Since this is an argument commonly made by conservatives, that tax cuts will spur economic growth and therefore pay for themselves, it's always worth noting a recent look at the issue.
Simon Johnson, former chief IMF economist, reviews a few studies in a New York Times column today and provides an answer:
Can tax cuts “pay for themselves,” inducing so much additional economic growth that government revenue actually increases, rather than decreases? The evidence clearly says no.
Nevertheless, a version of this idea, under the guise of “dynamic scoring,” has apparently surfaced in the supercommittee charged with deficit reduction — the joint Congressional committee with 12 members. Dynamic scoring sounds technical or perhaps even scientific, but here the argument means simply that any pro-growth effect of tax cuts should be stressed when assessing potential policy changes (e.g., reforming the tax code). For anyone seriously concerned with fiscal responsibility, this is a dangerous notion.
He cites two studies, one co-authored by Professor Gregory Mankiw, a former Bush economic adviser which finds:
...the economic growth caused by a tax cut can offset, at best, a portion of the revenues lost by that tax cut.
Specifically, Professors. Mankiw and Weinzierl calculated that 32.4 percent of the “static” or direct revenue loss of a capital-gains tax cut and 14.7 percent of the static revenue loss of a labor tax cut could be offset in present-value terms by additional growth, ignoring short-term Keynesian effects (i.e., any immediate stimulus provided to the economy).
Now 32.4 percent is a lot, but it is far less than 100 percent.
Offset at best a portion of the revenues lost. Further:
More broadly, in 2005, the Congressional Budget Office, then headed by a Republican appointee, Douglas Holtz-Eakin, estimated that the economic effects of a 10 percent cut in income taxes would offset from 1 to 22 percent of the revenue loss in the first five years; in the following five years, the economic effects might offset up to 32 percent of the revenue loss, but might also add 5 percent to the revenue loss.
This is an entirely reasonable assessment — the budget office exists to provide balanced analysis for the budget process. The bottom line is that betting that tax cuts will pay for themselves is a high-risk strategy and not a good idea at our current levels of government debt relative to gross domestic product. We do not have a large margin for error.
Another good resource on this question,
Mark Thoma's blog which has dealt with it extensively.
