NC Budget and Tax Center

Economic case for tax cuts rests on shoddy foundation

Tax cuts never live up to the extravagant promises of job creation and economic growth so often made by their supporters, and last year’s tax reductions are unlikely to turn out any differently. The most recent example is Kansas, which enacted massive tax cuts in 2011. Two years later the state has experienced slower job growth than the national average, contraction in the number of businesses employing people, and loss of its AAA bond rating resulting from its catastrophic, 50% loss in revenue.

While there remains no consensus among academic economists that tax cuts are a strategy to grow the economy—instead, evidence is mounting of their harm—some think tanks keep trying to play the same hand to get a different result. One example is the Beacon Hill Institute, which has frequently deployed its State Tax Analysis Modeling Program (STAMP) during tax cut debates in various states across the country, including last year in North Carolina. Using this model, Beacon Hill claims to show that lowering taxes, or refusing to raise them, will benefit state economies. In the case of North Carolina, they also went a step further to claim that all income groups get a tax cut on average.

A new report from the Institute on Taxation and Economic Policy reveals a number of serious flaws in the STAMP approach that undermine the accuracy of its claims. In doing so, it calls into question the rosy scenario Beacon Hill paints for tax-cutting states like North Carolina.

Follow me below the fold for are some of the problems identified by ITEP:

  • The STAMP model underestimates the economic importance of education, infrastructure, and other public services in promoting economic competitiveness and job growth over both the long-term and the short term. In other words, STAMP incorrectly assumes that changes in marginal tax rates are bigger drivers of economic activity than the public investments that mainstream professional economists have long considered for more important than tax changes.
  • The model also assumes that workers, consumers, and businesses are hypersensitive to tax changes—meaning that the economy will boom (or bust) as a result of modest changes in their incomes as a result of small changes in their tax rates.
  • Similarly, STAMP wrongly assumes that high-income workers in particular are extremely sensitive to changes in income tax rates—and far more sensitive than their lower-income neighbors. Both of these assumptions conflict with the findings of the nonpartisan Congressional Budget Office (CBO) and other experts.
  • STAMP assumes that economic growth results largely and almost instantaneously from tax changes. It assumes that people will flood into the state as a result of income tax changes and property values will soar without accounting for the fact that tax cuts will require spending cuts in the public sector that could lead to layoffs and a dampening of economic growth rates in the long-term,
  • STAMP ignores the role played by other factors like migration, property value increases, and business formations in influencing long-term economic growth rates. This means that the model assumes economic growth results from changes in taxation when in fact these factors may be responsible.
  • STAMP has no way for accounting for the fact that if spending cuts go into effect the quality of the state’s labor pool could suffer as a result of education quality and access declining or infrastructure crumbling.
  • Lastly, STAMP uses a General Equilibrium Model, which is a wonky way of saying that it assumes a simplistic, perfectly efficient marketplace where everybody that wants a job already has one. Given that there are still three unemployed workers for every one available job opening, it’s hard to take any results seriously from a model that assumes everyone has a job who wants one.

It’s unlikely that these tax cuts will ever live up to what was promised for them, and that’s because as a strategy, they just don’t work to build a stronger economy for all. Beacon Hill’s flawed analysis can’t change this reality.

 

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