Monday, March 27, 2017

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What Was Wrong with the Bush Tax Cuts?

Back in April, President Obama had this to say about the Bush tax cuts:

We tried this for eight years before I took office. We tried it. It is not like we did not try it. At the beginning of the last decade, the wealthiest Americans got two huge tax cuts, in 2001 and 2003. Meanwhile, insurance com­panies, financial institutions, there [sic] were all allowed to write their own rules, find their way around the rules. We were told the same thing we’re being told now—this is going to lead to fast­er job growth, it’s going to lead to greater prosperity for everybody. Guess what? It didn’t.

At first blush, the data would seem to be on the President’s side: even if we ignore the Great Recession,  economic growth in the 26 quarters that followed passage of the Bush tax cuts averaged just 2.5 percent while it averaged 3.7 percent in the 26 quarters that preceded the cuts.

So is this experience reason to throw out every microeconomics 101 textbook? Or at least to rip out the sections that cover the deadweight loss of taxation? No. The fact is that the Bush tax cuts were deeply flawed, even from a free-market perspective. In a new paper with Mercatus program associate, Andrea Castillo, we contend:

[T]he Bush tax cuts had a number of problems from a market-oriented perspective: they were phased in slowly, they were set to expire within a decade, they entailed a Keynesian emphasis on stimulating aggregate demand, and—above all—they were undertaken without any effort to reduce spending. In light of these problems, there is no reason to overturn decades of theoretical and empirical research supporting the link between low taxation and growth. The episode offers a cautionary lesson in how not to cut taxes.