TCJA Income Tax Extension Debate Reminds Us Tax Cuts Generally Do Not Pay for Themselves

The Tax Cuts and Jobs Act (TCJA) has been the single largest example of U.S. tax reform in the 21st century. Part of this Act was lowering the individual income tax. I bring this up because many of the tax provisions in the TCJA are set to expire in 2025, including that of lower income taxes. One of the major Republican talking points for the TCJA was that the tax cuts would pay for themselves, even though every major analysis at the time concluded it would add to the deficit, including that from the Right-leaning Tax Foundation. To paraphrase Milton Friedman, there is no such thing as a free lunch; there are only tradeoffs.  

What would have the Republicans think that cutting taxes would increase revenue to the point where the revenues from expanded economic activity spurred by the tax cuts would cover 100 percent of the revenue that would have otherwise been gained by the higher tax rate? This argument is based on the Laffer Curve, which postulates that there is an optimal tax rate that maximizes tax revenue. As the Curve shows (see below), there is a point where taxes end up being so high that they disincentivize economic activity, thereby reducing government revenue. In this model, there is a scenario in which cutting taxes can actually increase government revenue. 

Last week, Right-leaning think-tank Manhattan Institute released an issue brief entitled Correcting the Top 10 Tax Myths. The first myth they address is "Tax Cuts Pay for Themselves." They find this myth so problematic that Manhattan Institute labels it "the most common and harmful conservative tax fallacy." Why? Because it is sold as a free lunch that will come at zero cost. 

While well-designed tax cuts can boost savings, investment, and overall economic development, it is a whole different claim to assert that the economic feedback revenues will generate 100 percent of the static revenue loss of the tax cut. With regards to the TCJA individual tax cuts, a Congressional Budget Office (CBO) report released earlier this month concluded that extending the individual income tax cuts would be outweighed by more government debt. The bipartisan Committee for a Responsible Federal Budget (CRFB) confirmed this conclusion in its analysis of the TCJA individual tax extensions that all major analyses of the tax extensions would not pay for themselves. Why is this happening? 

• Yes, near-term demand and incentive to work would increase. However, the increased debt would eventually crowd out and reduce investment, thereby limiting the economic benefits (CRFB). 
• In its report, the Manhattan Institute brings up another valid point about tax rates. The peak on the Laffer Curve for income tax is somewhere between 55 and 73 percent, which is well above current rates. 
• To quote the Manhattan Institute (MI), "For a tax cut to pay for itself, tax revenues would have to match that would have been raised even without the tax cut." Once adjusting for inflation, MI found that 2018-24 revenue came in $665 billion below the levels projected by the CBO before the TCJA. 
• The CBO projected in 2018 that the TCJA would create $2 trillion in debt over 10 years. Per CRFB calculations, actual income and corporate tax revenues since 2017 have remained close to the CBO's projections. 
• While TCJA managed to pay for a modest portion of itself, it is nowhere the 100 percent to say that "TCJA paid for itself."  
• This 2017 report from CRFB entitled Tax Cuts Don't Pay for Themselves provides great insight.
• There would need to $5-6 dollars of economic growth for every dollar in tax cuts to make the tax cut self-financing.
• The Tax Foundation would have the most optimistic assumptions in its forecasting. In 2017, the Tax Foundation estimated in a report covering tax code reform alternatives that a 10-percent across-the-board income tax cut would pay for an eighth of the cost. As for a 10-point cut in the corporate tax, the economic dynamism would pay for three-fifths of its cost. 
• The tax cuts of 1981 and 2001/2003 resulted in lower cyclically-adjusted revenue, which is to say that past major tax cuts in the past half-century have not resulted in increased tax revenue. 

The Cato Institute refutes with two points. One is that when you factor in extending the business tax cuts in addition to the individual income tax cuts, then the GDP growth is larger. Conversely, the CRFB brings up that the business taxes would relatively do more to boost the economy, but not enough for the all the tax cuts in the TCJA to be self-financing. However, a separate CBO analysis shows that extending the 100 percent bonus depreciation and reversal of R&D amortization could offset the drag of the income tax cut extension. This would suggest a point I brought up in 2017, which is that tax reform needs to be more comprehensive than treating tax cuts as if they were the silver bullet that can solve all fiscal woes.  

Second, the Cato Institute brings up that the federal debt is a policy choice. That much I agree with because it is the ballooning spending that is exacerbating the U.S.' debt issues. The problem is that neither the U.S. Congress nor President-Elect Trump have the political will to want to cut government largesse in a way Argentinean President Javier Milei has successfully done in his first year in office. If there were corresponding spending cuts to help offset the tax cuts, I would be the first to advocate for the extensions. 

On its fifth anniversary, I concluded that the TCJA caused more good than harm. But as I said earlier, we have to factor in tradeoffs. Cutting taxes can increase economic growth. As a report from the Federal Reserve Bank of Dallas shows, a one percent cut in income taxes in the TCJA resulted in GDP growth of 1.5 percent and job growth of 1.2 percent (Kumar, 2023). Is the increased federal debt worth the economic growth? Is it worth people being able to keep more of their hard earned money instead of having it go to government coffers? Can we pass other policies to make the fiscal impact less harmful when U.S. debt is climbing, as I mentioned two paragraphs ago? 

I believe in lower taxes, but I also strongly believe that there needs to be significantly lower government spending. With a lack of fiscal discipline in the U.S. federal government, I have to agree with the libertarian Reason Magazine and its conclusion that cutting taxes without reducing spending is bad news for the national debt. Since increasing federal debt has significant spillover effects for the American people, I question whether the U.S. government could adequately offset the fiscal costs of extending the income tax cuts.