A Rather Odd Analysis from David Leonhardt

by Reihan Salam

David Leonhardt says he’s trying to understand the impact of the 2001 and 2003 tax cuts on growth. I think he’s asking the wrong questions. (And I’m struck by the extent to which he’s ignoring the pretty significant issue of causal density.)

 

Is there good evidence the tax cuts persuaded more people to join the work force (because they would be able to keep more of their income)? Not really. The labor-force participation rate fell in the years after 2001 and has never again approached its record in the year 2000.

Here the more salient question is about the effective marginal tax rates faced by people who are marginally attached to the labor force. I recommend that Leonhardt check out the book Reconnecting Disadvantaged Young Men. The effective marginal tax rates faced by ex-offenders and non-custodial fathers, for example, are very high, due to the garnishing of wages (a good thing, for the most part) and the large and prominent role played by means-tested benefits, which could be streamlined.

It might make more sense to look at work hours of those taxpayers who saw their marginal tax rates reduced. Part of the “problem” with the 2001 and 2003 tax cuts is that much of the value of the cuts went to measures that didn’t improve work incentives, but rather to make the tax code more progressive and more family-friendly (goals that are sometimes in tension) — and I don’t think anyone argued that, say, the partially refundable child tax credit was growth-enhancing. (I happen to favor a big child tax credit, but I don’t claim that they are as effective as cutting marginal tax rates when it comes to improving work incentives.)     

Is there evidence that the tax cuts led to a lot of entrepreneurship and innovation? Again, no. The rate at which start-up businesses created jobs fell during the past decade.

This isn’t really evidence of much of anything, I’m afraid, for reasons that should be obvious. 

The theory for why tax cuts should create growth and jobs is a strong one. When people are allowed to keep more of each dollar they earn, they are likely to work longer and harder. The uncertainty is the magnitude of this effect. With everything else that’s happening in a $15 trillion economy, how large of an effect on growth do tax cuts have?

Every available piece of evidence seems to suggest that the Bush tax cuts did little to lift growth. I have yet to hear a good argument to the contrary, but I’d be fascinated to see another blogger or an economist take a crack at it.

What exactly do we mean by little? And do we have a sound evaluation of alternative policies, e.g., what would have been the growth trajectory had President Bush’s proposals to cut tax expenditures and reduce the long-term cost of Medicaid also been put into effect? I agree that the 2001 and 2003 tax cuts were not an economic panacea. The high-income rate reductions were the most effective part of the cuts in terms of enhancing growth, and they were a relatively small part of the package — roughly one-fourth of the value.

So yes, I agree: the 2001 and 2003 tax cuts weren’t as effective as they might have been because they didn’t cut marginal rates on workers with high ETIs deeply enough. Rather, they placed a heavier emphasis on what we might call social justice considerations, which was a defensible move in some respects. I’m not sure that’s the conclusion David Leonhardt wants us to draw. 

And incidentally, I’m not sure who exactly David Leonhardt is engaging. He’s certainly not taking on claims that Alan Viard or Greg Mankiw have advanced. I assume he’s taking on claims that have been advanced by various supply-siders and reflexive defenders of all things done by Republicans, and I’m happy to dismiss those claims as overstated. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.