The Bush Tax Cuts: Were they well designed to strengthen long-term economic growth?
For any tax cut to raise economic growth, it must have a powerful enough direct effect on incentives for work, saving, and investment to overcome the drag on growth from the larger budget deficit (or smaller surplus) it causes. The Bush tax cuts are not well designed to provide strong incentives for additional saving, investment, and work. As a result, after taking the drag from the larger budget deficits into account, the net effect from the tax cuts is likely to be a reduction in long-term growth.
- One study of the long-term effects of making the 2001 tax cut permanent combined estimates of the actual changes in incentives provided by the tax cut with estimates of how a given change in tax incentives affects saving, investment, labor supply, and human capital accumulation. The study found that these "supply-side" effects would indeed, taken alone, increase GDP by almost 1 percent by 2011, but that the increase in the deficit due to the tax cuts would reduce national saving, which would cause GDP to fall by about 1.6 percent by 2011; the net effect of these factors, and others, would be to reduce GDP by about 0.3 percent by 2011.
- The impact of the tax cuts on long-term economic growth depends on how the budget is eventually adjusted to accommodate the reduced revenue due to the tax cuts; that is, tax cuts must eventually be "paid for" either by reducing spending or by raising taxes in the future. A recent Treasury study found that, under either scenario, the tax cuts’ long-run impact on the economy would be small and could be either positive or negative, depending on the fiscal response.