I teach tutorials in Economics 101. Yesterday an international student asked me to explain why “one of the American political parties” thinks cutting tax rates will increase fiscal revenues. I explained that their theory is that lowering taxes will encourage people to work, spend, and invest more; that this would spur economic growth; and that even a lower tax rate on this higher GDP could actually generate higher revenues.
“Oh, that’s interesting. Is it true?” was his reply.
I thought about it for a second. I briefly considered the implications of answering a politically-charged question. I worried a little that this was a student whose interest in economics was piqued, and that I ran the risk of blunting that interest. After contemplating whether I should answer whether it was theoretically possible or empirically verifiable, I gave him the most honest answer I could: “No.”
The consensus among economists is that although this “bigger cake” idea has some truth to it, lowering taxes does not increase the cake anywhere near enough to make a significant difference. Harald Uhlig thinks higher tax rates could increase American income tax revenue by 30%; the Congressional Budget Office thinks that although lowering tax rates would lead to more economic activity, the revenue generated by these new activities would only be a quarter of the revenue lost in the initial tax cut; and even Greg Mankiw, chairman of the Council of Economic Advisers to President Bush (the second), thinks this thesis is a bit silly.