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Some pundits have argued that the weak economic growth that followed the passage of the Bush tax cuts proves that free-market economics—specifically the belief that lower taxes fuel faster and stronger economic growth— doesn’t work. The reality of the Bush tax cuts is that they were deeply flawed in their design and implementation and far from the “failed experiment in free-market economics,” as they are often portrayed.
A new study from the Mercatus Center at George Mason University by Matthew Mitchell and Andrea Castillo identifies several faults of the Bush tax cuts and reviews the fundamental lessons to be learned from their failures.
A summary of the study’s key findings is below. To read “What Went Wrong with the Bush Tax Cuts” in its entirety, or to learn more about the study’s authors, please click here .
Tax cuts alone do not equal free-market economics, nor do they equal fiscal reform. Cutting taxes allows policymakers to give voters something they want, while appearing to rein in the size of government. But this is a temporary illusion unless the tax cuts are combined with necessary reductions in spending—a far more difficult but also the more important task.
Lesson 1: Tax cuts without spending cuts are not tax cuts; they are tax deferrals.
The Bush tax cuts were fundamentally flawed in that they were undertaken without any effort to reduce unsustainable government spending. In fact, spending exploded in the decade following their implementation:
Deficits and debt discourage spending and investing in lieu of saving for the inevitable tax crunch.
Lesson 2: Good tax systems are stable and predictable.
The initial slow phase-in and temporary nature of the Bush tax cuts made the policies less predictable—and also less potent.
Lesson 3: Low marginal rates tend to increase the incentive to work and save.
The 2001 and 2003 Bush tax cuts and the 2008 Bush stimulus plan included exemptions, deductions, rebates, and credits with the Keynesian goal of putting money back in the hands of consumers in hope that they would, in turn, purchase more goods and services.
Lesson 4: Real marginal tax cuts lead to economic growth.
Christina Romer and David Romer examined 60 years of U.S. data and found that “tax cuts have large and persis- tent positive output effects.”
Nobel laureate Edward Prescott attributed differences of work habits across countries to differences in labor taxation.
Lesson 5: You can’t starve the beast through tax cuts if you’re feeding it with borrowed funds.
Fiscal conservatism requires constraint both in taxation—and in spending and borrowing.
It would be a mistake to use the disappointing performance of the Bush tax cuts to dismiss decades of economic evidence that demonstrate that lower taxation is better for economic growth. Instead, the experience should prompt policymakers to utilize its lessons when crafting and implementing fundamental spending and tax reform.
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