Do tax cuts pay for themselves? The evidence from BC

Back in the 2001 BC election, the Liberals repeatedly made the voodoo economics claim that “tax cuts pay for themselves” as a means of heading off concerns that their tax cuts would inevitably lead to spending cuts. The Liberals won in a landslide, implemented a 25% across-the-board personal income tax cut and dramatically cut corporate income taxes – about $2.3 billion worth all totalled. Add in an economic slowdown in 2001 and 2002 and the result was that the provincial surplus of $1.6 billion in 2000/01 became a deficit of $2.6 billion in 2001/02 and $2.7 billion in 2002/03. As the economy recovered the deficit fell to $1.3 billion in 2003/04 then turned into surplus territory where we have remained. The deficits did lead to spending cuts: starting in the 2002 budget, a three-year spending cut package was brought in that hit hardest in the area of social services.

With yesterday’s release of the public accounts, the Liberals are now saying that tax cuts have indeed paid for themselves, as income tax revenues have recouped their pre-tax cut levels. In the Vancouver Sun, it is reported:

Personal income tax revenues in 2006-07 were $6.9 billion — nearly a billion dollars higher than in 2000-01, the NDP’s last budget.

“I think that these numbers are a really strong endorsation of our policies as a government,” said Finance Minister Carole Taylor. “What this … shows very dramatically is that, while tax cuts at first cause your taxation revenue to drop, as it stimulates the economy … your tax revenues start to go up quite dramatically.”

The question is to what extent have the tax cuts really stimulated the economy. How much credit can the Liberals really take? I commented on BC’s unusual expansion here. On the surface, the economy is booming, with the best job market in a generation. But if we peer beneath, there are some troubling findings: real wage growth has stagnated; the share of total income going to labour (in the form of wages, salaries and commissions) has declined substantially; poverty and homelessness are persistent, with poverty rates above the national average; and productivity, the holy grail of economic policy, has failed to grow at all. Clearly, BC is experiencing a strong cyclical upturn in the business cycle, but this is due mainly to a period of low interest rates that have been driving real estate and residential construction, and secondly, due to strong international demand and high commodity prices (in forestry and energy, global forces are providing a good tailwind to the BC economy).

How much have tax cuts been a factor? Hard to say. On the one hand, the timing of deficit-financed tax cuts during a downturn may be viewed as good fiscal policy (although the gains at the top were disproportionate since income tax is progressive). But I’d be skeptical of claims that they have boosted annual economic growth rates; that is, there is no reason to believe they have induced structural change, especially given some of the paradoxes mentioned above.

The Sun article does include a critical quote from SFU tax prof, Jon Kesselman:

“It all gets back to whether those [2001] personal tax cuts can get credit for most of the economic growth we’ve seen,” he said. “It’s quite plausible they get credit for some of it. But probably not most of it.”

In other words, said Kesselman, even though tax revenues are higher now than they were before the 2001 cuts, they’d probably be higher still if the Liberals hadn’t cut taxes. Kesselman said he thinks the Liberals have a stronger case to make that their corporate tax cuts paid off — because businesses often choose to locate in low-tax areas.

Ultimately, we live in a world of growth, which makes for the occasional mischief from pundits. BC’s GDP in 2000 was $131 billion, and in 2007 it will be $189 billion, a (nominal) growth of 44%. Thus, it has taken seven years and an economic pie two-fifths larger for budget revenues to have recovered pre-tax cut levels. This does not look like tax cuts paying for themselves to me.

A final point: with all of the crowing, we ought to see some really substantial differences in economic results. Since 2001, economic growth has averaged 5.4% per year. Over the previous ten years, during which it is claimed that the NDP destroyed the economy and caused widespread cancer, the economy grew an average of 5.2% (these are nominal rates; in real terms the difference is 3.1% and 2.7%, respectively). The difference is arguably due to factors outside the BC government’s control: interest rates; commodity prices; reinvigorated federal transfers; in other words, dumb luck.

2 comments

  • Neil Reynolds’ column appeared in yesterday’s Globe under the headline “Want more tax revenue? Just cut taxes.”

    The latest instalment in the C. D. Howe Institute’s “Tax Competitiveness Program” claims that “a 40 percent difference between Alberta’s effective tax rate on the cost of doing business and that of Ontario, results in roughly 12 percent more firms operating in Alberta.” By this benchmark, a 40 percent tax cut would reduce revenues by 33 percent (i.e. 60% of 112% = 67%).

  • The notion that tax rate cuts will stimulate growth to the point they will pay for themselves (the “Laffer curve” idea) has been thoroughly de-bunked.

    See, for example: Richard Kogan and Aviva Aron-Dine, “Claim That Tax Cuts ‘Pay For Themselves’ Is Too Good To Be True” (Center on Budget and Policy Priorities, July 27, 2006) http://www.cbpp.org/3-8-06tax.htm; Mark Thoma, “Do Tax Cuts Ever Raise Revenues” (Dept of Economics, University of Oregon, Dec 10, 2007) http://economistsview.typepad.com/economistsview/2007/12/do-tax-cuts-eve.html and sources cited therein.

    While some politicians (a shrinking number) still make this claim, professional economists do not, and a 2006 study by the Congressional Budget Office of the United States confirmed that tax cuts do not result in revenue increases. The CBO study estimates a recovery of 1% – 32%, at most. Congressional Budget Office, “Economic and Budget Issue Brief: Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates” (December 1, 2005) http://www.cbo.gov/ftpdocs/69xx/doc6908/12-01-10PercentTaxCut.pdf

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