universe.

It's easy to understand why. If so, then tax cuts come with no real cost. Presto: with a simple wave of the supply-side wand, you eliminate the tough choice between spending tax dollars on public goods and services and letting taxpayers keep more of their money. Instead, you can promise both.

Alas, there's a problem here: Alluring as such a theory may be, it's not true.

"It is amazing to me that people have treated this as though it is a debatable point, because it is really not," says economist Dean Baker, co-director of the Center for Economic and Policy Research, a liberal-leaning Washington think tank. "It is one of the most extensively researched topics in economics, and virtually all the research has concluded that there is no way that any growth stimulated through an income tax cut can replace the revenue lost."

McCain may be right that there has been some economic stimulus. But judged against other recoveries, it doesn't look like much.

The Center on Budget and Policy Priorities, another liberal think tank, has compared the current business cycle with others since World War II, adjusting for population growth and inflation.

Here's what it found: From March 2001 through September 2007, revenues increased by a paltry 2.8 percent. The average for a comparable period in all previous postwar business cycles was 12 percent. In the 1990s business cycle - when, contrary to the predictions of the supply-siders, an economic boom followed the Clinton tax hikes - revenues grew by 16.2 percent.

Concludes the center: "Revenues in 2007 were still more than $200 billion short of where they would have been had they grown at the rates typical in other recoveries."

The supply-side notion doesn't even work in responsible theory. In 2005, the Congressional Budget Office evaluated the effects of a 10 percent income tax cut on federal revenues, using a number of different assumptions. Here's CBO's conclusion, from a summary by then-director Douglas Holtz-Eakin, a well-regarded conservative economist: "The budgetary impact of the economic changes was estimated to offset between 1 percent and 22 percent of the revenue loss from the tax cut over the first five years and add as much as 5 percent to that loss or offset as much as 32 percent of it over the second five years."

So under the most optimistic assumptions, the economic stimulus from such a tax cut would replace about one-fifth of the lost revenue in the first five years and about one-third in the second. In the worst case, there would be no longer-term revenue replacement at all, but rather an even greater loss.

Now, Holtz-Eakin believes there are good economic reasons to keep taxes where they now are. But as he told me in an interview, "You are not going to get tax cuts to pay for themselves."

That's a laudably honest economic answer.

Holtz-Eakin is interesting for several reasons. Prior to his stint at CBO, he spent 18 months as chief economist for George W. Bush's Council of Economic Advisers.

And now? Well, one of the hats he currently wears is that of a senior policy adviser for John McCain's presidential campaign.

Scot Lehigh's e-mail address is lehigh@globe.com.

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