Tax Cuts Are Not Revenue Neutral By Assumption – What May Be Missing with Rosen’s Analysis

Greg Mankiw reads Harvey Rosen and emphasizes this:

I analyze the Romney proposal taking into account the additional income that might be generated by economic growth. The main conclusion is that under plausible assumptions, a proposal along the lines suggested by Governor Romney can both be revenue neutral and keep the net tax burden on high-income individuals about the same. That is, an increase in the tax burden on lower and middle income individuals is not required in order to make the overall plan revenue neutral.

Brad DeLong reads the same paper and notes:

If raising the net-of-tax rate for the upper class from 65% to 72%--an increase of 10% in the natural log--raises national income by between 3 and 7 percent, then wouldn't… • Reagan's ERTA raising the net-of-tax rate for the upper class from 30% to 50%--an increase of 51% in the natural log--have raised national income by between 15 and 35%? • Reagan's raising in 1986 of the net-of-tax rate for the upper class from 50% to 72%--an increase of 36% in the natural log--have raised national income by between 11 and 25%? • Clinton's lowering in 1993 of the net-of-tax rate for the upper class from 72% to 60%--a decrease of 18% in the natural log--have lowered national income by between 5 and 12%? • Bush's raising in 2001 of the net-of-tax rate for the upper class from 60% to 65%--an increase of 8% in the natural log--have raised national income by between 2 and 5%? We simply do not see such supply responses in the historical record, do we? To propose that they exist is wholly inconsistent with the fact that American growth 1938-81 was faster than since 1981, right? What am I missing here?

Maybe what is missing is something Harvey wrote that Greg forgot to mention:

Another important issue seems to have gotten short shrift in the debate over the proposal. To assess the effects of moving from tax system X to tax system Y, one needs to know what X and Y are. In this case, X is the status quo, and Y is the Romney proposal. Much of the current controversy has arisen because the Romney proposal is not fully articulated, and therefore analysts can disagree about what kinds of tax preferences would be eliminated.

I submit that Harvey was really modeling something we should call tax system Z – especially if he wants to follow in the tradition of the 2001 AER paper written by David Altig et al. That paper was the kind of supply-side experiment reasonable conservatives such as Bruce Bartlett advocate, which include not only reductions in marginal tax rates but base broadening changes in the tax code so as to effectively pay for revenue losses from the reductions in those marginal tax rates, that is, a fiscal policy change that is deficit neutral even before we worry about any alleged supply-side benefits. The tax system Z clearly differs from the Romney proposal (Y) as Romney has not proposed any offsets either in the form of elimination of tax preferences or spending reductions. In fact, Romney rejects the Medicare savings that used to be discussed by Paul Ryan so as to criticize Barack Obama for wanting to implement Medicare savings. Romney would also spend more on defense that would a President Obama. Greg Mankiw used to get why this mattered:

I used the phrase "charlatans and cranks" in the first edition of my principles textbook to describe some of the economic advisers to Ronald Reagan, who told him that broad-based income tax cuts would have such large supply-side effects that the tax cuts would raise tax revenue. I did not find such a claim credible, based on the available evidence. I never have, and I still don't.

If you read what Mankiw’s first edition said about the initial Reagan tax cuts, you will see a very traditional description of classical crowding-out. The fiscal stimulus from Reagan’s tax cuts sine any substantive reductions in government spending (domestic cuts yes but offset by increases in defense spending) lowered national savings which increased real interest rates and lowered investment demand. So whatever small favorable supply-side benefits we may have received were overwhelmed by crowding-out effects. Is there any reason fiscal policy will be different under Romney? I don’t see it. One might argue that having Greg Mankiw and Glenn Hubbard as economic advisors would change everything but recall they were also advisors to George W. Bush. How did that work out?